Owner or Employee? Financial Literacy and Openness Build a Partner's Perspective

10/01/2005

October 2005

Still an Achievement?

Historically, law firm partnerships have not been subject to discrimination laws because partners, as the co-owners of an enterprise, were considered employers, and therefore not covered by age discrimination law. The EEOC alleges that the "retired"/"fired" lawyers were partners in name only because they had no voice in the firm's management — including hiring, firing and salary decisions. Consequently, the lawyers were "employees" entitled to the protections of the Age Discrimination in Employment Act.

Today, ascension to the partnership is still an event, but partnership itself may be less of an achievement. Despite being called partnerships (or LLPs or PCs), the governance of large law firms has fallen to a very few in the organization ("the management committee"). The remaining "partners" have begun to look, act and think like employees, not owners. Certainly there’s not much groundswell for change: a recent article indicated that 93 percent of big firm lawyers wouldn’t go solo, even if they were guaranteed the capital to start a practice. But the trend may have real financial consequences for every large firm, over and above the threat of a lawsuit.

What’s Your Financial IQ? Those consequences begin with availability of and openness about financial information. As law firms become more corporate, dissemination of key financial benchmarks within the partnership, and the firm’s lawyers generally, tends to become more restricted. Consider this list of key metrics, then ask yourself how many of them you know for your firm:

  • Gross revenues
  • Net revenues
  • Revenue per partner
  • Revenue per lawyer
  • Profits per partner
  • Number of new clients per year
  • Total number of matters now active
  • New matters per year
  • Client retention and loss rates
  • Total billable hours
  • Cost of a billable hour
  • Billed hours
  • Realization rates

If your firm is on the "AmLaw 100," you may see round numbers for the first five figures in print. Otherwise, I wonder how many "partners" in large firms have access to all the data. More to the point, how many partners, even if they had access, would possess the business literacy to calculate, or even understand, the traditional key measures of law firm performance: realization, utilization, leverage and expenses? How many know, or understand, the firm’s collection rate – or their own personal one?

And if partners are in such a position, why expect different from the firm’s associates – potential partners of the future? Laments about the lack of associate loyalty are less frequent these days than at the height of the dotcom boom, but turnover is still much higher than a decade ago. I suspect that much of that is due to a lack of information and understanding of a firm’s financials, and how they apply to each lawyer.

Can You Calculate Your Worth?

When I was practicing as an associate, I had a conversation with the managing partner. I showed him what percentage my billings were of the firm, what my expense to the firm was and what my "profit" to the firm was (though I had no clue about the realization rate of my billings by the firm). After getting over the shock that I would attempt to have that information, he asked me why I kept that it. I told him that I enjoyed my job, wanted to keep it and knew that the firm could/would not keep me if I were not profitable for them. I didn't need to be profitable every month, but I needed to be profitable for the year. Shortly after that discussion I was invited to become a partner.

Ideally, the information should be available for associates to educate themselves in the business of law, determining their own P&L in order to determine and enhance their worth to the firm. The information to do that would include:

Their billable hours, for the latest month and year to date How many hours the firm billed out for them, versus a markdown or write-off for some of the work (individually or as an average percentage applied to all associates) Direct expenses for compensation (including bonus and benefits), clerical help, technology, office space, etc. Indirect expenses, or overhead (the percentage of rent, insurance, utilities, entertainment and education that each associate accounts for). The result should determine an individual net profit value to the firm: Billings - [Associate's Total Compensation + Direct and Indirect Expenses] = Net Profit.

What Does It Cost?

Few associates at large firms have access to the numbers for this calculation; fewer still would be interested or be able to do it. If these lawyers become "partners" they lack a sense of either management or financial ownership. The result, I believe, creates behaviors that have become the norm and that have huge financial consequences lawyers simply don’t understand. Take the following three examples.

E-mails involve costs that are not readily apparent. For example, based on my own experience, I would guess that most lawyers take about one to two hours each workday to "clear out" their e-mail boxes apart from getting to client matters. If we assume 200 workdays per year (there are more), and two hours per day and $200 per hour billable value for an attorney (most are charging more today), the calculation is $80,000 of wasted billable time annually. This huge expense doesn’t include the lost billings from quick e-mail answers that never show on a time sheet.

Telecommuting is attractive to many lawyers, but they cannot answer the economic question for the firm: what happens to office space that no longer will be used for at least 20 percent of the time? Is there someone else that can use the office on the lawyer’s day "off?" The firm still "eats" this cost and now incurs a larger cost of off-site operations, as well as the loss of direct input from being able to just pop in and ask the telecommuting lawyer a question.

Attorney turnover is viewed as a negative at most firms, but few of them calculate the cost of a lawyer who walks out the door. Consider a departing associate who makes $160,000 a year. That person likely was the product of a $135,000 investment: $25,000 in partner recruiting time (50 hours at a billable rate of $500/hour), $40,000 in search consultant charges (25 percent of annual salary) and $70,000 in training (100 hours of associate time at $200/hour, plus an equal amount of time for the $500/hour partners who gave the training). That $135,000 is lost every time a lawyer leaves the firm, and doesn’t include lost productivity and a host of other items. Managing partners have told me that the average loss to the firm each time an associate lawyer leaves is between $200,000 and $400,000! These are numbers that go directly to the "bottom line!"

More Than "The Numbers"?

All lawyers, including associates, need to be more sensitive today to the financial needs and operation of the firm. The necessary conditions for this to happen are increased openness with financial information, and better training in using it. When I've seen the "numbers presentation" at too many firm meetings, it generally is abstract and pro forma. If the presentation is at the personal level, and the means for understanding is there, the chances are better that the lawyers hearing it will understand why they need to be concerned about the firm's financial health and their part in the process. Whether they are owners and employers in name, they can become so in behavior – and the firm definitely benefits.

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