Creighton Condon.
Creighton Condon. (Courtesy photo)

As it struggles to maintain its standing among New York’s elite firms, Shearman & Sterling is trying a new tactic: expanding its nonequity partner ranks. The move will likely increase the firm’s profitability, at least in the short term. But it also carries risks.

Shearman announced last month that it is creating an expanded nonequity partner role for junior partners. The firm has also confirmed that it will be de-equitizing some partners.

With these changes, Shearman is increasingly breaking ranks with most of its Wall Street brethren, where nearly all partners are equity partners. Many firms outside New York have a two-tier partnership structure. But even among those, few have a mandatory nonequity track for junior partners. Kirkland & Ellis is the most visible example of a firm that has used this structure for decades, with great success.

According to people familiar with such a system, making it work requires a high degree of discipline. “The danger for any firm establishing a new class of nonequity partner is it becomes a dumping ground for people who are not living up to expectations,” said consultant Kent Zimmermann of the Zeughauser Group.

“If you have a nonequity tier, you want people who are moving up or people coming down for a limited time before they retire or transition out. Or perhaps you have people with special circumstances for a limited duration or who have a special skill,” Zimmermann said. “If someone is not in those categories, it’s better not to have them [in the firm].”

Shearman said in a statement that newly promoted partners had always started in a nonequity role, but that “the program has been expanded to allow more lawyers to become partners at the nonequity level.” When asked if associates will now be eligible to become nonequity partners at an earlier stage, the firm said that “consideration for nonequity status will depend on the development of the individual associate,” and that there is no set period of time before someone can be elevated from nonequity to equity status.

“The new role will allow junior partners to grow into equity partnership and facilitate the continued growth of our practices globally,” Shearman said. “We believe this change will provide significant benefits for the firm.”

Last year, Shearman, which ranked 36th in profits per partner on the Am Law 100, reported having 26 nonequity partners. Of the 10 most profitable New York-based firms, only Cahill Gordon & Reindel has a small nonequity tier, with 62 equity partners and 10 nonequity. (Cahill did not respond to questions about its partnership structure.)

Zimmermann offered one reason why New York’s top firms have shied away from adopting nonequity tiers. “Wall Street firms are able to get the cream-of-the-crop associates more easily,” he said. “[Those associates] are willing to stick around longer for the brass rings. The money and prestige keeps them around. … They do work that nonequity partners might do at other firms.”

Shearman management, led by senior partner Creighton Condon and global managing partner David Beveridge, has been under pressure to stem weakening profits and prominent partner departures. Last year the firm’s profits per partner dropped nearly 4 percent, to $1.835 million, which is well below all the other major New York-based firms. Compensation for all partners, including nonequity, was $1.675 million.

Up or Out?

Shearman announced the changes to its partnership structure last month in a firmwide email, obtained by Above the Law, titled “Accelerating Our Strategy.” The firm stated that management had decided to “create a new non-equity partner role” that would “allow junior partners to grow into equity partnership.”

It’s not clear how many other firms in the Am Law 200 besides Kirkland require lawyers to pass through a nonequity tier before they can make equity partner. One that does is Goodwin Procter, which declined to discuss its system. Firms that have nonequity partners, but don’t follow this model include Latham & Watkins; Gibson, Dunn & Crutcher; and Weil, Gotshal & Manges.

At Kirkland, associates can become a nonshare partner, as they’re called, after six years of practice. (Earlier this month, Kirkland announced a new class of 81 nonshare partners.) Four years after becoming a nonshare partner they’re considered for equity status. Typically, 20 percent of those who become nonshare partners make the cut, according to two former partners. With a few exceptions, it’s up or out.

Kirkland declined to discuss this structure, but several former partners said it works well for the firm and its young lawyers. One said it gives lawyers a better platform to develop business at an early age, while allowing the firm more time to evaluate talent. “It’s very helpful for generating business to have earned that title [of partner],” he said. “You have the next three to four years to prove your business case.”

A second former partner pointed out that lawyers with the title of partner can usually land better in-house jobs if they decide to move on, which helps the lawyer and the firm. “You can come into companies at more senior level, and be in a better position to feed work back to the firm,” he said.

Kirkland’s nonshare partners make a small fraction of the compensation that goes to equity partners. Based on American Lawyer reporting, these partners make less than $500,000 on average, compared to the $3.6 million average profits per equity partner reflected in Am Law 100 figures for 2015.

“The firm makes a ton of money on [the nonshare partners], and they work a ton of hours,” said former Kirkland equity partner Paul Cappuccio, the executive vice president and general counsel of Time Warner Inc., in a 2013 American Lawyer article. “It is the engine [of the firm]. It is genius.”

While the model works well for Kirkland, New York’s top-tier firms haven’t embraced it. “The idea of a Cravath or a Sullivan & Cromwell sullying their partnership with nonequity ranks, well, I don’t think it’s something they would consider,” said one former Kirkland partner.

A partner at one major New York firm said his firm considered creating a nonequity tier, but decided against it. “If it’s up or out, and if you have to leave after three years, that creates instability with lots of [nonequity] partners leaving,” he said. This partner also recalled that the firm made a list of all the firms that still had a one-tier structure, and was concerned about losing status if it fell off this list.

Consultant Joel Henning said he doesn’t see many Wall Street firms following Shearman’s move. “Given the nature of their client base and their brand, they can continue to attract top quality associates. So they can maintain a one-tier system,” he said

For others with two-tier systems, Henning offered some advice. Many firms, he said, are not “rigorous enough” about who ascends to the top. “You have to be ruthless about who makes equity partner,” he said.

Contact Susan Beck at SBeck@alm.com. On Twitter: @susanmbeck.

As it struggles to maintain its standing among New York ‘s elite firms, Shearman & Sterling is trying a new tactic: expanding its nonequity partner ranks. The move will likely increase the firm’s profitability, at least in the short term. But it also carries risks.

Shearman announced last month that it is creating an expanded nonequity partner role for junior partners. The firm has also confirmed that it will be de-equitizing some partners.

With these changes, Shearman is increasingly breaking ranks with most of its Wall Street brethren, where nearly all partners are equity partners. Many firms outside New York have a two-tier partnership structure. But even among those, few have a mandatory nonequity track for junior partners. Kirkland & Ellis is the most visible example of a firm that has used this structure for decades, with great success.

According to people familiar with such a system, making it work requires a high degree of discipline. “The danger for any firm establishing a new class of nonequity partner is it becomes a dumping ground for people who are not living up to expectations,” said consultant Kent Zimmermann of the Zeughauser Group.

“If you have a nonequity tier, you want people who are moving up or people coming down for a limited time before they retire or transition out. Or perhaps you have people with special circumstances for a limited duration or who have a special skill,” Zimmermann said. “If someone is not in those categories, it’s better not to have them [in the firm].”

Shearman said in a statement that newly promoted partners had always started in a nonequity role, but that “the program has been expanded to allow more lawyers to become partners at the nonequity level.” When asked if associates will now be eligible to become nonequity partners at an earlier stage, the firm said that “consideration for nonequity status will depend on the development of the individual associate,” and that there is no set period of time before someone can be elevated from nonequity to equity status.

“The new role will allow junior partners to grow into equity partnership and facilitate the continued growth of our practices globally,” Shearman said. “We believe this change will provide significant benefits for the firm.”

Last year, Shearman, which ranked 36th in profits per partner on the Am Law 100 , reported having 26 nonequity partners. Of the 10 most profitable New York-based firms, only Cahill Gordon & Reindel has a small nonequity tier, with 62 equity partners and 10 nonequity. (Cahill did not respond to questions about its partnership structure.)

Zimmermann offered one reason why New York ‘s top firms have shied away from adopting nonequity tiers. “Wall Street firms are able to get the cream-of-the-crop associates more easily,” he said. “[Those associates] are willing to stick around longer for the brass rings. The money and prestige keeps them around. … They do work that nonequity partners might do at other firms.”

Shearman management, led by senior partner Creighton Condon and global managing partner David Beveridge, has been under pressure to stem weakening profits and prominent partner departures. Last year the firm’s profits per partner dropped nearly 4 percent, to $1.835 million, which is well below all the other major New York-based firms. Compensation for all partners, including nonequity, was $1.675 million.

Up or Out?

Shearman announced the changes to its partnership structure last month in a firmwide email, obtained by Above the Law, titled “Accelerating Our Strategy.” The firm stated that management had decided to “create a new non-equity partner role” that would “allow junior partners to grow into equity partnership.”

It’s not clear how many other firms in the Am Law 200 besides Kirkland require lawyers to pass through a nonequity tier before they can make equity partner. One that does is Goodwin Procter , which declined to discuss its system. Firms that have nonequity partners, but don’t follow this model include Latham & Watkins ; Gibson, Dunn & Crutcher ; and Weil, Gotshal & Manges .

At Kirkland, associates can become a nonshare partner, as they’re called, after six years of practice. (Earlier this month, Kirkland announced a new class of 81 nonshare partners.) Four years after becoming a nonshare partner they’re considered for equity status. Typically, 20 percent of those who become nonshare partners make the cut, according to two former partners. With a few exceptions, it’s up or out.

Kirkland declined to discuss this structure, but several former partners said it works well for the firm and its young lawyers. One said it gives lawyers a better platform to develop business at an early age, while allowing the firm more time to evaluate talent. “It’s very helpful for generating business to have earned that title [of partner],” he said. “You have the next three to four years to prove your business case.”

A second former partner pointed out that lawyers with the title of partner can usually land better in-house jobs if they decide to move on, which helps the lawyer and the firm. “You can come into companies at more senior level, and be in a better position to feed work back to the firm,” he said.

Kirkland’s nonshare partners make a small fraction of the compensation that goes to equity partners. Based on American Lawyer reporting, these partners make less than $500,000 on average, compared to the $3.6 million average profits per equity partner reflected in Am Law 100 figures for 2015.

“The firm makes a ton of money on [the nonshare partners], and they work a ton of hours,” said former Kirkland equity partner Paul Cappuccio, the executive vice president and general counsel of Time Warner Inc. , in a 2013 American Lawyer article. “It is the engine [of the firm]. It is genius.”

While the model works well for Kirkland, New York ‘s top-tier firms haven’t embraced it. “The idea of a Cravath or a Sullivan & Cromwell sullying their partnership with nonequity ranks, well, I don’t think it’s something they would consider,” said one former Kirkland partner.

A partner at one major New York firm said his firm considered creating a nonequity tier, but decided against it. “If it’s up or out, and if you have to leave after three years, that creates instability with lots of [nonequity] partners leaving,” he said. This partner also recalled that the firm made a list of all the firms that still had a one-tier structure, and was concerned about losing status if it fell off this list.

Consultant Joel Henning said he doesn’t see many Wall Street firms following Shearman’s move. “Given the nature of their client base and their brand, they can continue to attract top quality associates. So they can maintain a one-tier system,” he said

For others with two-tier systems, Henning offered some advice. Many firms, he said, are not “rigorous enough” about who ascends to the top. “You have to be ruthless about who makes equity partner,” he said.

Contact Susan Beck at SBeck@alm.com. On Twitter: @susanmbeck.