Lawyers: Understand the Math
I sometimes hear from young (and sometimes not so young) lawyers who do not understand the math that supports their compensation in a law firm. They know that they are unhappy and they believe that deserve more. They are thinking of answering the romantic call of the recruiter. However, they often do not have a deep understanding (or any understanding) of how their contribution is measured by the firm, apart from the obvious factor of tracking billable hours.
This is frequently the firm’s fault for a variety of reasons which I will not get into right now. Instead, I would like to focus my musings today on what lawyers should understand about their own financial contribution to their law firm. With that understanding they will be better equipped to understand whether the value that they bring to the firm is being under appreciated by the firm or overestimated by themselves.
This may not be exciting stuff. But it is kind of crucial for lawyers who are devoting their mental energy to trying to decide whether to jump to another firm for a better financial deal. At least some of the lawyers who do that are going to learn the truth that ‘wherever you go, the contradictions remain the same.’ And those people may find that they would have been better off understanding their financial contribution and working to improve it rather than jumping into another fire.
So, let’s get started on some things that every lawyer should know about law firm economics and their own performance:
- Law firms, like every business, relate their costs to their revenue. The traditional approach is that an associate should bill three times their salary. The idea is that one-third of revenue goes to overhead and one-third to partner profits. Note that there are some who say that this has changed over time and that the new standard may be that associates should bill four or five times their salary.
- Of course the correct relationship between billings and salary will vary from firm to firm depending on their overheads. Perhaps salaries should be adjusted upwards in a Covid and post-Covid world where some law firm overheads have decreased with the elimination of many in-person marketing events, expenses related to clients attending at the firm’s offices, and in some cases the reduction of office space. Just don’t expect the partners to be instigating that conversation.
- As a starting point, every associate should figure out how their salary measures up compared to their own billings. If they are over-contributing, perhaps there is room for a salary increase. If they are not, they may have less leverage to ask for one. Start with asking whether you are billing more than three times your salary.
- Most lawyers have a billable hour target set by the firm. Multiply the target by your hourly rate. Divide by three. The result may come close to your salary. If it does, it will confirm that the firm’s expectations align with one long-accepted measure for determining associate compensation. If the result is significantly higher or lower than your salary, try to figure out what the firm’s thinking is in setting your target. Do they think that for their business, you should be dividing by 4 or 5 instead? Are their overheads much higher or lower than the norm? Are they particularly generous? Are they particularly greedy?
- Is your target reasonable? Do you think you can achieve it? If your health, values, and life priorities are such that you cannot make the target, perhaps you are at the wrong firm. Let’s be clear about lifestyle. I personally am a great believer in working less and enjoying life more. However, that comes with earning less. From the law firm’s perspective, those who put in more billable hours earn more than those who don’t. They are not going to pay for your lifestyle choices. Come to terms with it.
- If your target is reasonable and you still struggle to meet it, you have to understand why. There are good reasons (which should not drag down your compensation), bad reasons (which should suppress your compensation) and neutral reasons which should be up for discussion with management. Good reasons may include the firm requiring you that do other stuff, such as mentoring, marketing or administration beyond managing your own practice. Bad reasons may include poor docketing skills, excess write-offs of work in process or accounts receivable that you do not control, and being instructed by partners not to record time on certain matters. An example of a neutral reason may be being required to take on files that are outside of your expertise or to develop a new practice area. That type of investment benefits both you and the firm. There should perhaps be a discussion about who should pay for it.
- If you are not good at docketing, billing, and collecting all of your time, get good at it before you even think about complaining about your salary. In my experience, the simple fact is that partners care about what you bill, not how hard you work. If you are working hard but not recording and billing your time, you don’t have much of a leg to stand on to complain about your compensation and the situation is unlikely to be much better wherever else you may go.
- Every lawyer should understand their write-offs of work in process and accounts receivable. If you are the person making the decisions, you have little or no excuse if these write-offs are excessive. If someone else is doing that, the question arises as to whether they are all being handled in a reasonable manner. Good mentors will keep you in the loop and explain why the write-offs are being made so that you can learn to minimize them. If they are being made without your input and without explanation, you should try to fix that.
- A related issue concerns credit risk. Are partners requiring you to work for clients who do not pay? If so, are you getting paid for your hours anyway? On the other hand, if you are making the credit decisions or failing to get financial retainers, it’s on you!
- You also have to understand your billable rate. In some specialties, hourly rates are lower than in other specialties. For example, rates for employment lawyers tend to be lower than rates for tax lawyers. If you are in a lower billing specialty, either suck it up and stop complaining or change areas of practice.
- Who is setting your billable rate and how are they setting it? Are your clients willing to pay more? If so, are you being allowed to charge them more?
- Lawyers should also understand the financial metrics of their own practice, including things such as: (i) do you work with clerks who bill under their own names but who would not be able to do their work but for your supervision?(ii) is your collection rate much better or worse than that of others? and (iii) does your work allow other lawyers to do their work and bill large amounts that the firm would not be able to attract without your specialty?
- With respect to overheads, lawyers should know the answers to the following questions: Do you use significantly more or less overhead than others in the firm? For example, do you share a legal assistant with three other people while others have a legal assistant for themselves? Does your practice require that the firm have on staff a very highly paid legal assistant or law clerk while others use junior staff? Is the firm spending a lot of resources to market your practice? Someone has to pay for all of this stuff. It may be you.
- If you are not making your target because there is a shortage of work, you have to ask yourself whose fault that is. If you are in your first three years or so, that is probably the firm’s fault. After that, it becomes more and more your fault each year that you continue to practice without building your own client base.
- Another important issue is about client credits. Do you bring in business? If so, are you being compensated for doing that? Assume, for example, that you brought in $1,000,000 of business, some done by you and some done by others. In some firms that I am familiar with, that would be worth $100,000 more salary (10%) that the same person would earn just doing work that the partners brought in.
- Let’s talk about building a client base. With the exception of some large firms who may want their associates to focus on serving the firm’s clients instead of bringing in more clients, most firms want their lawyers to bring in business, especially after their first few years of practice. This leads to many questions that each lawyer must ask, the answers to which they have to understand. Some of these are:
- Does your firm record and track the business you bring in and compensate you for it in a measurable way?
- Does your firm keep you completely busy doing the firm’s work but still complain that you are not bringing in your own clients?
- Does your firm have a system to give you client origination credit for long-time firm clients for whom you now manage the relationship, or will you only get compensated for that by leaving the firm and taking the client with you?
- Does your compensation system reward you for bringing in clients and delegating the work to others?
- Does your firm support your marketing efforts with training, administrative support, and a marketing budget?
- On the topic of developing a client base, every lawyer has to understand that there are many firms which will not make people partners unless, at a minimum, they are self-sufficient in terms of bringing in work, and typically they would be expected to feed themselves and others. If you are not developing your own client base and you are not satisfied with what you are earning as a “grinder,” you have two choices. One choice is to learn to market and bring in business. It is fun and rewarding, and I am talking as someone who sucked at it in the beginning, learned how to do it and made a lot of money doing it. Alternatively, find a firm that will load you up with enough work to keep you busy. BUT, if you chose option two, make sure you really want to work that hard and that you don’t end up in a situation where the work dries up and your job is at risk because you don’t have your own client base.
Here is the bottom line. Lawyers often do not understand the economics of their practice. However, at the same time, they are frequently unhappy with their compensation. We tell our clients that we cannot form an opinion on their situation until we understand all of the facts surrounding their problem. The same thing goes for us.