How to Divide Law Firm Partnership Income

By Jeffrey N. Fink

One of the fastest ways to silence a roomful of lawyers is to raise the question of how to divide law firm partnership income. Many lawyers are reluctant to discuss the subject because they are unfamiliar with the options and uncertain how to select among them. Others are concerned that a conversation with their partners about compensation splits will be too uncomfortable (we can be a competitive bunch). Fortunately, there are enough different ways to slice the pie for each viable firm to be able to find a solution that works. As with other partnership agreements, the conversation becomes more manageable when the focus starts with what kind of culture and behavior the partners want to encourage, rather than with money. The actual numbers flow more easily once the goals are clear.

The major variations are as follows:

1. It’s Good to Be King. One lawyer is the face of the firm, attracting many of the clients by virtue of his expertise, reputation, or connections. Other lawyers bask in his reflected glory. He decides how much the other partners should be making based on subjective or objective criteria. He may not disclose all of what those criteria are. However, most people see the fairness of his decisions. There is enough money coming in to keep most of the people happy most of the time. The incentive is to keep the king happy.
2. The Gang of Four. Instead of having one king, a group of lawyers forms a committee to decide how to split the income for the rest of the partners. In larger firms, the compensation committee may be separate from the executive committee that runs the firm. In others, the compensation committee makes a non-binding recommendation to the executive committee. In still others, the same committee makes all decisions. Although the committee usually publicizes some of the factors it considers, the other partners often become petitioners who are asked to submit an annual impassioned summary of achievements and predictions. This structure works if people trust in the process and the people on the committee. The incentive is to shoot for the targets the Gang of Four makes public and to make sure everyone in the Gang likes you.
3. The Black Box. The Black Box is a variation of The Gang of Four, except that the criteria are entirely subjective. It may work if there is enough money to go around, but the problem is that lawyers, like everyone else, often compare themselves to their peers. The subjective element creates a huge potential for perceived unfairness that can cause rifts in the firm. The incentive is to work hard and play office politics.
4. Eat What You Kill. The EWYK model appeals to the strong strain of individualism in American culture. The theory is that all members of the firm are in control of their own destinies, can choose how much to work in any given period, and should be rewarded based on their current efforts. It is common among smaller firms in which partners are focused on sharing space and administrative resources, individual responsibility, the development of individual practice,s and a sense of independence. Some variations encourage other benefits of being in a partnership, such as cross-selling to other partners, a team-based approach to complex matters that need multidisciplinary support, the sharing of knowledge, and the development of associates. On the other hand, a pure EWYK model does not let partners smooth out their cash flows as their performance varies from year to year. The incentive is to work hard and control overhead. However, the EWYK model may actively disincentivize the development of a sense of community within the firm, leading to conflict, the development of divas, and partner departures. 
5. The Formula. The Formula multiplies distributable cash by a percentage that reflects some or all of (a) length of service, (b) client or matter origination, (c) ongoing relationship management (in case clients get handed over from one lawyer to another), (d) billing responsibility for a matter (which may be separate from relationship management), (e) time spent servicing clients, (f) management and administrative time, (g) special projects or other incentives, (h) total hours billed, (i) prospects for the coming year (especially if there are client payments that will straddle the fiscal year-end, as in corporate matters that get billed at the end of the transaction or contingent fee matters) and (j) other creative elements. As long as everyone knows The Formula, it increases the chance that people will see distributions for a particular year as being fair. It sets the incentives. Variations are common throughout the service sector since, if structured properly, the Formula encourages the kind of internal cooperation that is good for the firm’s longevity. The downside is that a formulaic approach may reduce business flexibility and encourage partners to structure their practices in ways the framers may not have intended. 
6. Solomon’s Baby. Outside of the law firm world, many people who own partnerships expect to receive a fixed percentage of the profits. Law firms have two variations:
   1. Lock-step compensation, in which everyone in the same year of partnership is paid the same, was the gold standard for generations. Not so today. It requires a huge amount of trust that all members will pull their own weight, make up for down years with future up years, get paid less in up years than might be possible elsewhere to even things out or out of a sense of community, and stay with the firm. It requires and encourages teamwork and long-term planning and reduces internal conflict over pay.
   2. Some smaller firms have fixed percentage distributions that reflect the perceived relative contributions of the partners. Often, they are based on circumstances at the time the firm is formed and may seem imbalanced as time goes on, fracturing firms that do not have a mechanism to revisit them as practices evolve.
7. The Reference Standard. In baseball, even the greenest Major League player is entitled to be paid a minimum salary. Law firms sometimes do the same, with each member of the firm being entitled to receive some minimum compensation. For instance, some firms have decided that no partner should receive less than the highest-paid associate. Others use a similar method to calculate retirement or buyout distributions. 
8. The Bleacher Seats. Firms began moving toward a tiered partnership structure decades ago. The structure often involves “non-equity partners” or “income partners” who hold themselves out as partners to the outside world but really receive a salary plus bonus (some of the many flavors of “of counsel” overlap with “non-equity partner”). The next tier up may be paid on a formula that combines a smaller fixed amount plus a percentage of the firm’s net income or divides a set percentage of firm profits among all partners in that class. The top tier is often paid on a percentage basis, divided using one of the approaches outlined above. The assumption is generally that total compensation – and risk – increases as one climbs the tiers. Firms use a tiered structure to manage expectations and attorney development and to maintain firm financial health. Some firms have a policy of moving non-equity partners out the door if they do not advance within a certain period of time, or de-equitizing partners once they reach a certain age. Other firms use an incentive structure that unsustainably focuses non-equity partners on either client origination or servicing existing firm clients, but not both. Rightly or wrongly, many perceive non-equity partners as being like tenured associates who can only advance if the firm fears they will walk away – meaning that they have an incentive to develop invaluable expertise or a separate, portable client base. As long as the firm stays on top of how its attorneys are developing, this system works well enough that many of the largest firms have adopted one or another variation of it.

There is no one “best” way to divide law firm income. Indeed, many firms creatively combine these approaches to reach a result that their members find fair. For instance, a firm could pay each partner a minimum amount and then use another method to divide up any balance of cash left at the end of the year. A firm could distribute a third of its net income on a lock-step basis, a third based on total hours, and the rest on a formula basis that gives 70% credit to origination and 30% to service. It all depends on what the partnership wants to reward.

Ultimately, successful partnerships have to work for all their partners, which depends on one vital factor: trust. Trust among partners enables them to develop and maintain their practices, collaborate on projects, assume shared liability, and build a cohesive, forward-thinking firm. As partners design compensation structures, open and honest discussions about the firm’s vision foster trust and drive their options.

If your business is reviewing (or rethinking) how partner compensation should work, you don’t have to navigate it alone. Jeff Fink helps law firm leaders build compensation structures that support trust, teamwork, and long-term growth—without the politics and uncertainty. Ready to create a model that fits your firm’s culture and goals? Contact Jeff Fink to start the conversation.

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