Episode 22 – Jonathan Karp: Helping Law Firms to Create a Foundation for Success

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Jonathan Karp

Jonathan Karp

Partner, Thompson Coburn LLP

Jonathan Karp is a California attorney who represents mid-sized, closely held businesses and their owners in a variety of fields, including law firms, CPA firms, and medical practices. We discussed those agreements that form the foundation of a law firm: partnership, shareholder, and compensation agreements. Having assisted many firms over the years, Jonathan shared his perspective on how firms use these agreements to engineer the conditions they wish to create in their firm.

Full Interview Transcript

Michael: Hi folks, a quick note before we start—

The information in this podcast episode you’re about to hear is not presented as legal advice and should not be relied upon as such. As a law firm leader, I have no doubt that you’re already well aware that if, and when, your firm decides to enter into any of the agreements discussed in this episode, you would of course, seek legal counsel from someone who practices in the appropriate area, is familiar with the issues facing your firm, and who is a licensed attorney in your state.

Michael: My guest today is Jonathan Karp, a partner in the Los Angeles office of Thompson Coburn LLP. Jon represents mid-sized, closely-held businesses and their owners’ in a variety of fields including law firms, CPA firms, and medical practice. Thank you for joining me, Jon.

Jonathan: Thank you, Michael. Happy to be here.

Michael: You bet, and I’m really excited. Today, we’re going to talk those agreements that form the foundation of a law firm. And I think, for folks who are running law firms, this will be riveting. And I think this is where we sort of find out who really is here to learn about that stuff. And I want to say, just for the listeners, is you and I met because years ago, at the firm that I worked at, we were looking for someone to guide us through this process, and we asked around and it seemed like all roads were leading to you. Everybody told us you’re the guy we’ve got to see. And we’ve had a wonderful experience through that process. But I just wanted to share that background.

Jonathan: Thank you, Michael. It was a pleasure actually working with you on that. And I think we have a lot of progress in what we did.

Michael: Yes, yeah. Okay. Well, what are those basic agreements that form the foundation of a law firm that’s run by anything other than a single individual?

Jonathan: Most of the time, if you have multiple partners, or you want to have multiple partners, you’ve got to have agreements between the partners. And by the way, when I use the word partners, it’s interchangeable with shareholders. So if I’m referring to partner or shareholder, they’re really meaning the same thing because the concepts in the agreements are pretty much the same.

You want to have operational issues covered. So you want to say even things as simple or small as who signs checks, whether checks of a certain amount need to be signed by two people. You also want to deal with votes and how issues are dealt with in voting and what the control is. You obviously want to deal with restrictions on transfer so that if a shareholder or a partner dies, becomes disabled, or if you want to expel a partner, and the expulsion can be for cause or without cause, you need an agreement to address that. And those are generally done in shareholder agreements or in partnership agreements, depending upon the type of entity.

But another extremely important one, and is really kind of the bedrock of a law firm, is a compensation agreement. Everybody knows that people are most interested in how much money they’re making. And how much money they’re making really is a reflection of what the vision of the firm is and what people really want to motivate out of attorneys there and partners or shareholders there.

Michael: Okay. So the shareholder or partnership agreement just sort of identifies who’s running the firm and how do they operate. Is that a fair assessment? What are the basics or the mechanics of who’s got authority to make all kinds of decisions?

Jonathan: Decisions can be striated. Is there going to be one partner who’s going to make all the decisions? Is there going to be a management committee that’s going to make all the decisions? What decisions need to be approved by all the partners? What decisions can be approved by only some of the partners? And if it’s a vote of all the partners, what’s the decision making number? Is it a majority, a simple majority, super majority? Does it have to be unanimous? I certainly hope not. And different decisions can have different voting provisions. So oftentimes, we’ll do that.

So the agreement will provide what vote is required, it will provide some of the operational issues. It will also talk about the transfers of interest in the event of a death or retirement, and they’ll also address buy-ins of new partners, new partners coming in.

Michael: Okay. Then the other piece, that compensation agreement, is that for every attorney in the firm, or is that just for folks at the partner level, typically?

Jonathan: It can be both. It can be just a partner at the partner level and the associates in the firm can be on a salary. But really, if you’re looking…for a firm that’s looking to grow, they’re looking to grow associates to partners, so you want to start putting in some of the philosophies that are going to affect those people as they grow. As they mature into partners, you want to start expressing those. So what you’re really doing in a compensation agreement is trying to figure out, “What behavior do I want people to exhibit?” And once I determine that, “How do I motivate that, and then how do I reward that behavior?” So that’s a lot what goes into a compensation agreement is to figure out who the firm is. Oftentimes, it’s called the vision of the firm.

Michael: Well, okay. So I’m curious, what you typically see in terms of, you know, when are people coming in to have the conversation with you about how to put this stuff together? What are the experiences that you typically have around that?

Jonathan: Well, if I have my preference, first of all, I’m brought in when the firm starts because then, nobody has an ax to grind, nobody is looking at retirement in the next few years. And so everybody is on a level footing. Of course, and I kind of laughed when you asked the question, very few people come in and do that.

The time I see that’s bad when people come in and ask about it is, “A partner is going to retire in the next six months. What do we do?” And that becomes, oftentimes, too late. Usually though, I’ll see firms will either be advised by their consultants, people like yourself or their accountants, that it’s time to mature and have a partnership agreement or have a shareholders agreement. There will be a situation where they’ve watched another law firm have a problem, or a client have a problem, and not have the agreement. Or when they’re looking to expand, to grow and add additional partners, whether from within or lateral, those are the key factors or key times when people start addressing this fact.

Michael: Okay, so there’s a partner leaving in six months, and they’re coming to see you for the very first time. Did they have a partnership agreement that someone else put together, or did they literally not have a partnership agreement?

Jonathan: You usually see three possibilities. One, that don’t have any agreement, whatsoever. Unfortunately, that’s probably the majority of the cases. Second, you have an agreement that the attorneys of the firm themselves have put together. And what becomes very interesting is if they don’t do this kind of law, they really don’t know all the factors that go into it. But it’s a home-generated document because we, attorneys, all like to think we can practice in every area. Then thirdly, you have an attorney who’s prepared the document but it is, either they’re not experienced in doing that, or the firm has grown beyond that point, or the agreement that they’ve done, frankly, is not reflect reality and is not affordable.

Michael: Oh, yes. Right, right. Can you expound on that? So the buyout for like half a billion dollars for a $1 million a year firm, that kind of a thing.

Jonathan: What you see is it’s a number of different things. It’s an unrealistic expectation or a document that has an unrealistic number in it for a buyout that the firm can’t afford to pay, and will bankrupt the firm. It can be a number that is too large for the, either younger partners, or the associates to be willing to pay. And they look at it and they say, “This is something we’re better off just going out and forming our own firm and leaving.” And obviously, that’s very detrimental to the firm.

And lastly, among other…actually, there are many factors. But another major one is that they haven’t considered the tax consequences. So I mentioned affordable. And if it’s being paid with after-tax dollars, that may make that payment less affordable. So you have to look at the tax sensitivities on those issues, the tax treatment, as well cash flow of the firm and say, “Can the afford to do this? And is it a realistic expectation?”

What I see sometimes, and I have experiences with a number of firms, is you have a firm about to go to its third generation. There was a first generation of partners who formed the firm. The second generation bought them out, and bought them out at a significant number because that’s what was done in the olden days. And that second generation is ready to be bought out, but the third generation says, “We’re not going to pay you that, and it’s cheaper for us to leave and setup our own firm because we have all the client relationships. So we’re going to leave and set up our own firm, and you’ll be paid nothing.” So there are a number of different situations you look at and a number of different economics on that as to how that can be done. And that’s what I meant by the phrase, “affordable.”

Michael: I’m really interested. So what was going on between that first and second generation where that made sense for everyone? Was it a sense of loyalty? Was it a different economic context where they really didn’t have the option to reform?

Jonathan: It was really in a sense, it was at a time when people were coming to law firms and they spent their entire life at one firm. So there was less mobility. Secondly, there was loyalty. There was a feeling of loyalty by generation two, if I may call them that. “The generation one gave us our start. They took all the risk in setting up the firm, they created all the client relationships, they created all the infrastructure, and we’re going to reward them for doing so.” And things may have been easier then, at that point. They practiced law, may have been less competitive and less price-structured.

Michael: Okay. So what typically ends up happening in that scenario, where the third generation is telling the second generation, “Sorry, gang, we’re just not interested in paying that?” How does that typically get resolved, or what kinds of compromises do you see people making to put that all together?

Jonathan: You would tend to compromise first. You try to convince generation two that if they don’t go along with a reasonable buyout, they will get nothing because it’s very difficult to sell your practice and your clients to someone not in your firm. So I try to talk to generation two to say, “Let’s come up with a realistic number.” Generation three looks at it and says they have to look at the opportunity cost and what the startup costs are to set up a new firm and do all the infrastructure.

Unfortunately, oftentimes, that lack of an agreement or the lack of a realistic price can lead to the dissolution of the firm because the younger partners leave, the older partners basically, who have decided they don’t want to practice any longer, have no…either they continue practicing and their practice winds down with them, or they simply close up the practice and go their own ways. And depending on what agreement there may be in existence, it can also lead to litigation between the various parties. So what I try to do is explain to clients that, “You need to act realistic here,” and, “Nobody wins if it goes to litigation,” and, “What’s better is to try to work out a realistic compromise on a realistic number that is affordable to the buyers and is something that the sellers will accept.”

And I commented on value, the values of the firm and the culture of the firm earlier. One of the real key questions is, in the olden days, that generation one to generation two, the firm was looked at as being the retirement vehicle. “When I retire, I will get all my money needed for retirement from the buyout of my practice.” That’s not as much the common theme any longer, that the unfunded retirement plan which is what that is. That isn’t done as much anymore.

We’ve all seen the newspaper articles about a number of firms that have gone out of business, have had to file bankruptcy because of heavy debt, heavy partner salary, and heavy buyout obligations. So the more modern approach for many firms is to say, “You will fund your own retirement. You’ll be paid well, but you can take advantage of the firm’s profit sharing plan or 401(k). But that will fund your retirement or your after-tax earnings will fund your retirement, not the firm.” So there’s been a generational shift in terms of how retirement is being funded.

Michael: Yeah, so if you are maybe in your 50’s in a leadership position in a firm and you have enough lead time, then you can accept that. But that’s probably a lot harder for someone who’s right on the verge of stepping out and they didn’t plan for that.

Jonathan: It’s always just a little bit too late there. And the problem is the person comes in and they say to me, because I’ve had this with a firm, they’ve come to me and said, “Well, we paid generation one this number. Why won’t generation three pay us the same number?” And I have to say, “The reality is that generation three is not willing to do so. They don’t think it’s affordable. They think that they can take that money and start a firm up much cheaper and take the clients or go elsewhere and move into another firm.”

So generation two has to realize that, “No, you should have been funding it.” Oftentimes it’s too late, but you should have been funding it out all along. That oftentimes leads to, and this can be a crisis in a firm, that generation two, not retiring, continuing to practice, continuing to conduct their practices, not giving as much opportunity for generation three to grow into partners, and basically diverting a lot of the income to themselves. So it can, that failure to plan, can affect what’s going to happen in the future in the firm and what will happen with the younger partners.

Michael: Yes. Well, I was thinking that the world is different in that nowadays, associates, junior partners, these folks have a lot of options. So it really even affects not just the retirement aspect, but also how are you actually running your firm day to day.

Jonathan: What you’re really saying is, what is the glue that binds the associates and the junior partners to the firm? What is it that keeps them because there are a lot of opportunities out there? There’s a lot more mobility in law firms. And the firm has to have something that, what makes people want to stay there? Oftentimes, that is money. To be very honest, that goes back to the compensation we were talking about earlier. What motivates people is money. So they have to believe that they may make more money at this firm than they would elsewhere.

What has to be the atmosphere of the firm, the culture of the firm that is supportive, that is a culture they want to be in as opposed to a culture they would find uncomfortable, or various other intangibles that they feel they are better practicing with this firm than they would be with another firm, whether it’s depths of service, so they can cross-market to services of other attorneys, to their clients, or whether it’s resources, or whether it’s even just as simple as congeniality in the atmosphere in the firm.

Michael: Right. Yeah, the way that I think about it is that the firm needs to be a platform for the success of the people who work in it.

Jonathan: Absolutely.

Michael: And if it’s not, then they can go create their own success or go find somewhere else that does operate that way.

Jonathan: Exactly. There are a lot of firms that are looking for additional attorneys, additional experienced, qualified quality attorneys. And so the market is out there. Your audience, I’m sure, knows or should know that their attorney staff are receiving calls or emails from headhunters probably every day. So the market is out there that all of your attorneys are being solicited to go work with another firm. So you’ve got to give them a good reason as to why they want to stay. It’s good for you as the senior partner, as the managing partner, and what’s good for them as the junior partner or the associate.

Michael: Yeah, I’ve got to believe most folks are quite aware of that, and yet there’s also just the reality of what it takes to run the firm, run their own desk. It can be tough to provide the environment even if you are desiring of doing so.

Jonathan: Exactly. Yes. The practice of law is a full-time job, and conducting the business of law is actually an equivalent full-time job. That’s why many firms have moved to having professional administration. The firm you were at before, that was a position you held. You were the professional running the business affairs of the firm to free up the attorneys to practice law and grow the practice. And while that’s an overhead expense, for many firms, it’s a very valuable overhead expense to incur.

Michael: Okay. So let’s think about what are some of the things, when a firm comes in to see you…let’s assume that they’re doing this at an appropriate stage. So if a firm’s in crisis mode, that’s a different conversation you’re having, right?

Jonathan: Yes.

Michael: But if a firm comes in because they’re thinking ahead or maybe they want to create the context for the long-term success of the firm, what are the things that ideally, they’ve already thought about before they come in to see you or that they’re aware that they should be thinking about?

Jonathan: There are a number of factors we talk about. The first thing I always start with, because it’s considered by most to be the most important, is what is their existing compensation structure? And I ask them, “What are you trying to accomplish with that compensation structure? What’s your goal?” And oftentimes, firms haven’t thought about that, that they don’t realize that the compensation structure is really an expression of their culture and their values. So I like to help firms identify that, and then say, “”What are you trying to accomplish, and what do you want to accomplish, and what should you be accomplishing with that?”

I deal with that on the partner level, and I deal with that on the staff level, on the associate level or junior partner level. Oftentimes, that will indicate a lot about the philosophy of the firm. For example, if it is a strictly numbers-based objective calculation formula, that means you may have partners competing with each other. And, “Why would I want to work on your client when I don’t get any points for it? I’d rather work on my client.” All of a sudden, we have a firm that’s a silo. So I talk to the firms and say, “Are you aware that that’s the behavior you’re encouraging and motivating? Is that what you want to do? If not, then we look at switching it.”

I will move from that into the operational questions of voting. I’ll start at, “Do you have a managing partner? Is that a structure you want to have? If so, how long does that managing partner serve, and what is that managing partner’s compensation? Do they get some extra compensation for running the firm? And do other people who do administrative tasks, quality control, training associates, etc., do they get additional compensation for doing that, or how are those jobs split up?”

You move from there in terms of voting. “What issues can be done by some of the partners versus all of the partners? How do you structure that, and what decisions require unanimous? What decisions require super majority? What decisions require simple majority? What decisions are made only by the managing partner?” Or if there is one, “What decisions are being made by the executive committee or management committee?

After that, we’ll move into questions of, “So what happens if a partner departs? What are the circumstances we need to address?” And oftentimes that will include death, disability, retirement, retirement to compete, expulsion without cause, expulsion with cause, and oftentimes, addressing the bankruptcy of a partner because that can have a significant effect on the firm. And we talk about what the payout would be, what the terms of that payout would be. What I find is, I walk in with that agenda and those particular items on the outline, and it expands well beyond that. All of a sudden, people start talking about what really is going on, and I find out a lot more, and you have to react and change as you go to reflect each firm.

Michael: Well, the cool thing is having those conversations with a lot of firms…somebody who’s only existed in a certain firm doesn’t see that there are other options. You were talking about the compensation, what’s the goal? And I was curious if you could maybe talk about some of the differences that you see. So what are some of the things that people incentivize through compensation or try to address that?

Jonathan: There are kind of roles if you talk about in a firm. And one of the roles are the finder, minder, grinder, and a new one has come up in the sense that people are using now, binder. The finder is the one who brings in the work. That’s the rainmaker in the old parlance. The minder is the one who supervises the work that’s being done, make sure that the work is getting out, make sure the associates are working properly, make sure the right people are getting the job. The grinder is the one who actually sits in the office and does the work. Usually, a junior associate, but there can be partners who are grinders.

And by the way, these are all three, and the fourth one I’ll bring up also, are all very valuable tasks. Firms have to realize that they shouldn’t just identify the finder because that just brings the work in the door, but that doesn’t get it out of the door. The last category is the binder, and that’s really the client relationships. That is not the originating partner, and that’s somebody who handles the client, make sure they’re happy, deals with them when they call with complaints, deals with issues that they have. And these are all very valuable roles.

What I found actually, because I’ve been with small firms and I’m now with a large firm, and what I found is that firms mature, size grow. In the beginning, when a firm is first set up, there’s a simple method of, “Well, we’ll all just all share equally.” And you can see kind of where that oftentimes goes, leads to jealously, and leads to problems and complaints.

You move from there to an objective formula, which is you figure out what your price. Most firms’ price originations, bringing in work and price work out the door, basically, hours that are billed and collected. And by the way, I do want to emphasize collected. What you bill is not as relevant as what you collect. So I try to focus all my clients on being it’s collections, it’s not billings. And I try to correct that phrase with them. So you look at that. And those are the two only factors, but those are the two primary factors that you look at. And you have to look at how you weigh those two, and what the formula is, and how the formula is applied.

But the other thing is, there are a number of other things, for example, that can be modifications to that formula, which are factors that people need to look at. When you look at it and say, “How’s the associate utilization? Is the partner using associates, and are we making money on those associates?” It’s profits, and so, “What is the profit? What’s coming to the bottom line from the use of the associates?” So you look and say, “We’re making money on the associates, so partner who generated that work should be rewarded for that.” Alternatively, if there are major write-downs or preferably, write-ups. But a lot of write-downs, whether it’s worked-to-billed or billed-to-collected, that is a ding on the the firm, and that may be an adjustment.

Michael: And just to clarify the term, can you define write-down?

Jonathan: Write-down is two components. I worked an hour, do I actually bill the hour? Or if I work an hour and I can only bill a half hour of that, that’s a write-down. And then if I bill that half hour and the client pays nothing, that’s a write-off, but it also goes into the write-down. That means that the hour I’ve spent, the firm has gotten nothing for it. More crucial for that is the hour the associate has spent, which we are paying the associate for, if we don’t collect that amount, then that’s a financial drag on the firm. So we look at that. That’s an important factor to look at in terms of, “What are you actually collecting on the work that’s done?”

As firms however mature, it starts to become a little bit…and then grow in size, it becomes a little bit less of a objective calculation and can become more subjective. There are a number of firms which basically look at it and say, “Let’s have a compensation committee sit down and figure out what your contribution was to the firm.” And everybody will talk it through, and figure it out what each person’s contribution is and figure out how to reward that among partners. And there can be combinations of these. There can be parked on one way, parked on another way.

Our firm structures it, and we call ourselves a meritocracy because we look at everything, all of the factors that people contributed. They contribute billing hours. They contribute originating clients. They also contribute managing matters. They contribute in terms of marketing, in terms of firm management and firm committees. And we look at all that and say, “Okay, we’re now large enough. Let’s look at that and say, ‘What are all the factors that go into how somebody is contributing?'” And that enables us to figure out what the person’s true contribution is and how to reward that person. So I’ve been with small firms and large firms and I’ve seen different compensation structures, and realized that there are benefits to both, and that the benefits change as the firm grows.

Michael: Okay. I have a question sort of percolating that I want to ask. And it’s not something that there’s…it’s not a factual thing. It’s just a gut thing, right? But I wonder, of those four roles, and just imagine in any firm, if we say that a grinder gets compensated at a value of, like an index value of 100, do you think you could put in like a markup or markdown value on the other folks? What do you typically see in terms of how people look at them?

Jonathan: I don’t know that there is any specific correlation or any specific numbers I can give you. I’ll striate it more in terms of importance of roles and how financial recognition is rather than percentages or multiples. But you look at it, the firm can’t survive without all of those roles being filled. Some people may fill multiple roles. So you may have the finder also being the minder. But if you look at it, the first thing that’s important is to bring work into the firm. And so that, finder is extremely important, maybe the most important.

Michael: And some would argue that’s the hardest job, or the job that the smallest percentage of people in the world generally are going to be good at.

Jonathan: Lawyers were not trained. If all of our listeners go back to law school, I challenge them to find the class where they learn to market, where they learn to originate work, because none of us went to law school and were taught that. And it’s something that lawyers don’t frequently do. So it is a very tough skill for people to learn. I still believe it’s learnable, but it is a tough skill for people to learn and to want to learn. But it is a lifeblood of the firm. Dollars coming in the door, the clients coming in the door to retain our services, to pay us, is lifeblood of the firm.

But the second, perhaps not as important but extremely important is getting that work out of the door to the client. And that is the minder and the grinder. It’s combination of those two. The grinder is the one who’s actually doing the work. The minder is the supervisor of that person. So normally, you find, as in any other company, that the supervisor is likely to be paid more because they are not only doing work, but they are making sure other people are doing the work. The binder is a relatively new description of people, and it maybe the minder is doing the binder duties. It may be that the finder is doing the binder duties. But it is also extremely important. Probably not up to the level of the finder or the minder, but it may be in between the minder and the grinder.

Michael: Well, and also, I would say it seems like maybe a career path that leads to finder. It’s a good way to develop the skill.

Jonathan: And we haven’t talked about this at all, but let me talk a little bit about the responsibility of the senior partner, of the finder. And one of the responsibilities of the finder, in order to ensure the survival and maturity of the firm, is to train others to be finders. So you segued into that perfectly, which is that it would be great if the finders were introducing the minders to the clients, helping them create the relationship, and then teaching them how to grow into being finders. A beginning part of that maybe to cross-sell other services of the firm to that client, and then to learn to go out and start bringing in clients of your own.

Michael: So I’m going to answer my own question and see if you argue against what I come up with, okay?

Jonathan: Okay.

Michael: So again, these are index values, not like dollars. But if the grinder is compensated at an index value of say 100, I’d say maybe the binder is 125…I’ll give you the whole slate, then you can comment…

Jonathan: Give me the whole slate, yeah.

Michael: The binder is 150, and the finder is 250 to 300.

Jonathan: I’m not sure I would take the finder up quite that high. Your steps are not out of line, but I’m not sure I would take the finder quite up that high because it depends on whether that person is also doing work. If they’re just bringing it in and turning it over, then that is one factor, but if they’re also doing the work, they might be entitled to more. I might take that finder up to closer to 175 to 200.

Michael: Okay. Every firm is different and every practice area is different, too. So this is not by any means something you can hang your hat on, but it does create a sense of…

Jonathan: I would call them priority of importance as opposed to necessarily priority of compensation. So those factors may not go in 100 to 125. It may not have a direct correlation to compensation, but it has more of a correlation to how important that person is to the future of the firm. And then you figure out how you compensate that. Again, it depends if you have a minder. If you do the minder stage, if they are doing a lot of work and getting work out, they may be at the higher range of that scale. Whereas if they’re just supervising and not necessarily having any client contact, not doing any work themselves but simply supervising, they may not be at the higher range of that scale.

Michael: Okay. Okay. So the obligation of the finder is to develop other attorneys. Do you have any perspective…do you see that as something that finders, generally speaking, have a willingness to do or have a resistance doing?

Jonathan: I’m going to give that typical lawyerly answer of yes to both, and that is it really depends on the firm and the person. A person who is really committed to the future of the firm, the survival of the firm and the growth of the firm, realizes that they can’t do it all themselves, and they have to help other people develop, and so they take other people under their wings. And they can be young associates or they can be the more senior level minder that we’re talking about. But they look at it and they say, “Okay, I want to grow and expand, and I want to keep this firm more than just me.”

Some attorneys look at it and say, “If I start teaching others, then I’m only going to empower them to leave. So I want to keep them in a position where they don’t know how to do this.” I don’t think this is good for the firm, but this is human nature, where they don’t have the younger people learn how to do that because they don’t want to train them because they’re afraid they’re going to leave, or they’re afraid they’re going to take their clients with them when they leave.

So you really have two schools of thought. And it really depends upon the philosophy and the culture of the firm is, “Do I want to grow this firm? Do I want to make it more than just my firm or the firm of two or three of us? Do I want everybody to be able to bring in clients and become a full-fledged partner, originating, as well as working?” And it’s a philosophical question that has come up. I find a lot of firms as they approach the issue say the right thing. They say they want to train people. They want to grow them. But yet, you see it less often in practice than you do in words.

Michael: Yeah, yeah. Well, okay. So it seems to me, I would argue that the firms that really have that openness, and instead of trying to retain their client base by maybe keeping their associates in a box as it were, struggle to truly grow and prosper, as opposed to the firms that are always looking to enrich their associates and give them every single opportunity and then attract them to stay in the firm with those clients because it’s a great place to be and a great place to succeed.

Jonathan: And I’ve got a great future at that firm. You want to instill in that associate and that younger partner the feeling that this is a great place for me to grow, this is a great firm for me to be part of, and this is a firm where I will be able to make as much if not more money than I would any place else in an environment that I want to be.

Michael: Right. So has that borne out in your experience, or is that just a nice idea?

Jonathan: It’s a nice idea that is not followed as often as I would like, but I have seen firms to be very successful with that. One of the examples, and I look at it and just one of the quick indicia of that is, do you see that when the senior partner goes out to have lunch with the major client, and the partner goes out to have lunch with the major client, do they bring the associate who’s doing the work on that with them? If they do, then you see that that’s a dedication to growing that associate, to creating a stronger bond with the client, and to developing the firm. I have seen that happen. I like it when I see that happen. Does it happen as often as I would like? No.

Michael: Have you heard the term…I think I heard it called “zippering,” where you try to match someone at every level in your firm with their counterpart at every level of the client’s organization?

Jonathan: I have not heard the term but I understand it. I actually will use it when I’m dealing with marketing. I do a lot of work with accounting firms for example, and get a lot of referrals from accounting firms. So I will try to, when I’m meeting with a senior partner of an accounting firm for lunch, I will try to bring along a younger associate, and ask the accounting firm to bring along a comparable-age person, and have those two bond, or zipper as you say, have those two bond so that when the senior partner and I retire, there’s still a continuing working relationship between the two firms. That works equally well with clients. It’s a question of whether you have the proper generation representation.

I represent a lot of family-owned businesses so I’m more attuned with the more senior member of that family. I’m happy to bring a younger associate along to meet the younger member of the family so that when the senior member of the family is out, we don’t lose them as a client. They stay as a client. They may be more associated with my associate than me, but that’s great. They’re still a client of the firm. So I think zippering, as you phrased it, is a very productive, but also, people look at as saying it’s a very dangerous approach because that empowers that younger associate to feel they may be able to take that client with them when they leave. So you have to trust the younger associate, and it goes back to you have to make the younger associate want to stay at the firm.

Michael: Right. Yeah, you can’t just deploy one piece of the strategy. You have to have all the pieces in place.

Jonathan: It needs to be integrated. It really needs to be integrated in terms of the approach of saying, “Here is why the five different directions I’m coming at it, as here’s why it’s a good thing to do, and here are the five different directions I’m going to deploy that strategy to integrate them all together.”

Michael: Yeah, yeah. Well, one of the other things I wanted to ask you about…well, there’s a couple of pieces of the agreements in particular that, or objectives that managers may have when they’re contemplating these types of agreements. One of those is putting incentives in place so people don’t leave, financial incentive. And just so I don’t forget the other one, I was thinking about…well, I don’t know. Let’s jump into that. I think the other will come back to me.

Jonathan: In terms of the financial incentives, you have to define, “What do I want?” And it actually applies my partners, as well as my associates. “What do I want people doing, and how do I incentivize or reward them for doing so?” So for example, it goes back a lot to the compensation structure, but do I want my partners trying to do work for other partners’ clients? If so, “How do I incentivize my partner to take me out to lunch with their client, and how do I incentivize them?” Because then all of a sudden, we get another area of representation for that client that we might not have heard before.

So you’ve got to look at it and say, “Have we created unknowingly a bias for people to hoard clients, or have we created a bias towards people sharing clients and sharing work across the firm?” We have to look at it and say, “What are we doing, and what can we do to encourage people to broad-spectrum the client services we provide?”

Michael: Right. So if it’s just pure points, like I’m competing against you for points, then that creates the hoarding?

Jonathan: That can create the hoarding, but it depends on how the points are calculated and what they’re applied to. Some firms have done it and simply said, “Okay,” and I’m going to pick arbitrary numbers here. These are not binding numbers, but I’m just picking a number to have a discussion.

Michael: Sure.

Jonathan: “My compensation is going to equal 30% of all the work I bring in. And is that my originations? Well, then I’m incentivized to have other people do work on my clients because I’ll get points for them working on my clients. So I’ll get 30% of the revenues we collect by my associate, Joe, working on the client.” Other firms say, “No, it’s 30% of the revenue you collect on your own time.” All of a sudden, that means there’s a disincentive from me having Joe working on that matter, that I really want to do all the work myself.

In an old firm I had, we had what we called red zone and green zone. Green zone was when a partner or any level attorney was working in the area where they shouldn’t be working. They were not doing work below their skill level. And red zone was when an attorney was doing work that they shouldn’t be doing. We tried to encourage…and my red zone is going to be an associate’s green zone. So part of the development of an associate is to have them me push my red work down to their green work and have them do their work on that.

So what does a compensation plan do? What does the structure of the firm do? What do we encourage? Do we encourage our people to be silos so that people will keep the work and not share it and I get no benefit from working on your client, or do we create a system where as the tide rises, all boats rise? There’s that expression that all boats rise on a rising tide.

Michael: Right. And the thing is though, you don’t want to make it so complex that it becomes a tracking nightmare. But there’s no question that…

Jonathan: Yes. We did have a very complex program, and it was very difficult to do the tracking, and our office manager was probably…this is in an old firm. He was probably one of the few people who understood it. But it worked very well because we had it setup and it had been there for many, many years, and it really did encourage. We referred to it as, “The best thing I can do is bring some work in and have somebody else work on them and not touch it myself.” That that rises the entire profits of the firm.

That’s where I was going in terms of saying, “It’s a 30% of what we collect from my clients’ billing, or is it really that I get points that are applied to the total profit of the firm?” What you really want to do is have a system that encourages me to be happy at your success because when you’re successful, you collect a lot, and your clients grow. I’m going to make more money. So all of a sudden, that leads to congeniality.

Michael: So is there a simple, straightforward way to do that?

Jonathan: Not necessarily. It depends on how strictly you want those measurements to be and how exact you want those measurements to be, or whether you want to do it as more of a subjective factor where all the partners in firm or the compensation committee gets together at the end of the year and figures out what everybody has done.

The ideal might be for the smaller firm to have a two-part formula. One part is strictly objective, is formulaic, and is based on rewarding the two key behaviors. There are other behaviors, but the two key behaviors, which is basically bring in a lot of work and do a lot of work yourself. But maybe that constitutes 75% of the compensation, and then there’s a 25% that is done on a subjective basis, where the partners get together and allocate it out, or the management committee gets together and allocates it out. And that’s what deals with a lot of what we can call the good citizenship activities in the firm.

Michael: Yeah, that’s interesting. I have a bias, or a preference rather, towards objective measure because I feel like anything subjective creates an environment where people have an incentive to jockey for position.

Jonathan: And what you have to do is keep that subjective portion important, but not so overriding important that it dominates the firm. We want that to become a nice extra, but not end all and be all. So you have to figure out what percentage is enough to make somebody feel like they’ve received something, they’ve received recognition, but not so much that you lead to the game plan. Some firms have done it on a ballot and said, “Let’s all the partners vote on how we allocate up this bonus pool.” And then you see lobbying and people going into each other’s office and lobbying, “I’ll vote for you if you vote for me.” That’s not productive for the firm. So you try to avoid it being that significant a number. If you’re going to do this fabricated system, you try to keep it from being that significant of a number as to lead to that lobbying.

Michael: Yeah, yeah. I mean, again, it all comes down to what’s going on in a particular firm for sure.

Jonathan: There’s not one size fits all. That’s really the sense of what you’re saying. Each firm has to look at this and design what works best for them.

Michael: I thought of the other thing I was going to ask about is making it possible for rising stars to become equity partners. Is there a way to help them? Because it’s great to become a partner, but if that comes with a need to deposit money, it’s not as attractive.

Jonathan: And the more senior partners in the firm have to recognize this. That your younger people, your younger partners, or your younger associates, they’re coming to you oftentimes with a whole load of debt. They’ve got school debt which may be still be being paid off. They want to buy a house, the house prices have gone up. They’ve got significant economic pressures on them. So where a lot of firms used to have a significant buy-in, that is becoming less so, because people can’t afford to do the buy-in. That can correlate to what the buyout is. So the senior partner has to recognize how that affects them. But it is difficult for the younger partner to come up with the dollars to be able to buy in.

So some of the buy-ins now are being structured rather than on a, what we’ll call for lack of a better word, a goodwill factor. They’re being structured more on, what we’ll call, on a cool balance sheet basis, which is a partner coming in, may have a partner buying in, they buy into the capital account, which the capital account is going to be the furniture, fixtures, and equipment, the cash, the kind of things that show on a cash basis balance sheet. And then the accrual portion is the accounts receivable collectible portion, plus the work in process collectible portion, minus the liabilities. And maybe a partner, if they’re an incoming partner, if they’re going to share in the collections of the accounts receivable, has to buy in for that portion of it.

The alternative is they don’t receive any portion of that accounts receivable. Again, a bookkeeping nightmare. But they don’t share in the collections of accounts receivable. They only share in the work that’s generated or occurs after they become a partner. And that is one way of minimizing their buy-in. But it also goes to the tail-end, and may minimize what the buyout is because they’re saying that, “This is what I paid to come in, then that’s what I want to pay you when you leave.” It’s a two-sided sword.

Michael: So let’s just say I’m an absolute rock star associate, the best that’s ever come along, and I’m getting to the point where I’m thinking about partnerships. So we get into that meeting and we’re sitting down, and I’m hearing all the stuff for the first time. I recognize the value of being a partner on my business card. I get that. But why do I want to pay money to assume a portion of the risk of the firm? What am I getting out of this experience?

Jonathan: And many firms have come up with what’s called the profits partner, the non-equity partner, which is really just a next step up from being an associate, but a step below being a partner. It’s no equity in the firm. But it’s either sharing in profits or it’s being able to put on your business card, I’m partner. And a lot of people feel they need to do that for marketing or otherwise. There’s a whole generation which doesn’t necessarily want to be partners, but that’s a different subject.

But that person coming up, you have to look at it and say, “If they want to be a partner, what do you want out of them as a financial commitment?” And it doesn’t need to be all upfront. Some firms require it all upfront. Some firms require to be paid over time. Some firms have an arrangement with their bank where they’ll say, “We want you, bank, to loan the new partner enough of the money to buy in,” and then they’ll arrange to pay it back over the next 5 or 10 years.

Sometimes, it can be structured, and it isn’t necessarily a…isn’t formally structured this way. But an incoming partner gets a lesser compensation than the other partners on a scaling period so that they, in essence, pay for it by their compensation. As the senior partners get more compensation, the junior partners earn their interest by getting less compensation. That’s a very tax-sensitive subject so your listeners who are hearing this need to make sure they consult with their own independent counsel and with their accountants to make sure that they’re doing this correctly.

Michael: Well, and I think that applies to this whole conversation however.

Jonathan: Yes, I’m a California lawyer. I’m not licensed in any other state. The law, I’m speaking from the California perspective. But it really is important for each person to talk to an experienced attorney, and talk to somebody who’s done this type of transactions and work through all these issues. We’re covering a lot of subjects on a very lighter, superficial level. For people who are looking to actually do this, they really need to think through all the issues, discuss it with their counsel, discuss it with their accountants, and other financial advisers.

Michael: And no question about that. Well, let me, if I may go back to that question because I still feel like if I’m looking at this opportunity as this associate is trying to decide what to do with the next 10 years of his or her life, why do I want to do that?

Jonathan: And it’s a very tough question. That’s actually a very good question which a lot of associates ask. It is that this is the path to partnership, this is the path to making more money. Some firms, and not all firms, but some firms actually base compensation, or at least a portion of compensation, on your ownership percentage. So the associate may be told, “If you buy in as a 10% owner, you will get 10% of a certain share of the profits, certain amount. You get a compensation, but then you will get an extra kicker that we will allocate the profits or the excess based on ownership percentage in part.” So there may be an immediate and ongoing return in terms of my ownership percentage of the profits. So it’s, again, money is the motivator.

Michael: Yes, well, that piece makes sense. The other thing is in a firm where there’s a smaller group of partners, being one of them means you have more ability to control your own destiny.

Jonathan: Yeah, more ability to control your own destiny or more ability to have input to the firm and input in the decisions being made. And it really is an indication that you have picked this firm. The young associate has picked this firm as being their future career, and this maybe the price of entry. It maybe the door fee to get in the door to be a partner in the farm, to have access to the additional profits and control and prestige of being a partner in that firm.

Michael: Right, and for attorneys who are oriented towards having a career in the firm, long-term, there’s also this aspect of, if you haven’t achieved that at that right point in your career, then you start to become less attractive. Your own options close off because it may be questions…

Jonathan: Why didn’t you make partner? It’s that question. And it’s a question asked if you decide to make a lateral move to another firm. It’s also a question asked by clients as you’re trying to originate work from them, or clients with whom you’re working. “Why aren’t you a partner?” So it does at a certain level of your career, the experienced associate has to say, “If I want to continue with this career, I’m going to face too many questions if I don’t become a partner. And I’m not going to be able to advance my career if I don’t become a partner.” Plus we’re all trained…frankly, this is one thing we’re all trained in law school, “Let’s grow up to be partners.” So that was considered the ultimate goal.

But the question you raised is a very good one and is one I raise with my clients all the time. “Why does this associate want to become a partner in the firm? What is in it for them?” And it’s a question that firms have to grapple with. Each firm is going to have a different answer to that. Sometimes, it’s compensation. Sometimes, it’s influence, and control, and input. Sometimes, it’s prestige. Sometimes, it’s simply the future. The senior partners are going to retire. The firm is only going to be “inherited,” and I use that word in quotes, is only going to be “inherited” by those associates or more senior attorneys who are partners. So it may mean that they’re no longer going to be at this firm or no longer going to be an important person at this firm if they’re not a partner and the senior partners retire.

Michael: So I was thinking as a closing question, I wonder if you have any interesting war stories or anecdotes that you can relate just from all the firms you’ve interacted with and anything come to mind as just fun and different, not a typical…

Jonathan: Each law firm is uniquely different. What I have seen and what’s just been really sad is the firms that don’t plan for this are the firms that when the senior partner dies or retires, the firm falls apart. And all of a sudden, the clients are cast out, the staff is cast out, and the attorneys are cast out trying to find new jobs, and the firm disappears. So it’s important to do so.

Where I’ve seen…probably, most of the war stories are not funny. They’re sad. And it’s really where I’ve seen senior partners say, “I expect and I built my entire lifetime around knowing I was going to get this when I retired.” And all of a sudden, they don’t get that. And it turns out that the younger partners are not willing to pay them that, and it upsets people’s lives completely. It upsets the whole plans for retirement. So it’s an interesting way and it’s a sad event, but it’s where expectations are not fulfilled.

What I’ve actually seen a lot of times with this discussion though, is on the positive side, I’ve seen the strength of partner relationships. And I’ve seen people, when we go into these discussions where I expect there, perhaps, to be a pitch battle or I expect people to disagree, it’s amazing how supportive the partners are of each other and what they will do to help each other. And sometimes, the example is if one partner is out for a health situation, what does the firm do about continuation of their compensation, and what do they do about continuation of their profit share, and when do they buy them out?

And what’s nice to see is the firm that has a long, binding relationship, congenial, their support. And that the partner who’s affected by that disability or affected by that short-term surgery gets immense support from their partners. And that’s what’s really gratifying is when you see a firm that works. And I see that when I talk about the agreements, and I see the way the partners approach it, and the way they speak about each other and speak about what they’d do for each other.

Michael: It’s interesting. It kind of speaks to a really important thing is that the core of any law firm are those personal relationships of either the founding members or the leadership team that’s in place. And when those are strong, then you can have a really good, healthy firm. And when they’re not, it doesn’t matter what you try to build around that.

Jonathan: Right. And again, I go back to the responsibility of those senior partners, of those management partner, the founders or the management partners, is it’s really their job, if they have a strong relationship with each other, to try to inculcate that in the younger generation and try to have the younger generation have that same feeling. If they don’t, there’s no firm. They’re a group of sole practitioners practicing together. And you see that all too often as just a group of sole practitioners sharing office space, and they’re just an expense sharing arrangement. And that is different from a firm. A firm shares clients, shares culture, shares the ups and shares the downs. And hopefully, it’s a situation where if one practice area is down, the other one is up, and they know that both of them are going to be up and down and everybody realizes it’s on the long-term, not the short-term.

If we spend probably more of our lives in the office practicing than we do at home, or hours certainly per day, and if the environment is not pleasant, if the environment is not conducive to success, that’s not a prescription for a firm to survive. And I can usually tell by talking to a firm in the first meeting or two, whether they’re going to survive the departure of their key partners or not.

Michael: Wow.

Jonathan: And you can usually figure that out just on the way they…interpersonal reactions, if you talk to the younger partners and what they’ll hopefully honestly tell me. I’ve had a number of firms who’ve brought me in and said, “Go talk to every single partner in the firm. Confidential, don’t report to back to us on any names, but talk to everybody. Don’t tell us who said what, but tell us what people said, making sure it’s anonymous.” And it’s amazing what you can find out about the firm. And you can really predict the firm’s future that way.

Michael: Yeah, that’s fantastic. Of course, when your conclusion, based on that initial round, is not positive, I guess you want to reflect that back, but in a way that they can take action as opposed to saying, “You guys, there’s nothing you can do here. It’s not going to work.”

Jonathan: I refer to that, and I say this at the client initial meeting. I say, “I get to talk about the elephants in the room. I’m here. I’m not going to be here tomorrow. I’m here today. I don’t have to deal with you getting angry with this one, getting angry with that one. I will deal with and address the subject of where I see the weaknesses of the firm, and tell you if you need to resolve those and tell those that are going to interfere with it.” And some firms will listen and try to rectify it, will ask me what to do to rectify it, and will bring in outside assistance to rectify it. Other firms will just laugh it off, and the senior partners may say, “I’m making enough money. I don’t care.” So it can be going both ways.

Michael: Well, fantastic. Jonathan, I really appreciate your time. And I know you put a lot of thought into this topic before we spoke so I really appreciate it.

Jonathan: Thank you, Michael. I appreciate the opportunity to share with your listeners, and hope I provided some valuable assistance.

Michael: Sure. And for folks who want to reach out to you, what’s the best way to reach you?

Jonathan: Probably, the best way to contact me is you can go on…basically, e-mail me, and it’s J-K-A-R-P at Thompson, T-H-O-M-P-S-O-N, Coburn, one word, C-O-B-U-R-N dot com, jkarp@thompsoncoburn.com. And they can also go on our website, and they can pull up my bio and pull up our practice areas. We’re a national firm. We have offices in Los Angeles, our newest office which I helped to open. And we have main office in St. Louis, we have Chicago, and Washington D.C., and Southern Illinois. So we’re a broad-based firm, and we have a lot of practice areas. Actually, a lot of the things I talked about are exemplified by this firm, that we really do congenial, we help each other, and we work for a common goal, not as silos.

Michael: Right. Yeah, that’s fantastic. Well, thank you so much, Jonathan. I appreciate it.

Jonathan: My pleasure, Michael. Thank you.

Key Links

Show Notes

  • What are the basic agreements that form the foundation of a law firm (that’s run by any structure other than a single owner)? [2:05]
  • Deciding on the structure for making key decisions in a firm [3:47]
  • Thinking about what to include in compensation agreements [4:42]
  • When a firm addresses the foundational agreements earlier, nobody has an axe to grind [5:38]
  • Waiting to deciding on arrangements just prior to the retirement of key partners is typically problematic [6:10 ]
  • Typical scenarios he sees when firms come to see him so late in the game [6:48]
  • Firms often have unrealistic buy-out numbers specified and this puts the firm in crisis [7:45]
  • Many problems arise (for firms that have been around long enough) when it is time to transition a firm to its 3rd generation [8:52]
  • Market conditions were different years ago for the transition from the 1st generation to the 2nd [9:39 ]
  • Why the lack of an agreement with a “realistic” price can lead to the dissolution of a firm [10:40]
  • Those changes in the marketplace that effect the buy-out calculus also impact the framework for day-to-day operations [14:43]
  • This is an environment where associates and staff are receiving inquiries from headhunters daily [16:42]
  • Topics to think about before beginning the process of drafting foundational agreements [18:04]
  • What parameters should you put in place for when a partner depart? [20:46]
  • Key roles for attorneys in a firm: finder, minder, grinder, and a newly-introduced term, “binder” [22:05]
  • What are the relative values of these four roles? [27:07]
  • Often finders like to focus solely on their own book of business, but in the best firms, they also focus on developing others into the finder role [30:10]
  • How top firms create a culture of developing associates and integrating them into client relationships [35:00]
  • Deciding on elements of compensation: objective vs. subjective measures [46:15]
  • Why is it a good deal for a rock-star associate to become an equity partner in a firm? [48:34]
  • Seeing firms fail because they don’t have sound agreements in place [55:47]
  • On the positive side, seeing strong partnerships support each other and be there during moments of crisis [58:45]
  • At the core of each firm are the personal relationships of the leadership team [57:50]
  • Being able to perceive the strength of a firm within that initial meeting [59:08]
  • Being able to talk about the elephants in the room [1:00:25]