This column is by Janet Stanton, Partner, Adam Smith, Esq.


Let’s get something straight from the get-go: “Equity” as it is known in Law Land is a chimera.  Unlike in the other 98% of the economy, equity in Law Land is an illusion.  It has no intrinsic or market value – you can’t sell it, trade it, borrow against it or bequeath it your grandkids in your will.  If you don’t believe us, just check with your accountant.

Further, the notion that equity partners are paid purely out of a firm’s profits is also a sham. Equity partners are first and foremost workers and their compensation is primarily based on their financial contributions to the firm (billing, business generation, collecting, etc.) and only de minimis as “owners.” (That law firms report their profitability without accounting for a huge proportion of their labor costs is merely another Alice-in-Wonderland aberration found only in Law Land.)

In fact, equity partners are the primary financial engine at firms.  In addition to churning out billable hours, they’re the group most responsible for business generation; charged with bringing in new clients and additional assignments.  Hardly the role of passive coupon-clipping owners.

And, then there are the downsides…

There are distinct tax disadvantages for individuals of K-1 compensation versus W-2; mostly related to FICA and health coverage which are not covered by firms under a K-1.  There are other consequences since K-1 folks are considered to be self-employed by the IRS – such as the quarterly estimated tax requirement under K-1.  Please note, we are in no way accounting experts, who should be consulted to spell out all the implications.

Moreover, most firms require capital contributions from their equity tier; we’ve heard as much as 50% of partner comp annually (though 25%, or so, is more common).  And, unlike what one would expect from investing such hefty sums, partners’ capital contributions earn little if any interest.

Of much greater consequence is the reality that equity partners can face significant financial and reputational liabilities if the firm finds itself in trouble – as for example, the firm goes belly up with an underwater balance sheet.  Creditors and bankruptcy courts are not at all shy about clawing back compensation recharacterized as a fraudulent conveyance – and equity partners are often the first to be targeted (as they’re the highest paid folks at a firm).

In fact, we know of several big-name rainmakers at prestigious firms who have affirmatively eschewed an equity position just to avoid these headaches.

Despite all of this, we well recognize that the myth and allure of equity are deeply entrenched in the psyche and lore of the industry; becoming an equity partner continues to be viewed as the crowning achievement in Law Land.

What do we suggest?

Firms and lawyers should wipe the pixie dust from their eyes.

Let us stipulate, law firm partners are a highly advantaged lot – whether equity or not.  First off, they are very well compensated; the “average” AmLaw equity partner reportedly earns about $1.4 million a year. And, since compensation is primarily based on financial performance, this would not change without equity status.  Many lawyers operate with a great deal of autonomy in how they run their practice; with much less management involvement (meddling?) than would be the lived experience of senior managers at any corporation.  Moreover, they are often well-respected “pillars” of their communities.

For firms, a non-equity partnership offers clear advantages, especially in terms of decision-making and innovation.

Going forward, firms and individual lawyers will be in a better position to negotiate truly mutually beneficial agreements once all acknowledge reality.

Surely, there are a few more nuances to think through, such as the governance role of partner agreements, which some may choose to overblow.

But, let’s not kid ourselves.


“The worst of all deceptions is self-deception.”

– Plato

Image Courtesy Ravit Sages, Unsplash

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