If you feel like you are always fighting to make a few more bucks at your current law firm, and you wonder whether other firms would value your practice more, we have a few general rules of thumb that help explain why you are likely hitting a plateau.
1) RPL v. PPP. True to the name, Revenue Per Lawyer is determined by dividing firm revenue by the total number of attorneys (both associate and partner level). Profits Per Partner is derived from dividing firm profits by the number of equity partners. A general rule of thumb is that the closer these two metrics are, the less profits equity partners will earn from the firm’s platform; if associates on average are generating a similar amount of revenue as equity partners are receiving in profit distributions, then partners are more or less not realizing profits from increased leverage or profitable bill rates (or a combination of both). Even worse, if PPP is less than RPL, then partners are actually subsidizing the costs of associates. It is not surprising that K&E has RPL of around $1.6mm and PPP of around $5mm while Steptoe has RPL of around $1mm and PPP of around $1mm. In short, K&E partners are very profitable given the platform while Steptoe partners hit a plateau with their profitability.
2) Leverage. Leverage is the ratio of all lawyers minus equity partners, to equity partners. In essence, it describes how the firm structures its practice around its main profit makers. As long as associates are generating more than they are taking after the firm incurs their direct and associated costs, leverage will increase the profit margin for equity partners. One single partner can only bill so much time regardless of premium bill rates. For example, say a partner bills out at $1,000 an hour and collects on 1,800 hours. That is $1.8mm in top line revenue (i.e., revenue before paying for office, admin, marketing, partner compensation, and the like). Without staffing and keeping busy associates as well, partners cannot expect to earn more than 40% on the very high end from his or her time. However, if the partner keeps four associates busy at premium rates, they greatly increase their and the firm’s earning potential. If four associates bill out at $600 per hour for 2,000 hours, the firm generates $5mm topline from keeping an additional four associates busy. Since associates are compensated at around market, a bigger chunk of their RPL flows through to the equity partners, who receive a higher take on profits. Unsurprisingly, there is a positive correlation between profitability and leverage, with diminishing returns.
3) Contingency. Now we are talking potentially big gains. Many law firms just don’t have the appetite for full blown contingent work. Some firms dabble in hybrid contingent work by receiving partial payment from litigation funding that guarantees some lower billable rate and some sort of success fee kicker. We have seen some game changing wins for certain firms from taking on the right contingent matters and hedging the opportunity cost of a loss in time spent on such matters by accepting confirmed, reduced rates from a litigation fund. That said, many firms have committees that approve these kinds of alternative fee structures, and if the firm doesn’t have the appetite to entertain the risk, a partner with a potentially lucrative contingent matter, coupled with litigation funding just may find him or herself boxed out of big gains.
4) Conflicts. The bigger the firm, the more likely the conflicts. Imagine winning a matter or transaction, and you are gearing up to staff the work, just to find out that the conflict committee has decided to decline the opportunity for either business or legal reasons. For every dollar of work conflicted out, you can expect to miss out in at least twenty-five cents. Unfortunately, we have seen some partners conflicted out of millions of dollars in lost revenue that went to another firm because of conflicts. You may want to ask yourself whether the firm’s office in Abu Dhabi is working for you or against you. Conflicts are sometimes crippling and game changing.
5) Profit Margins. Although profit margin is controlled by a number of factors, the most important two are cost controls and bill rates. Some firms are just not managed efficiently. They have empty offices with long term leases, they are effectively funding pension plans, or possibly they are writing off time and not collecting on work. Either way, conservative firm management in controlling cost is a necessary element of running a lean machine. That said, lean cost controls isn’t sufficient for high profit margins. Premium bills rates, coupled with efficient staffing arrangements, are necessary to generate high profit margins unless you are a firm with one or two offices and are expected to work your own hours and keep half of an associate busy. The firms that compete on price as a measure value are limited in their ability to pay their partners, and partners at these firms will finds themselves actually subsidizing their associates, not vice versa.
6) It’s not the firm, it’s your practice. Some practices are just not all that scalable, albeit important service practices that are necessary in a full-service platform (or maybe more appropriate in boutiques). The reasons are mostly tied to bill rates and leverage. Over time we have seen T&E move to the boutiques, tax is mostly limited to servicing deals, and the like.
Your firm may offer the best platform for your practice, but for most, you likely have hit a plateau in compensation. If you have questions on how to increase your compensation or how your business projects with other firms, my colleagues and I are happy to help. p