Shall I itemize the offenses for you?

  • By focusing externally on laterals, we risk sending the message internally that those stalwart contributors on the team are second class citizens—we’re not romancing them as energetically, are we? I believe the “romance” analogy applies here with force. What do you do to court a lateral? Have drinks and dinner; introduce him/her to your most presentable and charming partners; dress yourself up—you get the idea.
  • Likewise, in pursuing laterals, we’re (by hypothesis) focused on bringing new clients on-board, rather than cultivating and strengthening our relationships with existing clients. Clients will surely be less aware of this—and wouldn’t really care if they knew—than incumbent partners, but you’re choosing to fight a battle which is far harder to win. Roping in a new client is always harder than deepening the ties to an existing one.

As for the “accounting for performance” offenses, the primary one is that we don’t.

As our “drizzle-makers” author writes (selective excerpts, and emphasis supplied):

So, what are we talking about in real terms? Well, let’s imagine an example partner, we’ll call him Bob. A fixed-share equity partner in a mid-tier firm, Bob reckons he has a following of about £1m. He is earning about £300,000. He goes to see a few firms and gets an offer of £330,000, plus a potential bonus if he overperforms.

The firm is thinking that, if Bob is good for his stated following, his recruitment will neatly cover all the bases according to the traditional Rule of Three by which many firms still assess the viability of hires. One third of Bob’s revenue will cover his remuneration; a third for costs, such as property, staff and riotously expensive chocolate biscuits for the client meeting rooms; and a third for profit. It all sounds great. Let’s call it £330,000 for Bob; £330,000 for attached costs, including any staff, property and so on; and £340,000 for profit.

Except Bob, like many lateral partners, fails to hit his revenue target in his first year. Actually, he doesn’t bill anything in the first six months, but then he finishes the year at a decent run rate, billing a total of £500,000, or about half his stated following – not an uncommon experience among lateral partners.

Still, people at the firm are pleased. Bob’s run rate in the last couple of months of Year One is above the rate he needs to bill £1m per year. In many firms, that would most probably be the end of that. At the start of the new financial year, the account would effectively be zeroed and Bob’s healthy new run rate would mean the first-year loss would not be accounted for.

In fact, if we are going to judge the hire fairly we should roll over that loss into the next year and add it to his target, making his Year Two target £1.5m – three times what he billed in Year One.

Let’s imagine he puts in a sterling effort in Year Two and bills £900,000. Now, that would cover his salary and costs quite comfortably and make a small contribution to profit – if we were starting at zero. But, of course, we are not starting at zero. So instead we have a £600,000 undershoot on our combined Year One and Year Two expected revenue.

Looked at another way, if we assume Bob’s remuneration is not going to rise over, say, four years [but assuming 3% inflation and a goal of 5% annual increase in PPP], our Bob is going to have to bring in around £4.2m in his first four years just to cover his costs and make an average contribution to profit.

This starts to look brutal. If Bob bills £500,000 in Year One, that leaves £3.7m to bring in over three years, or £1.2m-plus a year. If he bills £900,000 in Year Two, that leaves £2.8m for the last two years, or £1.4m a year. And let’s not forget that, at this level, Bob is merely maintaining, not enhancing, firm profitability, which is not quite the point of lateral hires.

How many firms have done these “maths?” Has yours? If not, why not?

We’re not done.

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