Splitting profits: Review your partner profit-sharing arrangements

There are four main reasons why many law firms are reviewing, or considering reviewing, their partner profit-sharing arrangements at present:

1. there are greater pressures on profitability;

2. current arrangements are not fit for purpose;

3. dysfunctional partner behaviour is costing firms millions of pounds each year; and

4. there is considerable planned and actual merger activity.

 

1. Pressures on profitability

For many years, most partners took home more money each year in absolute terms. When profits were high and growing, it was easier to keep most partners happy. However, in the past three or four years, this has generally not been the case, and weaknesses in profit-sharing arrangements have been felt more keenly.

This does not, however, necessarily lead to partners agreeing to review profit-sharing arrangements immediately; it often takes several years of growing concern over difficulties and strain between partners. In some cases, nothing is done until breaking point is reached and, in ?a small number of highly-publicised ?cases, nothing is done at all and then it becomes too late.

Many firms are now realising that the boom years are not likely to return anytime soon and that now is the time to review profit-sharing arrangements.

2. Not fit for purpose

In the past six months alone, between 50 and 100 firms of all shapes and sizes have told me that they do not consider their profit-sharing arrangements to be fit for purpose. The reasons for this vary considerably from firm to firm according to its history, personalities involved, circumstances and, above all, culture. But, in almost every one, profit-sharing arrangements do not adequately incentivise and reward the full range of desired partner behaviours, including, in particular, cross-selling.

In some firms, the process of profit-sharing is not considered fair or transparent; many cite the need for better performance management of partners, as well as the need to focus on a longer-term horizon.

3. Dysfunctional behaviour

As part of our recent research into partner pay and performance, I asked firms to estimate how much partners' time is lost on average in their firm as a result of dysfunctional behaviours associated with partner pay and performance arrangements. Dysfunctional behaviours include:

• fee hoarding;

• short-termism;

• behaving in a way inconsistent with the firm's values;

• empire building;

• partners threatening to leave;

• information hoarding; and

• partners actually leaving.

Based on the answers given, a conservative calculation showed that, in 59 cases (out of around 150 firms), this equated to potential lost profits of between £1m and £16m per annum in each firm.

While this demonstrates an urgent need for many firms to address weaknesses in their profit-sharing arrangements, it also presents an opportunity to significantly increase ?firm profitability in many cases.

4. Merger activity

Many law firms are either considering a merger, planning for a merger, or have already merged with another firm.

The single biggest reason why mergers succeed or fail is the compatibility (or otherwise) of the ?firms' cultures. The way in which partners share profits among themselves is ?one of the most central determinants ?of a firm's culture. Firms that realise this will go to great lengths to ensure their profit-sharing arrangements are carefully reviewed and discussed between ?partners before, during and after any merger activity.

Avoidance tactics

Why is it so hard to review profit-sharing arrangements? Many excuses may be found for not reviewing them:

• "it will take time away from servicing our clients";

• "it is not high enough on our list of priorities";

• "will it actually improve our profits?";

• "people might leave if they are not happy with the outcome";

• "it's all a bit too risky, isn't it?"; ?and so on.

These are all different ways of saying ?"we are rather hoping that, if we do nothing, the problems we have might ?go away by themselves". I have never ?yet seen this occur.

There are, however, a number of very real, complex and profound underlying reasons that make a review of profit-sharing arrangements difficult:

1. uncertainty often exists among ?partners over their firm's culture;

2. some partners can become emotional and irrational;

3. there is often a lot of 'baggage' that needs unpacking first; and

4. confronting underperformance ?is painful.

 

1. Uncertainty over firm culture

At the heart of any profit-sharing discussions lies the question of what the firm's culture is. In scores of firms - big and small - there are a number of conflicting views among partners on this key question, especially when day-to-day behaviours are taken into account.

In some cases, partners have never even attempted to discuss it among themselves, either because it is not considered important, or because it is assumed that there is a shared view, which in fact does not necessarily exist. A lack of a shared and agreed understanding of a firm's culture makes it impossible to agree how to share profits.

2. Emotional and irrational partners

Most people are not logical, rational or economical when it comes to dealing with money. Strong emotions and behaviours can emerge where money ?is viewed as a substitute (even subconsciously) for things like power ?and self-worth.

'Lovaglia's law' tells us that, the more important the outcome of a decision, the more people will resist using evidence to make it. In the context of partner profit-sharing, this effectively means that, the higher the stakes, the more irrational the response may be. I have seen this firsthand on a number of occasions and it requires very careful handling.

3. Dealing with baggage

Perceived historic profit-sharing injustices and the resultant lost trust can run deep and be remembered for many years. Rather than healing with time, they often get worse. They cannot be ignored.

If partners feel that they have not had the chance to vent past grievances and have not been properly listened to, then they are less likely to endorse suggested changes to profit-sharing arrangements. This can create a formidable barrier to undertaking a review; not only do you have to be willing to 'go there', but it takes time and skill to conduct such conversations effectively, empathetically and, when required, firmly.

4. Confronting underperformance

There is often insufficient honesty about partners' performance, which goes hand-in-hand with profit-sharing decisions.

Some partners have inflated ideas about their own performance, which ?can lead to unrealistic expectations ?about their profit share. Many partners have been successful for all of their careers, have never had to face up ?to the idea of 'failure' and are horrified when they are told that they are underperforming.

At the same time, there is often an unwillingness to confront poor performance in the right way and at the right time. Partners who have been in practice together for many years may well have to tell close friends that they are underperforming. Not only can this be extremely painful, but it can also negatively affect their ongoing relationship.

Changing profit-sharing

Given the difficulties in reviewing profit-sharing arrangements, it is not altogether surprising that many firms have not adequately addressed their existing weaknesses. However, it is possible to successfully review profit-sharing arrangements by:

1. obtaining agreement to review profit-sharing arrangements;

2. recognising that your firm is unique;

3. consulting with partners;

4. making the process as objective, transparent and fair as possible;

5. understanding where the corridors of power lie; and

6. implementing change gradually.

 

1. Obtain agreement

This may sound like a statement of the obvious and it is certainly easier said than done. Obtaining partner agreement to review profit-sharing arrangements can be achieved by a combination of creating a shared sense of urgency among partners (by illustrating the risks of doing nothing and allowing problems to fester) and focusing on the benefits ?of undertaking a review.

Profit-sharing is part of the DNA of a professional services firm and its effective functioning is essential to the firm's long-term success as well as to the sense of collegiality between partners.

2. Customise the system

The single most important factor in ensuring a successful outcome to a ?profit-sharing review is to realise that you need to fit the system to suit the partners in your firm and not to try and fit the partners to any given system. What works in one firm may be completely inappropriate at another.

Partners in some law firms, for example, maintain that a traditional lockstep system is outdated and only rewards longevity, while partners in other firms strongly believe that it is the best way to encourage and reward cross-selling and collegiality. At the other end of the spectrum, there are firms that choose to operate an 'eat what you kill' model.

The key is to understand what type of firm you wish to be and which system is right for you.

3. Consult partners

It is vital to consult your partners during ?a profit-sharing review. This requires sensitive and careful handling, but it is key to avoiding and resolving disputes. When undertaken properly, it:

• ensures that all of the weaknesses and quirks of the current arrangements are fully understood;

• allows for a degree of cross-examination, so as to be able to separate fact from fiction;

• helps to identify the likely obstacles to potential changes to the system;

• helps to draw a line underneath historical grievances and perceived injustices, creating an environment in which partners are more likely to agree to making changes; and

• ensures that all individual perspectives are taken into account so that a solution can be found that is right for your firm.

It is important to get partners in the ?right frame of mind for future changes. So, if they make comments like "that ?was really therapeutic" or "that felt ?like a confessional" at the end of a ?profit-sharing review meeting, it is a ?sure sign that things are moving in the right direction.

4. Be fair and objective

Given the difficulties involved with reviewing profit-sharing arrangements, it is important that all partners believe that any such review will be undertaken fairly, openly and as objectively as possible.

The partners themselves are often ?too close to the situation to be able to assess matters dispassionately, not least because they will be directly affected ?by the outcome. Using someone independent to the firm can achieve this required objectivity.

5. Build support

To misquote George Orwell, all partners are equal, but some are more equal than others. There are often a number of partners who are more influential than others, and some who are more disruptive. It is important to understand who these partners are and then to work hard at ensuring their support is obtained for the proposed changes.

In some cases, this will be sufficient to ensure the desired changes are approved fairly quickly. In other cases, a more gradual approach may be called for, progressively expanding the nucleus of supportive partners and building momentum over time.

6. Implement change gradually

Finally, it is important to recognise that too much change too soon can be counterproductive and even dangerous, particularly if some partners are worse off financially as a result. And, even if the partners agree a number of wholesale changes in one go, these should normally be implemented over a period of time (often over two to three years), particularly where cultural change is required.

Benjamin Viney is a senior consultant at accountancy firm BDO (www.bdo.co.uk)