The Best Law Firm Compensation Plans Use the Rule of Thirds

How do you design compensation plans that are good for your law firm and the new hire? Follow the wise counsel of the rule of thirds.

Compensation plans have become a hot topic as competition increases for good attorneys. Yet here’s the problem: You still need to be profitable.

We have a client in the Pacific Northwest whose team keeps getting approached with offers trying to lure them away. They are loyal and want to stay with her, so they’ve kept her informed about the various offers. We analyzed eight of these offers and found one consistent thing.

Not one of them was going to be profitable to the firm.

Of course, the question you are asking is, “What do you mean by profitable to the firm?”

Understanding Law Firm Compensation Models

Navigating the landscape of law firm compensation models can feel like deciphering a complex roadmap. These models are essential for lawyers to understand their compensation, promotions, and bonuses, but they can be intricate and challenging to navigate. Unlike a one-size-fits-all approach, most law firms develop their own unique compensation models based on specific formulas and metrics tailored to their needs.

Traditionally, law firm compensation models fall into two main categories: formula-based and lockstep. Formula-based models rely on specific metrics such as billable hours, client origination, and revenue generation to determine compensation. This model can be highly motivating for those driven by clear, quantifiable goals. On the other hand, lockstep models reward lawyers based on their tenure and progression within the firm, promoting a sense of stability and predictability.

Understanding these models is crucial for both law firms and their attorneys, as it sets the stage for expectations and career growth. By carefully designing and communicating these compensation models, firms can ensure that their lawyers are motivated and aligned with the firm’s overall objectives.

The Rule of Thirds

We believe that you should run a firm based on the “rule of thirds.”

• One-third goes to the people doing the work (payroll).

• One-third goes to overhead (all the other expenses, including marketing).

• One-third goes to profit.

This means that, at the very least, you need to have billable employees billing and collecting three times their cost of employment. We generally want your billable team to have a multiple between three (3x) and five (5x).

The question I usually get at this point is, “Why do we want 5x if we only need 3x?”

Simple. Your billable people need to pay for your nonbillable people — like your receptionist.

But first, let’s start with analyzing attorneys.

Compensating the Grinders, Minders and Finders

All attorneys go through an evolution in their careers. When they start out as freshly minted first years, they know … basically … nothing. There is an unspoken contract that you will teach them how to practice law and pay them a living wage, and they will churn out billable hours. The Biglaw salary scale significantly influences first year associate salaries at major law firms, with firms closely monitoring trends set by prominent firms such as Cravath, Milbank, and Simpson Thacher.

Since you know it will take them twice as long to do something, their billing rate is half of what yours is. It wouldn’t be fair for the client to pay for their learning curve. In return for the patience you (hopefully) exhibit as you train them, you need to get five times (5x) return on them. They have no other responsibilities within the firm but to bill. We call these baby attorneys Grinders.

As baby attorneys learn and grow, the agreement changes. You discover new talents in them and assign them new tasks, such as supporting client relationships and even training some younger attorneys. Associate salaries, particularly for mid-level associates, have seen significant changes as firms compete to retain talent in major U.S. markets.

We call these attorneys Minders. Minders’ time is split between their traditional billing responsibilities and their new responsibilities, so the amount of time they spend billing goes down. Fortunately, this is offset by their rising billing rate. Unfortunately, since their salary is also rising, their multiple declines to around 4x.

And then there are my favorites — the Finders (also known as Rainmakers). These are usually the firm owners. It is the Finders’ role to go out into the world, club potential clients over the head, drag them back to the firm by the hair, and deposit them in the laps of the Minders. Do they know where the courthouse is? They might need to use Waze. Do they bill? Some. But when they do bill, their rate is higher than a cat’s back, as my friend Suz says. Which is good because so is their salary. When you have a Finder, you want to do everything possible to get that 3x multiple on their comp plan.

Which brings us back to today’s hiring market. Associate compensation, particularly following the Cravath scale, has seen recent increases in salaries and bonuses as firms adjust to attract top legal talent.

Challenges with Traditional Compensation Models

Compensation can be a touchy subject, and traditional models often exacerbate the pressure. Formula-based compensation models, for instance, tend to reward only billable tasks, leaving non-billable but essential activities like mentoring and business development unrecognized. This can lead to a competitive, siloed environment where lawyers burn themselves out trying to hit specific compensation targets, ultimately impacting the success of the entire firm.

Lockstep compensation models, while promoting stability, can also present challenges. They may disproportionately reward lawyers based on tenure rather than performance, potentially leading to dissatisfaction among high-performing but less-tenured attorneys. Additionally, these models often exclude non-attorney staff, making it difficult to retain valuable team members who contribute significantly to the firm’s success.

In the private sector, market bonuses and salary increases are common practices, but law firms can do more to create compensation models that fairly reward all members of the firm. By tying compensation to the firm’s goals, mission, and values, law firms can foster a more collaborative and supportive environment. This approach ensures that every staff member understands how their role impacts the firm’s objectives, leading to improved client relationships and increased firm profitability.

Moreover, law firms can encourage non-partner and non-lawyer staff by providing fair, market-value salaries and bonuses. Recognizing and rewarding staff for delivering a client-centered experience is crucial for retaining lifelong clients and driving business growth. By restructuring traditional compensation models to be more modern and equitable, law firms can create a more harmonious and productive work environment, ultimately benefiting the entire firm.

Designing Attorney Compensation Plans

How do you design an attorney compensation plan that is right for your firm and the potential employee? You know the multiple you need to get to keep the firm profitable: total billed and collected divided by the total cost of employment. The bonus scale is often standardized across the industry, with annual and summer bonuses contingent upon meeting certain billable hour requirements.

But what will motivate your new employee? A consistent market bonus as part of the annual compensation structure can be a significant motivator, aligning with the broader Cravath pay scale that standardizes compensation for associates across competing firms.

There is a saying, “When you have a hammer, everything looks like a nail.”

Law firm owners seem to think the only tool they have when offering a job is salary, and that’s simply not true. How entrepreneurial is this employee? How motivated by money? There are lots of levers you can pull to design a compensation plan for a specific person that is right just for them. Starting salaries in the legal industry are often influenced by the Cravath scale, which sets a benchmark for first-year associates’ pay.

Here are the components you can use in the plan:

• Salary

• Billable hour minimum

• Billable hour goal

• Origination bonus

• Billing bonus

For someone motivated by money, you can offer a low salary and a lower billable hour minimum. Then you can give them a tied system where they get an ever-increasing percentage (up to 33%) of the hours they bill (and collect) — billable hours goals and billing bonus. What’s the downside? They might decide not to work as much for one month because they have that option. They have a low billable minimum. The good news is you have lower payroll.

In a large law firm, competitive compensation structures are crucial. Risk-averse people will be much more attracted to the traditional high salary and a set minimum billable hour goal arrangement.

And there are those people who just love to network and will be motivated by an origination bonus. My brother started at his first law firm with a guy who didn’t know where the courthouse was and could hardly find the office — but, man, could he originate! He made a ton of money for the firm.

What’s the Silver Bullet?

I know you started reading this hoping I would give you the silver bullet to solve your compensation problems. Unfortunately, there isn’t one. And if people tell you there is — and they are happy to sell it to you — RUN. There are options, and there are guidelines, such as the 3x to 5x multiple.

You need to do what is right for you, your firm and your employee.

My parting thought is this: If you compromise and give somebody a compensation plan with a multiple of less than three, you (the owner) pay the price because your overhead won’t change. Your profit is the only place where there is room for change. And it will go down.

Are you willing to pay that lawyer at the expense of your family?

---

More Tips on Creating Law Firm Compensation Models

[Black-Box Compensation vs. Percentage-Based, Variable Associate Compensation Plans](https://www.attorneyatwork.com/the-law-firm-ecosystem-compensation/)

Nothing breaks up law firms more frequently, quickly, or completely than disputes over compensation.

5 Ways Your Law Firm Compensation Plan Is Failing You

A modern compensation system can give you an advantage over firms that cling to outdated practices.

Book Review: Everything You Need to Know About Modern Attorney Compensation Plans

RESPECT: An Insight to Attorney Compensation Plans.

How Are Law Firm Owners Paid? Total Compensation vs. Salary

During the year, most small firm owners can’t tell what they’ve been paid or how much it’s really costing to run the firm. Here’s a solution.

Lawyer Compensation: Taking Your Firm From Good to Great and Enhancing Firm Profitability

A modern compensation plan gives you an advantage over other firms that cling to outdated systems.