No, we are not economists from Yale but we have seen profitability for many law firms. It is imperative that accurate information and statistics are used to determine profitability splits. This is particularly true when an unknown is added to the firm.

We often hear, “Our gross receipts are going up and we are growing, but profit per partner is going down” or “We negotiated an arrangement with a partner-level attorney to split gross revenue and it should increase net profits, but it isn’t.” Often, about the third year of an agreement, it will become apparent that the firm has been subsidizing the new partner’s practice if good decisions weren’t made at the onset.

One of the ways firms grow is by adding partner-level attorneys. The idea is that new partners can support your clients in a different area, expand the firm’s reach geographically or add bandwidth. The assumption is that more partners bring in more profit and grows the firm in manageable way. What we are finding is the opposite in some cases.

If your firm’s gross receipts were $1,000,000 last year and you paid $700,000 costs and expenses and had $300,000 in profit, that doesn’t mean that a partner coming into the firm should get 30% of
their gross receipts. The following must be taken into consideration.

  1. Write-offs come out of the Firm’s 70%.
  2. The Firm finances AR.
  3. The new attorneys’ billing rates must be in line with the Firm’s billing rates to coincide with your overhead costs and payroll.
  4. What about your profit?
  5. Also, the expectation that an attorney or practice group will bring in the receipts they hope to is not always accurate.

As an example:

A new partner comes into the firm and expects to bill $1,440,000 in the first year. She brings with her one associate and a secretary but will have work for your paralegals and an attorney. If your
agreement is paying her 30% of her gross receipts, it could look like the following:

The cost of her practice – salaries $75,000 for a secretary and $150,000 for an associate $225,000 plus 15% for insurance and benefits total $258,750.00. You figure your E&O insurance will go up $10,000 a year. You are already paying the rent and subscriptions, etc. so the other added costs will be absorbed in the 70% of your split.

The attorney billing rate is $250/hr. and they are supposed to have work for 1,800 hours. The partner is supposed to bill 1,800 hours with a billing rate of $550/hr.

You figure that the billings from the three of them will be $1,440,000 and your firm collection rate is 90% so you expect to collect $1,296,000 from them the first year plus any work they give your current associates.  Your 70% will be $903,000.

Billings1,440,000
At Collection Rate of 90%1,296,000
Firm’s Portion903,000
Added Expenses(268,750)
Expected Profit to Firm634,250

Partner coming into the firm is paid $388,800 – 30% of Gross Collections

Looks pretty good right?  You are in the same building, don’t have to add any accounting or administrative staff.  That $634,250 is going to be added income since you are already paying the costs.

Let’s look at in a different light.

Billings are 20% lower.

Collections are at 80% instead of 90% as firm standard.

Billings are 20% lower than expected1,152,000
At Collection Rate of 80%921,600
Firm’s Portion645,120
Expenses(268,750)
Expected Profit to Firm376,370

The partner coming into the firm is paid $345,600 – 30% of Gross Income

So, you see just a relatively slight change in expected and actuals, leaves the firm taking most of the loss on a practice.

If the partner writes-off time for associates, you are paying those associates. Plus, if you are like most small firms, you could have used those associate hours on billable work.

The large firms charge the partners the cost of their practice before any distribution to partners. Salaries, rent, expenses, etc. are taken out of their Gross Receipts and then the split takes place.  This is incentive for the new partners to bill and collect as much as possible to cover their costs.  However, the split amount will need to be modified to entice the partner to join the firm.

Billings are 20% lower than expected1,152,000
At Collection Rate of 80%921,600
Deduct Expenses(268,750)
Net Profit662,850
Expected Profit to Firm456,995

The partner coming into the firm is paid $198,866 – 30% of Net Profit

Yes, this is a simplistic example and there are a lot of other considerations, however; you should be extremely familiar with the cost of doing business at your firm down to what it costs to house and feed each attorney.  When bringing on a new partner or practice group, error on the side of caution and start out with a reasonable agreement.

If you need help calculating the exact numbers for your firm, please let us know.  We would be happy to help.

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