Searching for the true meaning of equity partnership

It is interesting to note two recent trends in large law firms across the world. First, there was the now-notorious demise of US firm Dewey & LeBoeuf, in which backbench partners appear to have been left powerless, uninformed and disenfranchised as the firm’s leadership cabal drove the firm onto the rocks. In ?its last few years, it seems that new laterally-hired partners were prized more ?for the capital they introduced than for ?their skills or acumen.

Second, there has been the recent tendency for large law firms to streamline their equity structures, often ending up with so-called ‘all-equity’ partnerships, in which the classes of partnership are significantly reduced and the firm’s funding needs are met by the introduction of more partner capital.

These two seemingly unconnected issues have caused me to puzzle lately about the real meaning (if any) of equity partnership in the modern law firm. In return for joint and several liability and the introduction of fixed capital, the equity partner often has the somewhat dubious return of merely a vote in serious matters and the hope of a higher income.

In this respect, the new equity partner is often placed entirely in the hands of a powerful remuneration committee to assess his or her profit share and is at risk of a drawings freeze if the firm runs into cash problems. In other words, the modern equity partner in a mid-sized firm or larger often has very little authority or control over the firm’s management and destiny, and yet bears a huge amount of responsibility and risk.

The lockstep system of partner remuneration has been much derided recently as backward looking and a disincentive to high flyers but, as an essentially equal-sharing model, it at ?least endorses the spirit of true partnership as opposed to a system of rewards based upon the subjective judgement of a powerful and sometimes unelected committee.

One former partner of a large international firm told me that he regarded himself as no longer a partner but rather a freelance contractor on a short-term contract, with no employment rights and little control.

As an extreme example, the history of Dewey & Le Boeuf has shown how a firm can be hijacked by a small self-serving oligarchy, leaving the backbench equity partners little more than ciphers. Hence, it could be argued that the only real difference between equity and non-equity partners in many big law firms is the assumption of risk. It therefore has to be asked – as many younger lawyers are now doing – why anybody sensible would want to be an equity partner in such a firm.

Not every law firm is a partnership, however. Some firms have gone down a more corporate route, in which equity owners have a real stake in the firm’s real value (if it has one), represented by shares.

The equity options to be considered by law firm leaders are more complex, however, than a binary choice between a corporate model and a true and egalitarian partnership, in which partnership rewards are based on the principles of equality and partners have more than a token voice in the firm’s direction and management.

There are three questions any leadership group should consider before making profound changes to their equity structure.

First, there is a philosophical or cultural question to answer, which should be based upon the firm’s values. Unless all equity partners are treated as true owners and stakeholders in the firm, it is hard to justify the opening up of equity for financial motives alone. If the raison d’être is for the firm to just become a short-term vehicle to maximise earnings, and if the main reason for becoming an equity partner is simply to earn more, it will be difficult for the firm to become or remain an enduring institution.

Second, the firm should consider equity with a view to issues of succession and stability. The question here is around the best equity structure to help the firm to develop and grow in substance as opposed to size.

Third, the firm should only promote to equity those who are likely to make a sustainable and valuable contribution to the firm’s strategy, direction and goals.

Just as it is wrong for a firm to change its legal structure solely for tax reasons, so it also seems wrong for a firm to change its traditional partnership model into a structure that is dressed up as a partnership but has few of the egalitarian facets of such a structure – such as sharing, collegiality and collaborative autonomy.

If it is no longer strategically desirable or managerially practicable to maintain the firm as a true partnership, then a truly corporate structure might prove to be a more honest solution.

Ironically, however, the change from a partnership structure to a corporate one is usually a decision on which all equity partners have a vote, and many partners seem unwilling to trade in their partnership status – however limited it may be – to become an employee and a shareholder.

Nick Jarrett-Kerr advises law firms worldwide on strategy, governance ?and leadership development ?(www.jarrett-kerr.com)