The Non-Equities (& Others) Heard From On “The Great De-Leveraging”

Well, that’ll teach me…

The volume of commentary following my publication earlier this week of “The
Great De-Leveraging” has been unprecedented.  Depending on your attitude, that
is either deeply gratifying or almost overwhelming.  As one who takes the positive
view by default, I choose option A.

Therefore, I wanted to recap and respond to some of the very thoughtful remarks
I’ve received.  First, a few quick preliminaries:

• “Comments” on "Adam Smith, Esq." are broken.  Yes, I know, I
  know.  This is a technical issue and not an editorial decision. 
  We have a complete revamp of the site in the works–currently under wraps–but
  my devout hope is that that will cure this issue.
• I have attempted to keep the identity of all commenter’s scrupulously anonymous,
  and I hope I have succeeded.
• Without exception–even where people disagreed with my original piece–the
  remarks and observations have been thoughtful, reflective, and generous.
• I have, as editor-in-chief, reserved the right to condense comments.

Without further ado.

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First, “Regular Guy” takes issue with my description of the non-equity position
to begin with:

One of my friends forwarded to me your article on The Great De-Leveraging.
She was particularly interested in a section in which you wrote "Non-equity
lawyers don’t have to beat their brains out.  So they don’t.  Their deal–again,
a perfectly rational one, to them–is that, premised on good behavior, they
have a job essentially for life at, say, $350,000 to $450,000/year, adjusted
for inflation.  If you think that’s not an attractive deal, I suggest you
immediately take the elevator down to the street and ask the first ten people
you encounter if they’d like such a job."

I am a non-equity partner in Philadelphia, but there’s almost nothing in the
quoted section which rings true. I (and my friends who are non-equity partners
in Philly, DC and in NY) are under incredible pressure to bring in new business
and to meet billable hours requirements. And we do it (at least in Philly)
for substantially less than $350,000. And on top of it, we get to pay for our
own benefits out of pocket. I agree: if we ever had the deal you describe,
it would be perfectly rational to do it forever. But I don’t know anyone at
any firm who ever collected $350,000 to $400,000 for good behavior. I’ll be
on the lookout for it, though . . .

Frankly, I’m not quite sure what to make of this, since it was an “outlier”
in terms of reactions.  Clearly different firms operate at  different economic
levels and for some paying a non-equity the amounts I mention might not make
sense within their overall compensation structure or not be feasible financially,
so I don’t doubt that “Regular Guy” is describing his world accurately. 

My point was that, regardless of the exact level of the numbers, they’re quite
respectable incomes in the US economy as a whole–indeed, according to our President,
you’d almost certainly qualify as “wealthy” and worthy of paying additional
taxes.

Next up, we have a commenter at  Legal OnRamp who provided a remarkably thorough
canvas of the non-equity partner landscape.  I’ve highlighted key points.

Some excellent data.

Some conclusions I would respectfully differ with.

Nonequity partners, properly applied, are more profitable than associates, notwithstanding
their lower production of hours, for a number of reasons. Firstly, they are
considerably more experienced and efficient, and thus a higher proportion of
their hours worked are billed and collected.

Secondly, their billing rates are higher, and every hour worked has a higher
margin as against the allocation of fixed overhead to them as timekeepers.

Thirdly, they tend to have some book of business, just not
enough to justify a full equity partnership position. This provides some breadth
and stability to the enterprise business base.

Fourthly, they tend to have some real expertise and help
out in landing new cases.

Fifthly, they tend to contribute to the administration and partnership
duties, from recruiting, mentoring new associates, all manner of
committees, etc., thus spreading the burden among a wider group.

Sixthly, it tends to be very easy to project based on years of past experience
what the contribution to the bottom line of the firm will be, and their compensation
and benefits packages are correspondingly tailored so that the firm makes a
profit spread from every one of them.

So….you do not as a manager need to have them working 2,000 hours (though
you would like that!). You get 1600 hours at $500 collected from a service
partner and she puts $800,000 into the kitty. Salary and benefits at $400k,
overhead allocation $150k, net to the firm $250k. Bonus structures encourage
more work and there is often generous sharing for it. But it is not required
because there are all these other reasons not to force them out if you are
making a quarter million a year from their efforts and they carry all these
other burdens that would have to be borne by your equity partners otherwise.

Contrast that with an associate doing 1900 hours at $300 per hour, but a fairly
typical post billing write down of 6% on hours…or 120. Net collected 1780.
All in salary and benefits is $200k, less the overhead allocation of $150k
and you net $114k. But, there is great variability in associate productivity.
Many will work 2,000 hours or more, but the pre-billing write-offs can amount
to 15% for the first two years. Frankly, if you can collect 1600 solid hours
off an associate in each of the first two years, you are not doing all that
badly. And that alas means that you are about at zero net contribution. Maybe.

Additional partner time is spent reviewing work product, much of which is
not billed to the client. Associates in the first three to four years have
little ability to carry administrative and other burdens, at least not to the
extent of the service partners. And certainly they have no real expertise in
the first few years. And there is the element that large numbers of them are
going to leave to pursue other directions than big law, after a couple of hundred
thousand dollars of sunk costs in recruitment, summer programs etc. per person,
whereas the income/service partner has become a long term participant on the
team.

There are other elements that merit consideration. The income partner
position is also one that allows the firm to flex with people of talent that
have issues in "life" that you want to accommodate. A
disabled partner who can only work 1200 hours a year, or a partner that wants
to dial down the demands while she raises three young kids, would be only
two of dozens of examples of ways that the firm will "park" a valued
talent that is not in a position to churn and burn like an equity partner
must.

It is also an "incubator" position where young associates that
the firm has picked out as the "best of the best" are made partner,
or are lateraled in for a term to prove themselves. The ambition is to get
them up to equity partner performance numbers, because by definition that is
where the real economics happen. But obviously not all of them will make it.
Not uncommonly there will be some in this class that are an "investment" and
will be expected to generate more business, with a few less hours (say 1750
instead of 1950 but with a slug of development hours and activities in accord
with a formal business plan).

And, partner culture notwithstanding, this is a class that is effectively "at
will". There may be procedures and niceties, if you don’t cut it you
are out. There are no illusions about this. Whereas at the equity partner
level, the protections and practices of the past make the process difficult
and painful when they have to be implemented. But there is some stability
and comfort in that too.

There is much more to it than just this, but I respectfully suggest that this
income or service partner quadrant of the firm is not a wasteland of inattention
and losers in a major firm. Yes, there are some that need to be looked after
and in some cases counseled out. But the fact is, most of them are PROFITABLE
and contributing in myriad ways that associates cannot and do not.   And that
is but one reason why as the firm looks inward to decide where and how to cut….that
it will not fall on the income partner ranks as heavily as you may suggest
it should.

In a nutshell, I think many of these are valid points, especially the initial
ones about billable rates and realization ratios being strongly superior to
those of junior associates. 

But partly, I submit, this is simply a result of every junior person
being at a natural and understandable disadvantage in terms of clients’ willingness
to pay.  Once associates reach their middle, and certainly their senior, years,
their rates and realization rise to very comfortably profitable levels.  It’s
hard to imagine a world where lawyers vault magically from 3L grads to 4th
or 5th years with nothing in-between.  Until we can invent a time machine that
warp-bypasses those years, I’m not sure how having a larger cohort of non-equity
partners helps alleviate the inevitable waiting-and-training game.  How did
those non-equities get where they are, after all?

So it strikes me that those points may be less cause to celebrate non-equities
than cause to be grateful that junior associates finally do acquire experience
and talent, as costly as it may be to watch them do it.

The point about non-equities being able to assume “administrative and partner
duties” including recruiting and mentoring is one I violently disagree with. 
Indeed, part of the dysfunction I perceive in firms with large non-equity tiers
is precisely that they act as a buffer and “sound insulation” between the partners
and the associates.  This is neither healthy for associate development nor
for partners’ getting to really know the rising young talent pool–not
to mention associates’ prospects for partnership when that day finally comes.

This would also be the occasion for me to mention–as I did not in the original
article–that a common complaint about non-equities is that they hoard work,
depriving associates of essential training, implicitly overbilling clients
for unnecessary seniority, and gumming up the discipline of proper staffing
ratios.  To observe that this is an especially severe problem in this environment
would be stating the gruesomely obvious.

Likewise, the points about “life” issues frankly echo one theme I tried to
address, perhaps inarticulately, in my initial column on this topic.  

Let me hasten to confess that one reason I may not have been pellucidly clear
about this issue is its potential for being viewed as politically incorrect,
but here I’ll say it: 

I do not believe that a law firm can be simultaneously a “lifestyle” or
“work-life balance” firm and an uncompromising, bet-the-ranch,
“go to” firm for only the highest-value and most prestigious work.

There, I’ve said it.  You have a choice, and both choices are eminently defensible
and rational.  But I believe you must choose.

Next comes an observer who takes issue with The American Lawyer‘s
definition of “non-equity partner,” and who therefore concludes that my entire
ratio calculation is askew and fundamentally uninformative. 

While I don’t doubt that he has done has research assiduously, as noted in
my original piece, I took the “TAL” data at face value as having at least the
virtue of a consistent metric.

One failing of using the NEP to Partner ratio is that a number of the firms
with low or zero ratios just use a different title–counsel, senior attorney
whatever–to hide the economic equivalents of NEPs.  As you point out
in the productivity chart, counsel are even less productive than NEPs–meaningfully
so in the “more profitable” firms. 

Using Skadden as the first example–mostly because I know their web address
off hand–they have 236 partners and 96 counsel (not counting “of counsel”
or European, regional or pro bono counsel, but including “special counsel”)
for a ratio of 0.406.  This takes Skadden way, way out of your circle
of cultural stalwarts, which is a much more select group than the NEP:P ratio
implies. 

What follows is my quick counting of website listings [and he proceeds to
conduct a similar analysis across another dozen or so firms] […]

Anyway, very interesting post.  Thank you.

I shall re-direct his critique to Aric Press.

Next, we have a very thoughtful, even soulful, response, gracefully outlining
the pressures  generated when a high-performance culture collides with the
life of a mere human (highlights mine).

I would agree with you that some of those non-equity partners, senior counsel,
etc. are drags on the system.  But it is profoundly difficult to make
that out from just the "hours" figure.  The very deal in
becoming a senior counsel is that you have something the firm wants to keep,
but you aren’t willing to accept as remuneration the currency that they are
willing to give you for it — equity partnership. 

As you noted, it is obvious these days that the life of an equity
partner is no better than that of an associate – you just get paid more.  Eventually.  After
you have paid off your buy in.  In my firm, new partners made considerably
less than 8th or 9th year associates, yet had rainmaking responsibilities,
etc.  Lousy deal, and increasingly, talented people noticed.  Indeed,
because of all the additional time doing client development, etc. etc., the
equity partners who really WORK, carrying the load for those old guys who
don’t, have a terrible deal these days.  You’ll make a nice
corpse in your expensive coffin.

So what do the talented people do?  The ones who would be offered partnership,
but frankly aren’t sure that they want it?  Believe it or not, those people
do exist.  A lot of them are women.  And at least for a few key,
biologically-driven years, they want and need to dial back on the soul-killing
hours.  And if one is HONEST, billing 2500 hours is soul-killing because
you worked so many more hours than that.

I was offered, and did not take, a non-equity position.  I would have
been on reduced hours (work 40 rather than bill more than 40 was the deal),
I could be paid on a 1/3 eat what you kill. 

I was a talented antitrust litigator capable of running cases and capable
of very complex analysis.  The clients liked me.  There
was a core cadre of women with this deal at my firm who were routinely offered
equity partner status every few years.  Typically nobody took equity status
because the extra money wasn’t worth the price.  This is because
we were in control of our own hours (because successful participants under
this system have their own clients who are loyal and trust their work), our
conversion rates billed/collected were spectacular, and we represented niche
practices that were not easily replaced.  Why do you think that the
firm was willing to make these deals with us in the first place? 

So yes: in a world where only the raw number of hours billed matters, these
people are less profitable for the firm.  But if our conversion rate is
extremely high, we’re critical to the relationship with some long-term clients,
your "diversity" numbers plummet and there is no one to mentor new
female talent coming up, and we’re a straight 1/3 pay with risk borne by the
non-equity, I would argue that these people are one of the very best deals
in law firms.  Indeed, the fact that the firm was willing to think outside
the box to keep some of these folks tells you that there is profit there.

The bottom line of my little screed is that the raw hours worked numbers
don’t tell the story of a person’s value to the firm.  A senior
counsel (other non-equity) has a deal whereby they work fewer hours for less
pay.  If the deal doesn’t work for both sides, the senior counsel gets
canned.  In litigation, senior counsels are sometimes called non-equity
partners so that one’s card will say what the client wants to see.  But
really: this is a strategy for holding onto talent that has decided
that working even more hours than one worked as an associate is not worth
the price.

Hard to argue with.  So I won’t try. 

I told you it was soulful–and deeply appreciated by me.  Next:

Bruce,

A very interesting post.  One comment to consider regarding the relative
value of income partners to associates.  At least [in my non-US
country], most income partners feed themselves, in the sense that they have
direct client contacts that send them enough work that keeps their plates
full. 

It is not enough work to keep a pyramid of associates busy beneath them,
hence they are not equity partners.  Clients prefer experienced lawyers to inexperienced
lawyers because they get more value from them, despite higher hourly rates.  Clients
hate paying for 1st year lawyers who contribute relatively little to a file
when compared with their hourly rates. 

In my experience, until associates have 2-3 years experience under their
belts, they are rarely more useful than a good quality paralegal, whose hourly
rates are much lower.  [Here’s the same point our second commenter made, so
you can mentally reprise the same reaction I had then.–Bruce]  We need junior associates
only because we need a future stream of partners.  As you point out,
not a very high percentage of those we bring in make it to even income partnership,
let alone equity partnership. 

If you agree with Richard Susskind, as I do, that law has much work to do
on refining legal work process, then there will be even less work for associates
to do in the future, as, organized properly, more work can be done by paralegals,
or outsourced to contract lawyers or lawyers in lower cost centers.  Yes,
we will continue to need the future partners, but does it make economic sense
to pay crazy wages when only one in ten or twenty will make partner. 

The cost of associates is not only in their wages, but also in the time,
effort and money to recruit them, and then train them when they come on board.  The
best case scenario is that when they leave, they go in-house to a client,
and if you have treated them well and have a good alumni program, they may
become your client. 

In the worst case scenario, you have to pay to off ramp them.  For
a very large percentage, I doubt that their cost is ever re-covered by the
firm.  That is why firms hold onto those with experience who can feed
themselves, and give good advice to clients.  If they work fewer hours,
they are compensated less.  The key is that they are generally good lawyers
who are valued by clients.  I’ll admit that if they can’t feed themselves,
then you have to ask, do you keep them on board for what they are paid relative
to what associates are paid, who don’t bring in any work.  When you
add up the real cost of a 1-3 year associate in New York vs. an income partner
who completely or largely feeds him or herself, then the economics becomes
very different.

Thoughtful and, if I had to bet, penned by someone with a fair degree of exposure
to economics in their background.

Next, we have an opinion about how non-equity partners’ willingness to work
for (relatively) less could threaten the position of equity partners in the
longer run:

Your rant [Was it a rant?!?–I thought it was pretty reasonable.  Bruce] about
Non-Equity partners could be dead on if you are an equity partner worrying
about how to protect your $2 million draw. However, the prevalence of non-equity
partners is indicative of another unpleasant reality.

There are many many lawyers who are perfectly competent to do the work and
are happy or willing to do so for less money. As we all know, not everyone
is a rainmaker. Most of the horned rim types engaged in the securitization
mill are technical geniuses but clumsy back slappers. One way or another the
redeployment of these people in the legal market place is going to put pressure
on big firm economics. Particularly in world with bankers capped at $500,000.

Keep up the great blogging.
(former Big Firm equity partner happy to have left the law)

And finally, this piece from a BigLaw partner who’s a regular reader (highlights,
again, mine):

        Your last piece, the Great De-Leveraging
Article — is really one of your recent best analyses on the current law firm
model.  Well done. 

        As you will recall, you and I corresponded
a little over a year ago, when I said that I believed there was a "bubble" in
law firm "stock prices" in the form of profits per partner.  The
then-existing model could not continue to sustain its growth in profits per
partner at the historic rate.  All the available revenue levers — leverage,
rates, utilization — had all been taken close to their logical maximum points.  Moreover,
the drive to continue increasing those profits was leading to poor business
practices that would bite firms when they could no longer be increased.  For
example, the increased reliance on leverage, in large part through parking
associates in the income partner spot, would not be sustainable over the long
term and leads to an underinvestment in new talent.  Similarly, the
constant increase in rates, particularly for junior associates, was starting
to alienate clients.

        As we now are starting to see, the
bubble for law firms is popping.  They cannot maintain the
profits per partner at the historic rates.  In an effort to prevent
a free-fall in partner profits, law firms are now "de-leveraging."  And
many firms who could not (or are currently not) doing this fast enough, are
starting to fall apart (e.g. Heller, Thelen, etc.) because the collapse of
the PPP sends the rain makers to other firms, leaving the firm to collapse
of its own weight.

        I think you are right that
this is the time that firms need to start afresh — Andy Grove style — to
figure out their strategy.  But, I believe that the firm leadership
in only a few firms actually understand the dramatic nature of the strategic
decisions they should be contemplating.  Most firms will consider
whether to downsize, and if so in which practice areas.  They’ll take
some actions, and those in the top quartile may even align those actions
so that the resulting firm structure is aligned to those practice areas where
the firm sees opportunity in the future.  But, I think the choice
is much more fundamental, and most firms do not yet see it (or do not want
to see it).  I think firms need to think through fundamentally what
their competitive advantages are, what markets they are targeting, and as
a result, they need to decide what their firm business model is going to
look like. 

        A couple examples may suffice:  Some
of the highly profitable, NY firms (who are listed in your article as having
few, or no income partners), generally tend to generate work through the big
deals and the big litigations.  Those deals are large enough that the
clients become price insensitive, and they can be staffed with large teams
of lawyers paying attention to every legal detail.  For those firms, the
model of high fees and lots of leverage continues to work.  While they
may also be able to get premium pricing structures, they don’t typically
have to take any risk to get those premiums.  Those firms can continue
to use the "Cravath" model, where they churn through
the best and brightest of law school graduates, and are left with the brightest
(and most "durable") lawyers who become partners.  That model
will probably continue to produce $2-$4 million PPP. And while the growth
in those profits may be difficult, given the amount of those profits, the
model will likely still be successful.

           A second
model probably applies to many mid-tier firms  (AmLaw 20-60).  These
firms will need to adopt what I would call the "production" model.  Their
target markets tend to be Fortune 1000 clients.  In litigation, they
may not get the "bet the company" cases, but they will get significant
cases within the firm’s areas of specialty.  In deal work, they may
become specialists in certain types of deals (the equivalent of what securitizations
work provided for much of the last 7 years).  In both categories, clients
are increasingly fee sensitive.  And in both categories, the work, while
not "commoditized" is certainly of a type where sophisticated
firms could bid on the work on a fixed rate basis.  Those firms who
can figure out how to do this — and this requires an incredible control
over internal information within the firm to ensure that projects are properly
bid and managed — will have a chance of keeping up with the NY firms in
terms of profits (though I doubt they will maintain the same high level).   This "production" model
requires an ingrained systematization of process controls, teams of lawyers
who are deep experts, and leaders who are risk takers (for bidding purposes)
and project managers (for execution purposes).  It may still be a leveraged
model, but the leverage probably will not look the same as in current firms.
There may still be a place for income partners, but those partners skills
are now to bring deep expertise and extensive project management skills.  Think
of this firm like large construction firms.  The principals take significant
risk, have the potential for significant reward, but only if the team executes
flawlessly.

        A third model is what I
consider the "boutique" model.  These firms have
very talented senior lawyers in practices that are often difficult to leverage
(think of Regulatory work, Appellate practices, perhaps some IP litigation,
Tax advisory work, etc.).  These firms will likely have difficulty maintaining
significant leverage.  A 1:2 partner-associate leverage may be the most
that can be maintained (if that).  To the extent these firms can command
premium rates, they may support significant profits per partner, but probably
never at the level of the large NY firms.  The question will be whether
these firms can offer a culture that compensates partners in a non-financial
manner that makes up for the lost profits they might earn at larger firms.  One
could imagine a fairly idyllic life — less pressure to generate business,
more time engaging in the practice of law. 

        As you
note in your article, most firms currently don’t really know "who" they
are or what their strategy is.  Strategies
have focused on either "bigger, more revenue," or "focused,
more profits," but I don’t sense that most firms have really considered
what makes the firms a cohesive entity, how the firm differentiates itself,
what innovative services it might provide, or how the firm can leverage its
strategic assets.  The result is behemoth firms that keep getting
bigger, with shrinking equity partnership ranks in order to keep the PPP
at acceptable levels, and layers of "associates," "income
partners," "counsel" and "others" who largely become
cogs in an indiscriminate entity.  Loyalty to those firms is at an all-time
low, because all the firms basically look the same, so partners
defect when they see a chance to increase income.  Clients have a hard
time telling firms apart, so success in client marketing focuses mostly on
the personal relationship because there are very few other differentiating
factors (to be sure, personal relationships will always be important). 

        Most firms are following the crowd
like lemmings, breathing a sigh of relief that now, given Latham’s large layoffs,
it is now "ok" to really cut into lawyer staffing levels.  When
the markets return, the pecking order for law firms will probably stay the
same, though mid-tier firms may be at even a greater competitive disadvantage,
having lost even more of their rain-makers to higher-tier firms.  A
few smart mid-tier firms might realize that downturns are opportunities.  In
good times, it can be hard to rock the boat; In downturns, there is a burning
platform where partners can be galvanized to take action, if a good roadmap
is provided.  Firms with strong leaders will take the opportunity
to "right-size" and "right-structure" their firms.  They’ll
adopt new business practices, invest in training on those skills critical
to the firm’s differentiated success (e.g., project management, or substantive
expertise) (after all, their idle lawyers now have more time to attend these
trainings), institute systems to track costs on the types of matters they
want to focus on in the future, they will start partnering with clients now
(when clients may be eager to take risks to reduce costs, and law firms may
have excess capacity in their system) to find ways to take risks together
to find a better long-term model. 

           The bubble
has popped.  The market is in a downturn, and businesses are being reinvented.  Some
law firms will keep doing the same old thing (and for some, like the NY firms,
that’s probably a good model).  A few well-managed firms will use this
time to determine "who" they are, and how they want to compete; assess
what sort of PPP they really need and want, develop a strategy that builds
on their strengths to differentiate themselves from other firms, and develops
a structure and set of expertise to execute that strategy. 

        But then again, for most firms,
they’ll just hunker down, cut costs, and hope their relative standing somehow
improves when the market returns.  Good luck to them.

A fascinating roundup of responses–and all, Dear Readers, thanks to you. 
As they used to say somewhere in the lost mists of collective media memory,
“keep those cards and letters coming.”

---

What, finally, then, do I think about the remarkable growth over the last
decade of the non-equity tier, and of the advisability of same?

As Tolstoy famously wrote in the opening of Anna Karenina, “Happy
families are all alike; every unhappy family is unhappy in its own way.”  I
would paraphrase, or mangle, that to observe that “single tier firms are all alike;
every two-tier firm is two-tier in its own way.”

By that I mean there is no template, no equivalent of the Cravath Model, for
what being “two-tier” means.  We as an industry continue to experiment on this
front (as we are experimenting, abruptly and unwillingly, on many other fronts,
of a sudden in this environment).

But I continue to believe that the burden of proof is on those who would argue
for the expansion and not the contraction of the non-equity tier.  Economic
reasons, as I noted in my original piece, are the least of it–which, ironically,
is at odds with the gravamen of most of my interlocutors above who argued for
the non-equity tier on economic grounds.

The core of the debate, in my mind, is all about culture.  Many are the reasons
to have a substantial  non-equity tier, and many are the reasons, as I have
argued, to strictly limit it.  But do not, under any circumstances, pretend
that you are not making a decision with vast cultural implications.