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Equity Partners Told to Bear Brunt of Downturn, But It’s Tricky

April 16, 2020, 9:31 AM

Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. Today, we look at the complex relationship between pay cuts for associates and equity partners. Sign up to receive this column in your Inbox every Thursday morning.

Just about two months ago, before the world changed, I wrote:

“Big Law firms have just begun reporting their profit from last year, and by all indications it was another strong year. As profits per partner continue to increase, associates may question the fairness of the current compensation structure. The question partners will have to answer is how much that matters to the ongoing health of the firm.”

I’d forgive readers for dismissing the idea at the time. It was about how associate salaries in the wake of the Great Recession hadn’t kept pace with inflation—and had fallen considerably behind the growth in profits per partner. Where’s the urgency in that, right? The party was still raging, and associates were comfortable.

Flash forward some 60 days, and firm leaders across the country are now grappling with the very question of “fairness” in compensation decisions. Except now the issue is about how to share pain, not gain.

Big Law firms are cutting associate salaries and some are furloughing staff. Many are announcing large delays or reductions in partner profit distributions.

In some of the announcements, there is a noble twist on the salary decisions firm owners made during the good times. Some firms appear to be promising that equity partners will see the biggest cuts in their compensation. This is a markedly different approach than the associate layoffs the industry was criticized for in 2008. Well-intended as those promises may be, they are not necessarily as straightforward as they sound.

The main reason for that is because the majority of equity partner “compensation” comes in the form of a share of firm profits—at least 50% according to the standard industry definition of “equity partner.”

It is unclear whether firms are saying that equity partners’ year-end take-home totals will be cut deeper than the salary reductions for staff and associates. Or are they talking about temporary reductions to partners’ monthly profit distributions?

If it is the latter, the promise has a caveat. That is, equity partners’ pain could potentially be made up at the end of the year if revenue projections beat expectations. The question is whether the same is true for associates and staff, or whether firms are unintentionally signaling that it is.

Firms making decisions to cut salaries today don’t know what their profits will be at the end of the year. And cutting expenses in the form of salaries will have the effect of increasing the end-of-year profit pie—which equity partners will still divvy up.

Firms are no doubt projecting huge declines in profits even with the cuts to salaries. But promising that an equity partner’s profit distribution will decline in greater measure than associate wages has an odd effect of blurring the line between firm owners and firm employees.

And that means there could come a time when firms will need to revisit their egalitarian promise. If a law firm’s revenue projection doesn’t fall as far as leadership anticipates when announcing today’s salary cuts, and partners don’t end up taking a bigger hit than associates, will the law firm retroactively keep its promise to associates?

“This is so unprecedented that you really have to preserve your options” and conserve cash, Janet Stanton, a partner at law firm management consultancy Adam Smith Esq., said. “But the people with integrity will do exactly what you are talking about.”

To be sure, law firm leaders are operating with imperfect information.

They are making decisions to cut salaries based on projections of significant declines in revenue. None of them have a crystal ball. They don’t know what portion of client bills will be paid. They don’t how much work they will have. And, ultimately, they don’t know how much profit there will be at the end of the year.

They do know that they have very few options to preserve cash. And among their largest expenses are staff and associate salaries.

“What I would focus on if I were a managing partner is cash. Because when you run out of cash, the game is over,” Bruce MacEwen, an Adam Smith Esq. partner, said. “And a big cash expense that is variable in the short-term is compensation and salary. So you almost have no choice but to look at that.”

There is one other complicating factor law firm leaders need to consider when weighing weather to promise that equity partners will shoulder the largest compensation cuts. That is, how the decision will be received by equity partners.

“Attracting and retaining sought-after people is mission critical to most high-performing law firms,” said Kent Zimmermann, a principal at Zeughauser Group. “And decisions during a downturn that put a competitive disadvantage to continue doing that could redound to the benefit of other firms that want to attract those same people.”

For law firms, the instinct to protect jobs and preserve wages is heartening. But there may come a time when those promises will need to be revisited.

And yes, that scenario can only happen if there is an upside surprise to law firms’ revenue projections. That may be unlikely, but if it does happen, managing partners will have another chance to share gains with their associates and staff. And there will be bigger concerns this time than keeping up with inflation. It will be about keeping a promise.

“They will either have to say you were part of our family and you helped us get through this and we are giving you bonuses,” said Kay Hoppe, a legal recruiter in Chicago. “Or the owners of the businesses will stay whole.”

Worth Your Time

On Law Students: My colleague Meghan Tribe wrote for Businessweek a story that describes the pain being felt by law school students . Consequences run the gamut from awkward Zoom classes to economic hardship caused by diminished job opportunities.

On Virtual Summers: Speaking of law students, many rising 3Ls looking forward to summer associate positions in Big Law will now be working “virtually.” But what that online summer experience will actually look like is anybody’s guess.

On David Lat: The legal news pioneer turned law firm recruiter is out of the hospital after battling Covid-19, and he tells Elizabeth Olson that while the Big Law is experiencing uncertainty, “It’s not in a freefall.”

On Lateral Hires: Willkie Farr & Gallagher expanded its Chicago office with the hire of yet another Jenner & Block partner. The hire comes just two weeks after the Wall Street firm opened a Windy City office led by Craig Martin, Jenner & Block’s former chair.

That’s it for this week. Thanks for reading and please send me your thoughts, critiques, and tips.

To contact the reporter on this story: Roy Strom in Chicago at rstrom@bloomberglaw.com

To contact the editors responsible for this story: Jessie Kokrda Kamens at jkamens@bloomberglaw.com; Rebekah Mintzer at rmintzer@bloomberglaw.com; Andrew Harris at aharris@bloomberglaw.com

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