2/11/13

"Equity" Partner or PINO?

image [cc] Andrew Mangum
Following on the heels of recent posts on the market value of BigLaw and the behavior of partners as workers, we explore the merge-point for those two topics in discussing partners as equity owners.

The market refers to the owner level of law firm partners as “equity partners.” After giving this term some thought, I came to the conclusion that equity is not the right word. Equity implies a share of ownership (beyond what "partner" implies). And when you own a share of a business, you have certain rights. One is the right to receive dividends based on your proportional share of ownership. Another is having a say (a.k.a. a vote) in the business. This vote is usually focused on choice of leadership or management. Finally, you own an asset which you can hold or sell.

For law firms, and presumably most professional service firms, these rights take different forms. Instead of dividends, partners in firms receive a proportional share of profits. This difference may appear to be nuance, however as we have previously explored, partners are both owners and workers. Yet their pay is based on some sort of modified ownership share that is based heavily on their effort as a worker (ala billable hours) . The point: partner pay is not a dividend like those paid on a share of stock.

The second right to vote on leadership is actually enhanced and expanded in a law firm. Here the owners have a say in far more than leadership selection. Often they have a say in the minutiae of operations. This right makes it difficult for leadership to make decisions and implement them, since the various and numerous owners have the ability to influence, amend and outright thwart those decisions. The impacts of this are far reaching and left for another day’s discussion. Needless to say - this type of ownership right makes it hard for firms to make effective operational changes. And again, this is not like the equity rights of a stockholder.

The final right - to sell your asset - does not apply to equity partners. Most firms have some level of capital buy-in for partners. However, that does not equate to buying a share of the firm. If that were the case, then partners proportional ownership and income would be determined by how many shares of the firm they had purchased or earned as executives. Instead, a ‘modest’ capital account exists. Partners cannot sell their shares from this account but can only withdraw some proportional share when they leave or retire. My guess is most of these capital accounts are pennies on the dollar compared to the annual revenue of a given firm, evidenced by the recent Dewey press, Therefore the asset value of a partner’s ownership stake is negligible to nonexistent. This fits with the concept that BigLaw firms have zero market value, since that is how they are internally valuing the "real" ownership shares.

My epiphany related to this subject came into focus based on a call with a colleague at another firm. It’s partner compensation season at his firm. If you have never lived this experience, you are not missing much. At its foundation, this effort is a battle for partnership share, which determines individual partners’ incomes. The epiphany came when I considered that partners' incomes go down when their shares are reduced. This can occur on a relative scale or via a direct reduction. When laterals are added to a firm, an individual partner’s proportionate share is reduced. This reduction is similar to a company issuing more stock and technically shouldn't result in a reduction in income, since the value of the firm should rise at the same time. 


When the second method is employed, a redistribution of shares occurs. And here’s my epiphany: companies cannot do that. This would be a ‘taking without compensation.’ Taking shares from one owner and giving them to another is not legal. Yet law firms appear to do this on a regular basis when they conduct the partnership compensation dance.

The epiphany in practical terms: partners do not hold ownership shares in the standard business sense. If they were shares, they could not be taken. Borrowing a political phrase, equity partner implies on ownership share, when in reality equity partners are better called Partners In Name Only (PINO). Law firms (and perhaps many professional service firms) have convoluted ownership. Thus my assertion that “Equity Partner” is a misnomer. This odd blend of ownership and compensation drive unique behaviors. Are they good or bad? Is there a better way? 


I can see the value of a much brighter line between ownership and compensation having value for a firm. Partners could have two distinct rewards pools. Once for driving the success of a practice and thus the firm, much like an executive would receive. The other purely based on share of ownership.

This post is a bit of a rambling since I see no definitive conclusion in the short-run. At its base is yet another question about the business model of a law firm. Law firm business models are unique and evolved out of a certain market circumstance that no longer exists. This equity question is another manifestation of that apparent disconnect. And more evidence law firms need to rethink fundamental aspects of their business.

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2 comments:

Moe said...

I very much look forward to the day you discuss right #2!

Debra Bruce said...

Toby, I agree. Much of law firm dysfunction comes from the structural fiction that it is a partnership. As you suggested, it's an outmoded form of a bygone era. Two or three partners can function reasonably well together if their values and goals align. How can you align 500 partners?

Of course, the other big contributor to the dysfunction of law firms is that the owners are all trained to conquer, and very few are trained to collaborate.

 

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