The fiction of ownership

OK, before the comments-moderating engine goes into meltdown, let me hasten to add that when I say ownership in any meaningfully-sized law firm partnership is a “fiction” I do so in the ancient and honorable tradition of distinguishing facts from truth.

Of course it’s an almost tautological legal fact that every member of a partnership has an ownership interest (this is established by statute in most cases, common law otherwise). That’s partnership 101: So stipulated.

But the truth of what that ownership interest entitles partners to do, certainly in firms flunking the Two Pizza Rule, is very different.

I aver that since lawyers can be legalistic, they (wrongly) translate the legal fact into the operative/managerial fiction that they ought to have a co-equal hand in control of the enterprise. They ought not. Yet it would be unavailing at best, and a career-ending injury at worst, to explain that to most partners when they attempt to grab the steering wheel. This leads us to:

Implied license to run other people’s lives

As I noted, this is perennially the least attractive behavior the partnership form in theory permits and in practice sees abused. The presumed right of any given partner to issue orders to others who do not in any organizational sense whatsoever report to that individual is nakedly premised on the trump card, “I’m the partner.” (Whether or not the card is actually played is mostly a matter of social grace and discretion; everyone knows the card is held in the partner’s hand.)

Now, this may seem utterly logical to you, and I would be the first to admit that it’s about as common as the sun rising in the east. That’s the perspective of fact.

But from the perspective of truth, in a sophisticated enterprise it should receive zero organizational deference. It’s not any more mature—and it’s every bit as revealing of the vacuum of justification behind the demand—as the truculent, “I’m the mommy, that’s why.” This:

• Elevates the partner’s whim over organizational structure and priorities;
• Is nakedly insulting and, given sufficient repetition, terminally demoralizing to the business professional on the receiving end; and
• Again, exalts the trivial perspective of fact over the existential perspective of truth.

No, I don’t think “existential perspective” is putting it too strongly. The organizational and enterprise perspective is what matters, and always behaving in its long-run best interests is (I would argue) a obligation of membership in that enterprise bordering on the existential. Elevating one’s own immediate selfish impulse over that end is a betrayal of what partners above all should see as a bedrock obligation of their membership and participation in the enterprise.

[If you disagree with the enterprise’s behavior, values, or strategy, you are face to face with the classic choice of “Exit, Voice, or Loyalty;” but that’s not what we’re discussing here today.]

The lawyer or the law firm?

This debate has been nothing if not long-running. And at this juncture we have little to add other than to reiterate our view, which seems breathtakingly obvous (although perhaps only to us) that, essentially, the answer is “Both” and “It depends.” (For confirmation see this column by a former AmLaw 25 partner, now GC of one of the world’s largest insurance companies.)

But what the answer to the question is doesn’t really matter for today’s purpose, recall. Today we’re tasked to design the ideal law firm of the future, and from the perspective of the firm as an institution, there’s no question the corporate form beats the partnership form hands-down. You may appreciate that BMW (say) has great engineers and designers, but you’re not likely to follow any one of them over to Audi for your next new car if they move. Your loyalty is to the firm, the product, and the brand. And that’s the way it should be.

Distorts financial reporting

No, I’m not going to go rehash the exhausted topic of the value of AmLaw-reported numbers. Not only have we all heard and some of us have participated in that debate ad nauseum, but I think the verdict is in and the issue is frankly settled. At this point any thoughtful observer can conclude that they’re not reliable, not comparable, invite gamesmanship, and purport to prominently measure things that don’t mean what they seem to mean. Which is not to say they aren’t an engrossing guilty pleasure.

Rather, the problem with partnership accounting is two-fold.

First, as universally practiced by law firms, but contrary to economic and management reality, profits of the enterprise are calculated before partners are paid. I don’t know how to say it much more directly (and we’ve written about this before): This is bizarre from a number of angles:

• Partners perform at least three roles, including laboring as hourly-billing lawyers, participating (some of them, anyway) in firm management, and then and only then being residual owners of the enterprise. Logically:
  • They should be paid for their labor as an ongoing operating expense of the firm, analogous to what nonequity partners are paid for their labors;
  • They should be paid for management also as an ongoing operating expense, analogous to what business professionals are paid for similar functions;
  • and then and only then should they be entitled to the residual profit of the enterprise.
• Failing to recognize and distinguish among these three roles produces chronic and large over-statements of law firms’ profits compared to what those profits would be if accounted for on an economically rational basis.

Second, the requirement that partners are liable for income tax on their proportionate share of earnings whether or not actually distributed to them has served as an all but absolute bar to firms’ retaining income for future investment. Of course, all the tax laws say is that the tax is due on the partner’s entire share, not that it has to in fact be distributed. But I’d be shocked if you’d be invited back to any partners’ meeting where you bring up that distinction and suggest the firm actually has an important choice to make about paying out something < 100.00% of earnings.

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I said at the outset that this piece would read as one of naked advocacy, and I hope at this point you would say I’ve been as good as my word. Now it’s your turn.

Time and again I’ve heard the virtues of partnership sung, whether it’s to serve as cultural glue, to bring out people’s most energetic and dedicated efforts, to encourage seamless collaboration, to inspire loyalty, or to provide a clutchless transmission between firm performance and individual recompense. And I’m sure there are other supposed linkages out there. All these goals are undoubtedly essential, and beyond that worthy and even aspirational for a sophisticated professional services firm.

So I invite you to make the case—in the comments here and/or at The Lawyer event in London in September—why the partnership form is indispensable, or optimal, for their achievement. Because I look at global consulting firms, investment banks, architectural and engineering firms, and more, all full of Type A individuals playing on some of the world’s great canvasses, and I see no shortfall in cultural glue, energy and dedication, collaboration, loyalty, or market-rate pay.

Or consider the corporations operating in the four-dimensional space of innovation, customer passion, employee engagement, and financial power, where (even if you might not do it exactly the same way) absolutely everybody is ravenous to know how they do it—Amazon, Apple, Facebook, Google, Tesla. Not a partnership to be found.

Why must law be different?

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This article was originally published in The Lawyer, and is reproduced here with kind permission.