Due Diligence

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What is your compensation philosophy?  (Continued)

 

We’re all familiar with eat-what-you-kill versus a merit-based scheme versus a lockstep partnership system. While one is not innately superior to another, a firm chooses its compensation philosophy for a reason. It speaks volumes about its culture and its business. Obviously, some will be more interesting to you than others. Secondly, ask who determines the compensation and whether partners are compensated on an open or closed basis. Third, ask whether behaviors that are important to you (e.g., referring work and cross-selling) are rewarded in the firm’s compensation structure.

How many tiers is your partnership? The trend today (overwhelmingly) is a two-tiered partnership. What it means to be a partner has changed dramatically over the past 10 to 15 years, and becoming an equity partner has, in some ways, become more difficult. A two-tiered partnership may offer a firm more freedom to promote its lawyers without having to split up the profits. It usually also raises the barrier to entry for the equity level. Ask about why the firm chooses to have the partnership structure it has. You should also ask whether the firm has de-equitized partners in the past, and under what circumstances.

How is my compensation affected in a down year for my business? Again, there aren’t any right or wrong answers to this question, but if your business is one that runs with the ups and downs of the economy, it is important to try to anticipate how a more modest year of collections will be viewed by a new firm.

What business lines are you focusing on in the next 5-10 years? The uncertainty in today’s economy underscores this question — which is often forgotten when law firms are thriving. Is the firm thinking ahead of the market to anticipate what practice areas will be most in demand down the road? As a corollary, how dependent is the firm on any one particular practice area? If the market for a particular legal service wanes, what are the other practices that will pick up the slack?

How much debt does the firm have? Both capital investment and ongoing debt obligations of the partnership are paramount issues in joining a firm as an equity partner. A firm should be forthcoming about its debt and use of lines of credit. In my opinion, profits per partner figures on which we’ve relied so heavily in the past will not be as reliable as indices of future success as a more critical analysis of how the firm manages its business on behalf of capital partners.

Is there a mandatory retirement age? Like partnership tiers, the mandatory retirement age issue has been one in transition at many firms. However, this is a defining question I’ve seen be a pivotal issue in terms of suitability.

I encourage firms to resist the short-hand temptation to try to simply say ''we’re better than the rest.'' I prefer a law firm that can identify those lateral partner candidates in the market to whom its particular business model is attractive, and sell the firm on that basis. As important as it is to acknowledge what types of attorneys succeed at the firm, it is as important to acknowledge what types of attorneys don’t succeed.

Lastly, profitability is paramount, but the structure that supports that profitability is what makes a law firm a good home for its particular partners. When a lateral partner in the market can make those distinctions on his or her own, the decision-making becomes far clearer.
 

Interviewing a law firm - distinctions that make a difference:

Due Diligence for Lateral Partner Candidates

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Of course, neither the firm nor the partner can ascertain with 100% certainty that a lateral relationship will work. However, appropriate due diligence can minimize the risk of failure, as important facts are revealed and future expectations can be managed. While there are many areas in which you’d like insight, three top concerns are (1) the firm’s financials, (2) the firm’s management and (3) the firm’s culture.

The Firm’s Financials

Law firms are businesses. As a lateral partner candidate, there are many financial criteria that you should investigate. Admittedly, firms will treat financial diligence differently – some firms will be transparent and others will be opaque. Ultimately, you’d like to understand the overall fiscal health of the firm. Here are some suggestions on particular issues. This is certainly not an exhaustive list.

1. Debt: What amount of debt does the firm have on its books? How is the debt serviced?
2. Litigation/potential firm liabilities: Is the firm currently involved in litigation? Are there potential firm liabilities known to the partnership?
3. Leases: Is the firm involved in long-term leases?
4. Client base diversity: From what industry sectors are the firm’s clients? Are they relatively recession-proof? Is there a good economic balance and financial stability among the client base? Firms heavily-rooted in the financial industry – particularly in structured finance.
5. Large upcoming costs: Is the firm purchasing a new building or anticipating capital improvements in the next few years? How is the firm’s capital being spent?
6. Historical financials: How has the firm performed over the past 3 and 5 years?
7. Compensation structure: Overall compensation structure for associates and staff. How much money goes to the payment of salaries?

The Firm’s Management

As a firm is guided by its management, it is important to investigate key management issues. It is important to assess these management issues from your individual perspective, but also from the perspective of your practice group.
1. General management: Who is on the executive/management committee? In what offices are they located? Who are the firm’s key partners and practice areas?
2. Selection of management and leadership succession: You might like the current head of the firm, but what about the next one? How are leaders selected and groomed?
3. Partner compensation issues: Who decides compensation levels? On what bases are the compensation decisions made? Is it a transparent process?
4. Tiered partnership: How many tiers? Equity v. non-equity? Can partners move from equity to non-equity? What requirements must be satisfied?
5. Individual group standing in the firm: How many of your group’s partners are on the firm’s committees? How does the firm’s management perceive your group?

The Firm’s Culture and Operations

Many partners leave a firm because of cultural, not monetary, issues. As such, it is vital to understand the culture of a firm. It is highly improbable that the partners from one firm would enjoy the other firm and vice versa. A “culture fit” is a very individual analysis – what works for you might not work for another partner. It is important that you speak to individuals at the firm and get a sense of the “feel.” A culture fit cannot be completely determined in advance but due diligence will get you to a certain level of comfort either way.

1. Recent partner departures: How many partner departures has the firm had in the past year? Were these homegrown or lateral partners? What reasons were given for their departures? Where did they go? Is the firm comfortable with you contacting the departed partners?
2. Associate satisfaction: How do associates feel about the firm? Does the firm have higher-than-normal associate turnover?
3. Lateral partners: How are lateral partners treated? Are there any lateral partners in management roles at the firm? Is the firm successful at lateral integration?
4. Additional staff: Would the firm welcome additional partners and associates to join you in your practice? Would your lateral associates have an opportunity for partnership?

Conclusion

Partners investigating a lateral partner move should conduct thorough due diligence on a potential firm. In-depth knowledge of the firm’s landscape will help you to make the decision whether or not to join a new firm with greater certainty. It will also help you to manage your expectations as to what will be waiting for you upon your arrival and beyond.

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