Smith and Jones felt that they could justify adding an associate. Their choice, fresh out of law school, did good work—so good that after three months she requested a salary increase. When Smith and Jones pointed out that the associate’s output was actually down during the latest month due to time spent in CLE training, the associate replied that the training made her more valuable, justifying more pay—and threatened to quit if she didn’t receive it. Smith and Jones faced losing their help and the benefit of the training they paid for. What should they do now?
This type of scenario doesn’t have to occur in your law firm. Junior attorneys need to understand their monetary value to the firm and how their role is integral to the success of the firm and, therefore, their personal success. Such an understanding can be part of self-education or education by the firm. Regardless, junior attorneys must gain perspective on how their work impacts the firm and their net worth—and their pay.
Despite being called partnerships (or LLCs or PCs), large law firms are generally governed by a very few people in the organization (the management committee). This tends to create a corporate-style environment in which most attorneys see themselves as employees, not actual or potential owners. This has a big impact on business competency. As law firms become more corporate, dissemination of key financial benchmarks within the partnership (and among the firm’s lawyers generally) tends to become more restricted.
This needs to change. If you are part of more than a solo practice, consider this list of key metrics and ask how many of them you know for your firm:
- Gross revenues
- Net revenues
- Revenue per partner
- Revenue per lawyer
- Profits per partner
- Number of new clients per year
- Total number of matters now active
- New matters per year
- Client retention and loss rates
- Total billable hours
- Cost of a billable hour
- Billed hours
- Realization rates
Estimates of the first five metrics appear annually in print for the largest firms. Otherwise, few attorneys in large firms have access to all of the data. More to the point, how many partners, even if they had access, have the business competency to calculate, or even understand, the traditional key measures of law firm performance: realization, utilization, leverage and expenses? How many know, or understand, the firm’s collection rate—or their own personal one? And if partners are in such a position, why expect something different from the firm’s associates—potential partners of the future?
Laments about the lack of associate loyalty are less frequent these days than at the height of the dot-com boom, but turnover is still much higher than two decades ago. I suspect that much of that is due to a lack of information and understanding of a firm’s financials and how they apply to each lawyer.
Various factors in partners’ performance affect the firm’s efficiency and profitability. But associates also play a role in the firm’s bottom line, so let’s look at the junior lawyer’s impact on profits as well. Remember, every lawyer in the firm has an impact on the business’s success.
To measure the junior lawyer’s impact we need to know:
- The lawyer’s billable hours for the latest month and year to date
- How many hours the firm billed out for the lawyer versus a markdown or write-off for some of the work (individually or as an average percentage applied to all associates)
- Direct expenses for compensation (including bonus and benefits) for the lawyer and any direct clerical help, office space (cost per square foot of the real estate directly attributable to the lawyer and any direct help), etc.
- Indirect expenses, or overhead (the percentage of revenue that the firm assigns on a per-attorney average to cover the cost for insurance, utilities, technology, entertainment, education and other such expenses needed to keep the doors open).
The result should determine an individual net profit value to the firm:
Billings – [Associate’s Total Compensation + Direct and Indirect Expenses] = Net Profit. The net profit is the amount available resulting from an associate’s effort. This is the bottom line in determining a young lawyer’s value to the firm.
When analyzing the value of a partner to a firm, management will frequently talk about “realization.” Realization focuses on collected billings, not just billing statements sent out. Normally, however, an associate will not have any power to deal with a client directly to collect billings. Since the firm generally selects the client, it should be the firm’s responsibility to collect the fees. The associate’s responsibility is to do the work assigned in the most effective and efficient way possible and in the shortest amount of time.
Associates should realize that they cannot and will not remain with their firm unless it is profitable for the firm to keep them—if not for every month, then on an annualized basis. While the new, high-priced associates may not earn more than they cost the firm in the beginning, at some point that situation must change. In fact, large-firm managing partners agree that it takes, on average, from three to five years to break even on the investment in a new lawyer.
Few associates at large firms have access to the numbers for this kind of calculation, though with a little effort they could probably learn enough to make an educated estimate. Ideally, the information should be available to associates to educate themselves in how the law business works, so that they can figure out their own profit and loss and enhance their worth to the firm.
In truth, few associates are interested in doing this. However, if these lawyers become partners, they will lack a sense of either management or financial ownership. Associates who learn to calculate their net worth and, based on this, fulfill their responsibility to produce net profits for the firm will prepare the firm for the business challenges of the future. By taking financial ownership of the firm’s success as part of the team, the associate will assure his own success as an individual member of that team, too.
Associates, and indeed all lawyers today, need to be more sensitive to the financial needs and operation of the firm. The necessary conditions for this to happen are increased openness with financial information and better training in using that financial information. Far too many firm meeting “numbers presentations” are abstract and pro forma. If the presentation is at the personal level and the means for understanding is there, the chances are better that the lawyers hearing it will understand why they need to be concerned about the firm’s financial health and their part in the process. Whether or not they are owners and employers in name, they can become so in behavior—in this way, the firm will definitely benefit, and the individual lawyer will benefit, too.
About the Author
Ed Poll is the founder of Law Biz, a business consulting firm for lawyers and law firms. Follow him on Twitter @LawBiz.