Not only is there no market for an equity partner’s share in a firm–which often can characterize many other closely held organizations coming in all sorts of legal forms–there is no provision for departing partners to sell their share to the firm (or to anyone else in the world for that matter) under an appraisal valuation, a right of first refusal, an auction process, or otherwise. This law firm partner’s “equity” has no present or future or terminal value.
You are free to defend our odd usage of the term, but all I ask is that you recognize Law Land distorts what rank and file businesspeople and economists would assume the word means.
Productivity:
Industry usage is that productivity means billable worked hours per lawyer. This turns inputs and outputs on its head. Hours worked is an input measure pure and simple, but productivity is defined (typical Econ 101 textbook) as “output per unit of input.” This is not far removed from Orwell’s “Ministry of Truth” in terms of turning what words mean upside down.
I know some readers will attempt the jujitsu move in their minds of arguing that billable hours “produce” revenue to the firm. Nice try. What any organization produces is the goods and/or services that clients come to it for and purchase. Clients, trust me on this, do not come to your firm to write checks and call it a day. To generate revenue, organizations must produce the goods and/or services they’re known for, but in no tenable sense does that mean the revenue is what the firm is producing.
Profitability:
According to innumerable MBA programs, Accounting and Econ 101 textbooks, common sense, and the entire universe of business journalists and Wall Street analysts, net profit is, as the redoubtable FT puts it:
The profit of a company after operating expenses and all other charges including taxes, interest and depreciation have been deducted from total revenue. Also called net earnings or net income.
But despite the universal assent to this straightforward definition everywhere else in the economy, that’s not the way we in Law Land use “profitability.” We (The American Lawyer and the rest of the legal media, managing partners and executive committee members, recruiters, etc.) have decided that what we mean by “profitability” is, yes, income minus expenses, but calculated before we pay the equity partners.
Imagine a publicly traded company deciding that, henceforth, it would report profits before paying middle and senior management. Even the non-securities lawyers in the crowd can imagine how long it would take before the SEC opened an inquiry on this.
On the other hand, reporting as we do has undeniable cosmetic advantages: We can as an industry boast of profit margins anywhere from 30–50+% of revenue, which, if calculated under GAAP, would indeed be enviable: So enviable, indeed, that they would attract a host of new entrants seeking to compete them away. But since that hasn’t happened, it may be that we have not pulled the wool over the world’s eyes. Maybe all we’ve done is annoy our clients, encourage even greater innumeracy and lazy thinking about the business our firms are in, and once again decided that words mean what we decree and not what the rest of the world employs them to mean.
Ministry of Truth
Bruce –
Great post.
This should be Exhibit #1 when addressing why clients complain that outside counsel don’t understand the clients’ business. How can they even understand each other when the definitions of key terms are different for each party?
I’ve been annoyed by the “profitability” metric for more than a decade for a different reason, because it distorts the effect of leverage, and I’ve advocated measuring a firm’s financial success by its average lawyer income, rather than average partner income. Consider two firms, both grossing $2MM/year and with identical overhead of $800,000 each on all things except lawyer salaries. Firm X has 2 partners and 4 associates. Each associate is paid $100,000/year. Firm Y has 6 partners and no associates. Four of the partners In Firm X, the two partners make $400,000 each. In Firm Y, the six partners make an average of $200,000 each. In both firms the six lawyers together make $1,200,000 – maybe in Firm Y two partners each have 1/3 of the profits ($400,000 each) and four partners have 1/12 of the profits ($100,000 each). Firm X is more profitable to the partners, but it’s no more profitable as a law business.