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The law firm as an institution
Much has been written about the nature of the real assets and value of a law firm as an ongoing and enduring institution. It is clear that there are some intangible assets of a law firm which go far beyond the balance sheet.
These intangible assets used to be known in part as ‘goodwill’ and form the firm’s intellectual capital which will drive the long‑term financial success of the firm. It is much more than the sum of the intellectual prowess of the partners, and is best described as ‘firm-specific intellectual capital’
Firm-specific capital is that which cannot be easily removed from the Firm, nor duplicated outside it. In the context of clients, having a prestigious client is clearly valuable to a firm but if there is no individual partner who upon leaving the firm, can take that client with him, then the client relationship is an asset of the Firm. Those involved in law firm management have always mused about what make up the assets of a law firm. It is clear to all that the assets which appear on the balance sheet – office equipment, cash assets and creditors, and (sometimes) cars or premises – all give a very limited insight into the real worth of any firm. The firm’s annual accounts seem to bear very little relation to every day activities and give few clues as to the firm’s current state of health or its future prosperity or fate. Even when you look at the firm’s monthly management accounts – for the most part a historical record – the overall health of the company going forward remains murky. The brutal truth is that the present and future success of a law firm simply cannot be understood solely by looking at traditional financial data, but requires a better understanding of all the firm’s intangible assets. In this context, it is universally accepted that one of any firm’s main non-financial assets is its people. Indeed, when you ask the average law firm partner about this subject, the response is that the firm’s people are its only real assets. Additionally, however, one also hears law firm managers at times talking about the value of their firm’s brand and client relationships. All this, whilst correct, is far from the full picture.
Firm-specific Capital can therefore be defined as meaning the assets and value of a Firm as an ongoing institution and taking into account, in particular:
- The value of the predictable flow of work from an established client base.
- The ability for Partners to work from established premises and with the Firm’s systems, equipment and staff.
- The reputation and name of the Firm and the consequent value of the Firm as a means of quality assurance to existing and potential clients.
- The efficiencies and economies of scale associated with the Firm.
- The collected know-how and applied knowledge of the Firm.
- The synergies obtained from the development of expert teams across a broad range of professional disciplines.
The article “How Valuable are your Assets?” Shows how intellectual capital is made up and how it is centred on and specific to the firm rather than the individual partners in the firm. As a summary, the intangible assets of a law firm are made up of its relational capital (network, brand and clients) its human capital (its professionals, its partners and its managers) and its structural capital (its solutions, processes, work flow and intellectual property). All these combine with the firm’s business recipe to form a firm’s intellectual capital. The roles of partner must then be aligned with and contribute to the development of these intangible assets – the joint effort which will help to develop the firm into an enduring institution.
Governance in law firms
A combination of tightening margins and increasing competitive pressure has recently placed a lot of strain on the ‘true partnership’ model, so it is no surprise that – as the Legal Service Act kicks in – many firms have been looking again at their governance, their decision-making model and their leadership styles.
The problem is that, unless carefully done, firms can tend to flip flop from a gentle consensus model into an aggressively controlling style of macho-management in which gung-ho gun-slinging partners dominate by brute force and intimidation. Aligning management structures and management styles is therefore important and was discussed in an article “Leading Questions – Management Styles”
As firms grow and evolve, their need for more advanced methods of governance develop. The start-up firm in a creative phase needs little by way of management system. Such firms are entrepreneurially oriented and talented people drive the firm forward through hard work. In a more adolescent phase, the firm can usually be managed by consensus and the leadership abilities of the movers and shakers. Progress can often, however, become stultified because nobody has sufficient time to get the firm better organised . As the firm increases in maturity and size, consensus become even more impossible and firms have to professionalise the governance and management model by the appointment of managing partners, committees and professional managers.
In order to achieve the objectives of any new governance structure, partners need to recognise that the changes will not just be theoretical but that the whole mode of operation will alter. Whilst there will of course be consultation, there will no longer be consensus on many areas of decision-making. The leadership team must be allowed to get on with its job and make decisions which would then be reported to the partnership. Additionally, those board members who are partners will not just be representing their office or division but need to understand that their role will be executive and decisive. They will be part of a leadership team which is responsible for driving the firm forward.
Profit Sharing and Partner Compensation
The subjects of partner profit sharing and compensation, as well as partner performance and progression are of world-wide interest to every law firm partner, member and aspiring partner. It is not surprising to find many law firms re-examining their profit sharing structures. Law firms vary enormously in size, structure, specialisation, client types, and culture and changes also take place as the firm evolves. As far as I am aware, no firm has found the perfect set of answers to what has always been a difficult and sensitive area. Most firms struggle to find the optimal way of sharing profits and compensating or remunerating their partners.
There are some uncomfortable truths which seem to apply to the whole area. It seems that, however arrived at, no partner’s profit share is ever enough if it is less than that of some other partner. There is also an uneasy balance in any professional service firm between comfort and insecurity, happiness and misery, and between partner trust and distrust. There is, furthermore, no one system which can be guaranteed to work well at all times and within every firm. Equality of sharing and lockstep disadvantages the high performers and assists the low performers. Some of the worst schisms we have seen in partnerships have been where a small group of partners (or just one partner) feel they are carrying the rest of the firm. Equally, formulaic systems based on revenue generation (sometimes known as Eat What You Kill) encourage work-hogging and selfishness, and militate against collaboration and team work. Discretionary or flexible reward structures rely heavily on subjective judgments and assessments, and have been known to stimulate the outbreak of World War 3 where partners feel that favouritism, bullying and harassment by the firm’s prima donna partners have led to unfair decisions being reached.
I can identify eight elements which are necessary for a successful Partner Performance Management System. First, it must identify the criteria – the Critical Areas of Performance or ‘balanced scorecard against which partners will be evaluated. Second, it must lay out in some detail the processes and systems for partner review and appraisals. It must thirdly clarify the evidence, metrics and data which the firm will employ to inform the firm’s evaluation procedures. It should fourthly contain the firm’s requirements for each partner to compile some form of personal business or contribution plan, containing goals and objectives which are directly related to the firm’s overall strategic objectives. As a fifth element, the expectations of partners and the firm’s leaders should be firmly set in identifying the methodology and frequency by and with which the partners and their teams will be actively managed on a day to day basis. Sixthly, it must set out the firm’s processes for dealing with underperformers. Seventh, the performance management system should contain the firm’s methodology for partner promotion, progression and development. Finally – but perhaps most importantly, the system must support the firm’s strategic and economic goals.
There is, therefore, a very long list of issues, challenges and processes which need to be considered when making any change to a partnership remuneration and compensation scheme. All these can form projects which can be dealt with iteratively and incrementally, provided that they are part of an overall plan. What is quite dangerous is to try to make a shift towards a subjectively assessed system without having first introduced a balanced scorecard or agreed on the firm’s critical areas of performance and bedded those changes in. Where the firm has already decided on its critical areas of performance, those areas will often need to be revisited to make the criteria as clear and measurable as possible.
I strongly suggest, therefore, that the compensation system itself is the very last change to be made as it needs to be built on the firm foundations of all the other areas listed above. It should also be clear that the new compensation system as such cannot be introduced incrementally, in that you can have some partners on the old system and some on the new
Over-simplistically described as “the way things are done round here”, a firm’s culture is generally defined in three ways. It is first defined by the firm’s rituals – the way work is organised, authority exercised, and how the firm’s structures and processes are constructed. Second, it is identified by the firm’s values – the way people in the firm relate to each other and to the firm itself, and how people behave are rewarded, empowered and controlled. In this context, it is also determined by the way the firm adapts to its clients and the outside world, the firm’s history and experiences and the way the firm sees its values, direction and strategy. There is a third and deeper level which is the firm’s shared and yet (often) latent or tacit beliefs, perceptions, thoughts and feelings.
It is quite interesting to note how few Firms have an in depth understanding of their own culture and in particular those cultural traits which should be nurtured in order to increase the firm’s effectiveness in the market place. When Managing Partners are asked to describe their firm’s culture, there are very often similar responses (a popular one is ‘we are collegiate’). I am often left with the impression that many Managing Partners tend to believe their own publicity and rely on their own perspective without necessarily asking the right questions in the deeper subterranean layers of the firm. I believe it is vital to gain an intimate knowledge of the levels of culture, the sub-cultures and the behavioural traits which are evident throughout the firm. One way is to take some form of cultural survey, though it is important to accompany any survey with more detailed work on a face-to-face basis. Knowledge of these traits and behaviours can help enormously to understand how the firm is likely to react to change programmes, and new initiatives and strategies. In addition, the culture in many firms is quite heterogeneous rather than homogeneous, with almost as many mini-cultures as there are partners. In some firms different offices and different departments display quite different cultural traits.
To view NJK’s Articles on Governance and Structure click here