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Among the most perplexing problems facing many law firms are what to do with associates who do not meet the standards for equity partnership — and what to do with those existing equity partners who are deemed to be less than fully productive. In an attempt to reduce the angst involved in resolving these problems, some law firms have created a new use for the nonequity partner class, and in doing so have created a new partnership action: “de-equitization.” The question firms need to face is whether the use of nonequity partnerships as a place to park attorneys who do not meet the standards for equity partnership is a politically easy but ineffective solution to a difficult problem. Nonequity partnerships have become increasingly popular with law firms as an alternative partnership tier, both for the promotion of associates and as a form of “limbo” for lateral-entry attorneys. For associates, the jump from being an employee to becoming an owner represents much more than a change in title. In most firms, the measure of associates’ success — indeed, the basis for promotion to partner — is heavily weighted on their performance as working attorneys. Associate compensation is largely based on the marketplace: There is rarely much difference in compensation among similarly sized firms within a city. But when an associate is promoted to partner, compensation has nothing to do with the marketplace; instead, it’s dependent on how profitable the firm is (the size of the pie) and how each partner compares with the others (the size of each partner’s slice of the pie). “Two-tier firms,” those that have an intervening nonequity step for new partners, are able to take some of the economic pressure off associates for a period of time as they adjust to their business development and client management responsibilities. In some firms, nonequity status may also help associates move from the certainty of a monthly paycheck to the inconsistency of being paid out of profits. For lateral-entry attorneys, nonequity partnership allows firms to substantiate portable billings, work ethic, and cultural compatibility before vesting them with the tenure that generally comes with equity partnership. Often, it also allows the firm to structure a compensation deal that protects the firm from overpaying the lateral attorney in the event that he or she is less successful than anticipated. WHAT DOES IT MEAN? The role of the nonequity partner varies tremendously among firms. In some firms, there is little difference between equity and nonequity partners: The nonequity partner enjoys all of the privileges of partnership, including the right to attend partnership meetings, receive financial reports, vote in partnership affairs, and in all ways hold him- or herself out as a partner. In other firms, nonequity partners are viewed as advanced-level associates with few, if any, trappings of partnership. Until now, few firms have spent time fretting about documenting what it means to be a nonequity partner because it was only meant to be a transitionary classification. But new uses of the nonequity status may significantly change the structure of law firms. Traditionally, associates have joined firms with the hope that, after some unspecified number of years, they will be able to reach for the brass ring and, perhaps, be elected to partnership. Usually, few specifics are given to the associates about the standards on which partnership decisions are made, how much capital contribution is required of a new partner, or even how much money they will earn as a partner. Associates who are not elected have been expected to fall on their swords and seek their fortunes elsewhere, under the policy of “up or out.” TOO PROFITABLE TO LOSE Some firms are finding, however, that the new realities of associate profitability and ambitions are rendering this model antiquated. Firms that take the time to do the math are finding that their most profitable fee-earners are senior associates and young partners. At their level of sophistication, lawyers with eight to 10 or so years of experience command high hourly rates, rack up a large number of hours, and earn (comparatively) low compensation. The last thing a successful firm wants to do is lose its most profitable timekeepers to an up-or-out policy. At the same time, some law firms are experiencing a new phenomenon — associates turning down offers of equity partnership. Having become comfortable in their practices, some associates look to the prospect of becoming a partner and, instead of a brass ring, see only the pressure to generate new business for the firm and sign on for a big capital account loan just when they’ve paid off their law school bills. That’s in addition to paying their own employee benefit costs and a larger Social Security contribution, and waiting for large chunks of their compensation until year’s end. Although there is a strong desire to present themselves to the world (not to mention their mothers and spouses) as partners in the firm, the relative security of associateship has a certain appeal to it. For both the firm and the associate, therefore, nonequity partnership may be an attractive alternative to the traditional equity partner status. PROFITS PER PARTNER At the other end of the spectrum is the problem that law firms have with equity partners who either never raised themselves to the level of partnership expectations or who have partially retired without telling anyone. This was not a problem until about 20 years ago because firms were “big tents” that could accommodate a wide variety of work levels through compensation systems that reflected differing levels of effort and financial performance. In the early 1980s, however, The American Lawyer magazine popularized a new statistic as the measure of law firm economic success — profits per equity partner. With the public availability of law firms’ comparative financial information, profits per partner developed into a competitive issue. Lateral prospects used PPP as a means of differentiating among firms; it became the first cut for judging the suitability of law firms as merger partners. Even within law firms, average PPP statistics became as important to individual partners as their own actual compensation in evaluating their firm’s performance. It didn’t take long for firms to realize that the denominator in this calculation (the number of partners) is as important as the level of profits themselves. Indeed, by adjusting the partnership ranks and converting equity partners to some other status, a firm could see a double-digit increase in its average profits without bringing in one more dime in revenue or cutting a single expense. TAKING THE EASY WAY OUT The biggest problem with the use of nonequity partnerships is that it makes decisions too easy. Advising a likable associate that she has been elected to nonequity partnership is certainly a less onerous task than telling her she has been rejected for equity partnership and must either remain an associate or leave the firm. Unfortunately, some firms are finding that what is relatively painless in the short term can have devastating long-term ramifications. Associates promoted to nonequity status — to keep them on board without letting them share in the profits — may be strung along by the hope of full equity partnership, when in actuality they have already been deemed to be lacking in the qualities for equity partnership. Caught in this amorphous system, they may even be reconsidered for equity partnership year after year — particularly if they have a protector within the partnership. Some candidates, due to sheer longevity of their appearance on consideration reports, might actually be elected to equity partnership in a year when the recommending committee is feeling particularly soft-hearted. As firms now attempt to deal with unproductive partners, they often realize that it is just such “lapses” in their partnership admission process that caused the problem in the first place. DEMOTION DOESN’T WORK By the same token, using de-equitization to deal with underproductive partners is certainly easier than firing the person. But from a practical point of view, this step rarely resolves the underlying issues for either the firm or the newly demoted partner. In fact, the more likely outcome is that, rather than sending a “wake-up call” to the partner, his or her reaction will be a declining sense of urgency. This often shows up in a lack of responsiveness and a deteriorating client-service ethic. It doesn’t take long for this decline to be recognized by the partners assigning work and — given the alternative of using senior associates with a comparable skill level and a more responsive attitude — the demoted partner’s hours soon dry up. All of these factors combine to sabotage hopes of returning to being a fully productive member of the firm, or ever regaining full-equity status. Worse, because nonequity partners fall between senior associates and equity partners in their level of practice sophistication, if a nonequity partner attracts work that would be valued by up-and-coming senior associates, an important associate development opportunity is missed. Good associates are able to see handwriting on the wall very quickly and, rather than risk being passed over for partnership themselves, will seek better learning opportunities at competing firms. Perhaps most important, rarely do law firms want to be judged on the basis of people they reject for, or remove from, equity partnership. But the outside world — and, often, even associates and employees within the firm — cannot distinguish between equity partners and nonequity partners. If the individual doesn’t meet the firm’s standards for equity partnership, then including him or her as a partner devalues the designation for those who do meet the standard. NO SILVER BULLETS Not surprisingly, there is no easy way to deal with difficult personnel decisions. There may be legitimate situations where time spent as a nonequity partner may help an associate mature into a successful partner. There may also be situations where being reclassified from equity to nonequity partner status does provide a “wake-up call” for a partner that compensation adjustments alone could not. But the truth is that those exceptions are few and far between. Being reclassified to nonequity partner status will likely only exacerbate whatever deficiencies were previously evident in the demoted attorney’s work. Increasingly, law firms are utilizing nonequity partnership status to avoid the tough decisions; some have amended their partnership agreements to make it procedurally easier to create nonequity partners. This is akin to removing the salary caps for sports team owners — it facilitates bad decisions. If nonequity partnerships offer management an easy course of action, then there must be a supervising authority who can throw up a red flag occasionally. Requiring a partnership vote for promoting or demoting current attorneys to nonequity partnership may make the process a little less convenient, but years from now when someone asks, “How did this guy become a partner?” or “Why is this person still a partner?” the answer will not be: Because the firm took the easy way out. H. Edward Wesemann is a partner with the legal consulting firm Edge International. His practice is limited to strategic growth issues. He can be reached at (877) 922-2040 or [email protected].

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