The problem with many of the traditional profit-sharing formulas is that they usually have a negative impact on the firm’s employees.
The profit-sharing formulas used by law firms are a complicated and often controversial subject. Any conversation about law firm compensation could potentially cause an argument. Most legal professionals have very rigid opinions regarding what they believe to be the best way to share profits.
The majority of law firms use standard, origination-based profit-sharing formulas and compensation methods. These systems often lead to issues like attorney burnout as well as foster a toxic working environment. When employees feel underpaid and undervalued, turnover tends to be high.
The fact of the matter is that there is no one ideal formula that works for every single law firm. Some formulas are structured, some are subjective, and some are a combination of both. If you have questions regarding profit-sharing and alternatives to traditional compensation models, consider looking into lawyers for partnership agreements.
How Do Law Firms Split Their Profits?
Profit sharing in a law firm means the firm’s employees collect a share of the profits. This share is a percentage based on either annual or quarterly earnings. A law firm’s profits are usually divided among the firm’s partners.
Traditional Profit-Sharing Formulas
An example of a traditional profit-sharing model looks something like this: If a law firm has 10 equity partners, and netted $1 million in profit, then the calculation per partner would be:
$1,000,000 net profit / 10 equity partners = $100,000 per partner
Unfortunately, this formula will only work for partnership agreements if the profits are split equally. Partnership agreements normally employ a different formula for dividing profits.
For instance, if a law firm has ten equity partners and two of them are senior equity partners who get twice the share of profit, then the correct formula would be:
- $1,000,000 net profit / 8 equity partners + 2 senior equity partners = $83,333 profit per partner and $166,666 profit per senior partner
Even though every law firm handles its accounting differently, the majority of profit distributions are paid out of anticipated profits, either on a quarterly or monthly basis, which is why most law firms make quarterly tax payments on their projected yearly income.
By and large, law firms use fiscal calendars that align with a regular calendar. Accounting records January 1st as Day 1 for the year, which ends on December 31st. So, at the start of the fiscal year, law firms don’t have much in the way of expected profits, but a partner is still required to make a quarterly tax payment on March 15th based on the firm’s estimated annual profits.
Many partnership agreements also have minimum distribution amounts worked into the contract. A firm may decide to pay its partners $10,000 a month without any regard to its current profitability. These payments are essentially an advance on any forthcoming profits and would be subtracted from the profits per partner they owe at the end of the year.
To pay their minimum distribution amounts, a firm may actually have to incur debt, making it risky to agree to an advance that is either too low or too high.
How Are Profits Per Partner Calculated?
Simple! Profits per partner are calculated by taking the law firm’s net profit, which is their revenue minus their expenses, and dividing the total by the number of equity partners.
Issues With Profit Sharing Formulas
The problem with many of the traditional profit-sharing formulas is that they usually have a negative impact on the firm’s employees, such as:
- Burnout: Since this formula concentrates on new business and billable hours, employees are pushed to work extremely long hours to ensure their goals are reached. Many law firms set yearly hourly billing objectives for their lawyers who are not part of the profit-sharing. This means that the non-partnered employees only collect a bonus, albeit a very large bonus, if they meet their targets. According to Clio’s Legal Trends Report, 75% of attorneys regularly work well past normal business hours. Furthermore, the report discovered that attorneys work an average of 140 unplanned hours every year. This data certainly demonstrates that most attorneys are willing to do what is necessary to meet hourly billing objectives, even when it inexorably leads to burnout and total exhaustion.
- Toxic working environment: When a compensation system is solely based on revenue, it can generate a workforce that is overly competitive. For some employees, this type of competition could have a negative impact on their work/life balance and their mental health. This system also only acknowledges and awards those who accomplish their goals and reach their targets, which often discourages cooperation and collaboration among employees and creates cliques inside the organization.
Consider Non-Attorney and Non-Partner Staff
The Model Rules of Professional Conduct clearly indicate that attorneys may not share legal fees. It is, however, vital to the success of a law firm that non-attorney and non-partner staff are encouraged to perform their roles to the best of their ability.
Alternative Profit-Sharing Formulas
There are several ways law firms can prevent the pitfalls of traditional profit-sharing methods, such as:
Offer Market-Value Bonuses and Salaries
Providing your employees with fair, market-value salaries will help motivate them as well as ensure they feel valued by the firm, which in turn will encourage them to do their best in their position. When analyzing what would be considered fair compensation, take into account things such as:
- Time with the firm
- Area of law practiced
Reward Staff For Delivering a Client-Centered Experience
Giving a client an experience that is completely centered around them means putting yourself in their shoes and looking at what they are going through from their perspective. Building an experience that is both memorable and positive for your clients is always good for your firm. A lot of firms may think this approach means sacrificing their profitability but providing your clients with an experience centered on their needs facilitates referrals, repeat clients, and will raise awareness of your law firm.