Attorneys at the largest, most selective law firms work in a rarefied space. And a select few may eventually become partners—which is both a professional and financial triumph.
Years of creating complex financial plans for legal professionals have revealed that the transition to partner can be financially difficult. Many new partners are not prepared; grabbing the golden key may require paying in capital, being taxed as a K1 owner of a partnership, and dealing with a complex set of financial expectations and obligations, not to mention liability and significant compliance limitations. And while the financial rewards of partnership will certainly be extensive, the transition and first year can be complex, and cash flow difficult.
Rising partners can prepare for the transition and avoid pitfalls by taking the following into consideration. Note that the “income partner” tier at some firms can provide a gentler glide-path to the jump to true ownership at the “equity partner” level. Here we are talking about equity partners.
Understanding the Landscape
The cultures and approaches to partnership at law firms vary widely. Some law firms can be paternalistic, laying out specific expectations and surrounding their partners with various benefits and support systems. Others are more hands off, with attorneys fending for themselves.
The financial process of becoming partner at some firms may require up-front cash for paid-in capital, while others may subtract an attorney’s partnership stake from earnings over time. It can come as a surprise to have to “pay in” to become partner.
First year partners face other cash demands such as transitioning from W-2 employees to K-1 owners, as well as expectations that they contribute to firm sponsorships or other charitable requests. Some firms will facilitate cash flow in the first year and beyond, offering pre-approved credit with little if any underwriting through the firm’s primary banking relationships.
Whether taking advantage of this type of financing is a good idea is another matter.
A New Way of Getting Paid … and Taxed
Overall compensation will be driven not only by one’s own productivity, but also by the firm’s earnings. In the first year, junior partners who haven’t participated in any prior year-end distribution may need to scramble to find the cash to pay their estimates. This can be exacerbated if a senior associate had used her savings to pay down law school debt or put a deposit down on a home, leaving little cash on hand.
Don’t Put Away Your Checkbook
Newly minted partners also face other demands on their cash. Charitable and sponsorship requests are generally paid by the partners at most law firms. It’s hard to say no when a client asks a young attorney to support an event or donate to a pet cause.
In addition, there are often co-investment opportunities offered to law firm partners, including venture or private equity investment funds that, while potentially lucrative in the future, require a cash commitment now.
Other Things to Keep in Mind
Partners also face some unique compliance constraints by virtue of their profession, making it important to avoid conflicts of interest. That means it is critical that attorneys only use financial advisers with full discretion over their accounts.
Some will need to get firm approval to set up accounts and send trade confirmations to the firm. They may need their adviser to avoid trading in certain securities or even set up blind accounts.
Becoming a partner means becoming an owner, and new partners are now potentially liable for the firm’s operating decisions. While rare, law firms can overextend themselves and be forced into bankruptcy.
For example, after overextending its payments for leases and retirement benefits, the former New York-based Dewy Ballantine’s partners found themselves targeted in the firm’s bankruptcy case.
Here are a few tips for new partners hoping to ease the first-year transition:
- Senior associates should talk to a financial adviser to create a short-term plan to identify cash needs and avoid common missteps in the year or two leading up to becoming partner.
- Consider using an investment account as collateral for margin borrowing or a line of credit. This is a relatively low-cost way to tap needed cash in the first year.
- New partners should think carefully before taking advantage of the convenient financing firms may offer as part of a transition to partner. The cost for these unsecured credit programs may be significantly higher than other credit arranged privately through an adviser.
- Recognize the value in delegating financial decisions. Lawyers are accustomed to giving advice and are generally good at taking it. Most find their time limited and are often willing to assign the management of their financial affairs to experts they trust because they have similar relationships with their own clients. Selecting an adviser who understands the constraints a partner may face—including cash flow and compliance—is critical.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
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Michael Delgass is managing director with Wealthspire where he provides complex financial, tax, and investment services for attorneys as well as clients with family businesses, special education/special needs issues, and complex estate planning structures.