Succession Planning: ‘What’s in it for me?’ Compensation pitfalls that doom law firm succession planning

By David E. Wood

An entire generation of senior partners is retiring from law firms with little or no warning to fellow  partners or clients. Clients are left to pick up the pieces of broken off relationships, abruptly having to do all the work required in finding new counsel. Often, their firms do little to provide service continuity to these clients. Instead, they are quickly forgotten.

Clients are understandably vexed – and baffled – by this behavior. They remember how hard these lawyers competed to get hired in the first place. What changed?

Unannounced senior partner retirements do not happen because law firms have no interest in retaining clients. Firms are not in the habit of turning away business. However, their leaders are often hamstrung by internal disputes over investment in succession and partner compensation. This is likely to persist until market conditions compel firms to focus more on providing clients service continuity when partners retire and compel partners to focus less on self-interest.

Compensation issues often defeat retirement succession

Firms and their partners understand that, all else being equal, migrating partners’ practices to successors as they retire, thereby retaining client revenue streams, is a good thing. But all else is rarely equal. Effective practice migration requires a lot of nonbillable work by a senior partner in the leadup to retirement. If a partner’s compensation is not protected, the lawyer is less likely to do this work. Yet firms are often unwilling to motivate senior partners to make this effort.

At many law firms, partners cannot talk about this subject without coming to loggerheads. Typically, discussion is stymied by partners’ often widely divergent perceptions of how their personal financial interests will be affected if their firms protect a retiring partner’s compensation while transitioning clients to younger lawyers.

Some partners object to this investment because they believe it disproportionately benefits the younger partners positioned to inherit retiring partners’ clients. One way of addressing this objection is to fund the investment through what is in effect a commission structure, i.e., by deductions from fees collected from inherited clients over some period postdating the senior partner’s retirement. Done this way, the investment is paid for by the younger partners who benefit from acquiring a ready-made practice, albeit at a value diluted by the share paid to the retiring partner.

This dilution may be enough to dissuade the most promising younger lawyers from offering themselves as successors. If they are on track to self-originate enough work to keep themselves busy, these partners may be reluctant to service a retiring partner’s clients at a discounted value to them. Younger lawyers who are open to this arrangement may be the ones who struggle to keep themselves busy, and who clients may be less likely to perceive as able substitutes for the retiree. Some firms solve this problem by treating the cost of protecting a retiring partner’s compensation as a long-term investment and spread it out over the entire partnership, because it will benefit all partners over time through increased profits from retained revenue streams.

Many times, partners resistant to investing in retirement succession claim that the cost is too high. When a retiring partner’s collections drop for any reason, the firm loses gross revenue, a portion of which would have constituted profit enriching every other partner. An investment in topping up a retiring partner’s compensation while doing client transition work would be an additional hit to gross revenue, triggering an additional reduction in profit. Some partners complain that this double hit to the top line cancels out the small upticks in their shares of profits achieved by keeping retiring partners’ clients.

At firms that take the long view to retaining retiring partners’ practices, managers point out that every investment has two costs: The money invested, and the value achieved had it been invested elsewhere. The relevant question is whether the value earned from retaining these practices justifies inclusion of the expense in a balanced investment strategy. Because (as the adage goes) it costs five times more to acquire a new client than to retain an existing one, this value is often easy to establish.

Another issue that gets in the way of retaining retiring partners’ clients concerns the sharing of credit for originating a client relationship. Lawyers qualified to credibly substitute for senior partners are sometimes unwilling to work as seconds-in-command without receiving a share of this credit. They argue that origination credit reflects the value not just of bringing in the client, but also of servicing the business to a high level. Allocation of credit is a zero-sum game, so when a successor receives a share, translating into higher compensation, it means less compensation for the senior partner.

If a retiring partner and a successor cannot agree on the sharing of credit, the succession process quickly grinds to a halt. Some firms overcome this stumbling block by making credit allocation an institutional decision, rather than a matter for negotiation between individual partners. At these firms, contributions to successful client relationships are viewed holistically. With very capable lieutenants, a senior partner can develop more new business and produce more billable hours. Without them, the lead partner must self-perform more of the work, taking away from business development time. Seen this way, sharing credit with lieutenants positioned to inherit the senior partner’s clients is a good deal for everyone.

Many firms’ compensation systems discourage succession

At many firms, retiring partners are penalized for doing the work that practice migration requires. Some firms use an “eat what you kill” compensation model, paying partners a percentage of the prior year’s collections without taking into account other factors. But at most firms, a partner’s compensation is based on a combination of objective factors (like the prior year’s collections) and subjective ones (such as the partner’s nonbillable work for the benefit of the enterprise). At these firms, partners are vulnerable to mistreatment by management if they announce their retirement dates well in advance.

Their fears of being mistreated, and losing compensation as a result, are not imagined. It happens all the time. For example, firm leaders know a partner plans to retire on a date certain and is unlikely to continue practicing at another firm, they may see no downside to assigning a zero value to the subjective component of the partner’s compensation in the lawyer’s final year. The partner must then decide whether to quit now or swallow the resentment and keep working to year-end at reduced compensation. In this example, the firm recognizes no value in the partner’s nonbillable time spent transitioning client relationships to successors.

These concerns drive senior partners to end their careers in whatever way best protects their compensation — even if it results in the firm’s loss of their clients.

The cost of abandoning retiring partners’ clients Is growing  

Even when law firms are motivated to change compensation structures that discourage migration of retiring partners’ clients, they often do not do so. Letting these clients walk away is regarded as easier and less controversial than changing compensation systems or trying to make their partners more civic-minded. These firms reason that their partners have always brought in enough new business to make up for this loss, and then some. Why shouldn’t this strategy for replacing each successive generation of producers keep working like it always has?

The answer is that a combination of demographics and client demands will put pressure on law firms that they do not experience now. The pool of talent needed to replace outgoing partners is shrinking because retirements are outpacing the influx of new lawyers. Members of Generation X (those born between 1965 and 1980) are fewer than the Baby Boomer Generation that preceded it, or the Millennial Generation that followed. This means that in the future firms will have to compete harder, and spend more, for the highly qualified younger lawyers (organic and lateral) required to maintain and grow revenue.

Law firms will also have to cope with clients’ increasing intolerance of being abandoned as their relationship partners retire. Clients are beginning to require firms to disclose who will take over when relationship partners leave practice, and to commit to providing service continuity when this happens. Firms that cannot make this commitment will chase a dwindling field of clients that do not yet insist upon it.

To adapt to this new environment, law firm leaders must do two things. First, they must find ways to restructure their compensation systems to make the intergenerational transfer of practices advantageous for partners. Second, they must administer these restructured systems in a way that inspires loyalty and trust. The objective must be to change the behavior of partners preoccupied with the question that dooms effective succession planning: “What’s in it for me?”

 

 

David Wood is a retired trial lawyer who helps law firms and senior partners plan and implement retirement succession programs. He can be reached at [email protected].