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Managing Up

The Law Firm Ecosystem: Compensation

By Erik Mazzone

Your law firm is a complex ecosystem made up of technology solutions, business development strategies, billing practices and, of course, systems for compensating the people who work there. In part two of his series on reimagining your firm’s ecosystem, Erik Mazzone looks at status quo black-box” compensation vs. percentage-based, variable compensation plans.

variable compensation plans

Nothing breaks up law firms more frequently, quickly or completely than disputes over compensation. We don’t like to talk about it — it’s crass to discuss money and we’re members of a learned profession, as law schools liked to drill into our heads from the first day.

But if you’ve practiced law for a while, you doubtless know many lawyers who have changed firms. Maybe you’re one of those folks yourself. Better culture, better fit, better work-life balance … these are the reasons we give each other for making a change. But all those usually translate into one of two things: compensation or being cut out of the decision-making (managerial) process.

Today, we’re going to focus on compensation and its role in making your firm ecosystem a place that is a bit easier to recruit and retain talent.

This is part two in the Law Firm Ecosystem series. If you haven’t read the first installment (on having a location-neutral practice), you can check that out here. Specifically, we’re going to discuss compensation for associate attorneys, or whatever you call non-owner attorneys in your firm.

The Lawyer Comp Status Quo

Like the venerable billable hour, there is a standard, default approach to associate compensation. Although each firm likes to put its own stamp on it, the rudiments are:

  • A base salary
  • A clearly (or not so clearly) articulated set of expectations for productivity in exchange for that salary, usually expressed in terms of hours billed or collected
  • Some kind of bonus structure for production beyond the base expectation, usually expressed in terms of a percentage of fees collected or just nebulously sketched out as “bonus potential”

We’ll call this the “black box” approach because the calculations and mechanics around attorney compensation are not visible to anyone outside of the management structure, and most critically, not to the associate attorney.

Flat-Fee, “Black-Box” Compensation Plans

This standard compensation approach makes some things clear:

  • There is no incentive to generate work.
  • While the compensation is presented as a flat salary, there is in fact a calculable percentage (total collections divided by total compensation) that is the basis for the compensation.
  • The opaqueness of the compensation plan reduces control on the part of the associate to determine their compensation in any but the vaguest way.

The upside of this kind of compensation plan is that a flat salary feels “normal” to attorneys and is appealing to our generally risk-averse nature. It feels stable, solid and dependable and works fine if the attorney’s sense of the value of their work produced is adequately met by the compensation. But once an attorney starts to feel their salary increases are not matching their production, origination and other contributions to the firm, they start to get very curious about that black box. They want to know how compensation is calculated and who else in the firm is making how much in exchange for what.

That curiosity — pulling on that thread about how compensation is determined — is the road that most dependably leads to attorneys leaving firms and partnerships breaking up.

There’s a better way to handle compensation, though; one that makes it easier to manage and retain the team that you’ve worked so hard to put together. It is a clearly articulated, percentage-based approach, uniformly applied across the attorney team. It depends heavily on the twin forces of transparency (in how the compensation is determined) and variability (of the compensation to match performance). And when you get it right, it feels fair to the associate attorney, gives them an increased sense of control over their earnings, and doesn’t shackle the firm to salaries that aren’t justified by the work performed.

(Not Terribly) Radical Transparency

You don’t have to throw open all your firm’s books to increase transparency. A little bit goes a long way to increasing trust, understanding and a sense of control on the part of your team.

I know this is scary to contemplate. Keeping compensation secret in law firms is so common it may as well be a Rule of Professional Conduct. But in most small and medium firms, it does not lead to longer tenures, happier lawyers or more functional cultures. “You’re only as sick as your secrets” is a shrink’s bromide for a reason, and nowhere do law firms have more secrecy than around compensation.

The simplest way to approach transparency in compensation in a small firm is to think about every dollar collected by the firm being broken into three segments (we’re going to leave owner profit out of it at this time to keep the calculations cleaner and simpler):

  • Production — doing the legal work
  • Origination — generating the legal work
  • Overhead — insurance, rent, technology, administrative salaries and so on (basically, everything else)

Percentage-Based, Variable Compensation Plans

You can think of these segments as percentages, and those percentages reflect the relative value of those segments. Different firms will place a higher or lower value on production and origination. Figuring out the percentages for your firm will take some trial and error, so I’d suggest starting by looking at your accounting data for the past two years and grouping it into those four segments and determining what your current percentages are. Don’t be put off if your current profit percentage is 0% or if you’re compensating your team above a sustainable percentage. These are all levers that can be pulled and operated in the months ahead to get your compensation humming along.

This is by no means the only way to approach this, but in the interest of giving you a frame of reference, here is a baseline set of figures to start from and adjust to your situation:

  • Production 35%
  • Origination 15%
  • Overhead 50%

Again, for a more sustainable, long-term approach, we would want to claw out a percentage of profit for the firm’s owners, but for the sake of this article, we will keep the discussion to these basic building blocks.

Back to Transparency

It’s not necessary to discuss every part of your firm’s budget with your attorneys, but sharing the percentage of compensation awarded for production and origination will give them a clear understanding of how their compensation is awarded and the path forward to earn more.

Performance reviews and other management tools having had the compensation structure denuded and clarified, can now focus on helping the attorney progress professionally and do their best work. (More on that in an upcoming installment in this series.) Since their compensation will be the unsurprising and clear result of several key data points, you have a straight line of sight on how to coach them toward increased earning: produce more revenue or generate new revenue for the firm (as fits your firm’s values).

The other piece of your compensation strategy — and it’s baked into the percentages you assign — is that it is variable.

All Compensation Is Variable

Anyone who has run a small business with at least one employee will know in their bones the deep frustration that comes with paying an underperforming employee a flat salary while your take-home pay as the business owner is variable by the month. It’s hands down one of the worst parts about owning and running a business.

As we touched on earlier, though, paying flat (non-variable) salaries is appealing to a lot of attorneys (as risk aversion is pretty breed standard for us) and remains the default option for a lot of firm compensation plans. It’s understandable; a high base salary makes an employee feel comfortable that they will at least receive that compensation while any bonus potential is speculative and not to be counted on.

The thing is, as all business owners also know, all compensation is variable. It’s just that with an underperforming employee failing to meet expectations and being paid a flat salary, the variability is they get fired. It’s binary, with little room for nuance. If you’ve ever engaged in a doomed but irresistible attempt to lower the salary of an underperforming employee, well, IFKYK.

The variable compensation of a percentage-based approach allows your attorney’s compensation to float up and down with their performance and aligns their incentives neatly with the firm’s. If they have a problem at home or lose focus and have six bad months, you are not stuck paying their full salary and you won’t feel compelled to fire an employee who has been otherwise satisfactory. Their compensation will rise and fall with their performance and allows you to coach them toward better days ahead without saddling the firm with a salary that isn’t being earned.

Restructuring Compensation Is Worth the Investment

Ultimately, moving to a percentage-based, variable compensation plan that is clearly articulated to your staff can be a great strategy for increasing retention and reducing management burden. You won’t burn energy and leadership capital defending a black-box strategy, spend your performance reviews debating the fairness of compensation, or get stuck carrying the salary of an employee who isn’t pulling their weight.

It takes a while to implement a new compensation plan and to get the percentages right for your firm, but it’s worth the investment.

More on Lawyer Compensation

“Everything You Need to Know About Modern Compensation”

“Five Ways Your Law Firm Compensation Plan Is Failing You”

“The Best Compensation Plans Use the Rule of Thirds”

“Building a Law Firm That Pays You First”

Recent “Managing Up” Articles

“Law Firm Ecosystem: Location Neutrality”

What Got You Here Won’t Get You There: Tools for Law Firm Growth

Image © iStockPhoto.com.

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Erik Mazzone Erik Mazzone

Erik Mazzone is a law practice management advisor, writer, speaker and adjunct law professor. As a consultant, he works with individuals and organizations to help them use technology and strategic business practices to reign in chaos, build systems, and grow their practices in smart, sustainable ways. Previously, Erik served as Senior Director of the North Carolina Bar Association Membership Experience and Director of the NCBA Center for Practice Management. He writes and speaks widely on legal technology and practice management, in North Carolina and throughout the country. Follow him on Twitter @ErikMazzone and on LinkedIn.

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