The 1990’s and early years of this decade saw a dramatic trend away from the traditional single tier of partnership among large law firms toward a new model where most larger firms today operate with both a traditional tier of equity partners (owners) and a second tier of non-equity partners whose status is somewhat different. These trends were driven by the twin assumptions that a second tier of “partners” would increase profitability by boosting leverage with highly productive and trained lawyers, and improve long-term performance by assuring that the owners/decision makers were those partners who were truly crucial to the firm’s success while giving these rising stars an extended period of time to prove themselves. Based on the evidence of the early 1990’s, these assumptions seemed reasonable. At that time, the dominant version of the two-tier structure, sometimes called the Chicago Model, was focused on using the non-equity tier as a stepping stone to equity. In well managed two-tier firms at that time, an analysis of the profit contributions of the various classes of lawyer generally demonstrated that the most senior associates and the non-equity partners were by far the hardest working lawyers in the firm, and contributed dramatically to firm profitability.
But past was not prologue, and these twin assumptions often did not turn out to be justified over time. There is evidence that suggests making the change to a two-tier structure actually failed to improve the firm’s performance. Moreover, when we fast-forward to the present day, and examine conditions during a dramatic period of structural industry change, it is clear that the non-equity ranks of many firms are their single biggest structural economic problem. The weight of anecdotal evidence suggests that non-equity tiers are more a millstone (one Managing Partner recently described the program to me as a “flat tire around our waist”) than a positive. Chart 1 shows average hours performance by class of lawyers over the past three years (dating back to before the recession):
It is clear from these data that, on average, non-equity partners are far less productive than other lawyers in the typical firm. Although the data do not go back that far, in the early 1990’s this was not generally the case. Today, most of these lawyers are not self sufficient in terms of client generation and in many cases never will be. This condemns many to permanently scrounging to remain marginally productive and “hang on”, displacing mid-to senior associates, albeit at a higher level of compensation. And that hanging on comes at the expense of opportunity for other lawyers and excessive cost of service delivery to the client. The two-tier model is broken for many firms – and whether this break will ultimately prove fatal depends on how firms are prepared to respond.
How did we get to this point? Most firms adopted two-tier structures for legitimate and compelling reasons:
- They would improve the firm’s leverage and profitability, making the firm more attractive to quality lateral partners. (As a measure of how important this concern has become, many in the industry believe that the AM LAW equity/non-equity census figures, and by extension profit per equity partner numbers are manipulated and hence unreliable.)
- A genuine belief that by delaying the ultimate decision on admitting young lawyers to equity the firm would be in a better position to judge that lawyer’s suitability for equity, and most importantly his or her ability to develop business. The result would be better partnership decisions.
- A belief that by controlling true ownership, the firm would make better management decisions.
- Providing an alternative track for valuable lawyers who, for one reason or another, preferred not to be equity partners.
Many consultants, including me and my colleagues at Hildebrandt, were, and to some degree remain, supporters and proponents of the two-tier model under the right conditions, but outcomes have reinforced the warnings on how, when and where this model should be used.
What is clear in retrospect is that for most firms, two-tier structures were poorly implemented, however well intentioned. In particular, many firms failed over time to maintain the discipline and accountability that is needed to make these structures work well. Key components of the initial two-tier concept included:
- A two-tier screening process for promotion with very rigorous criteria at both promotion points, not just the promotion from non-equity to equity,
- Strong emphasis on “rising stars”, giving them the time, and hopefully the support, to develop a client following. (Some firms justified the entire concept by concluding that if you didn’t have the title “partner” you were at a disadvantage on business development.),
- Continued strong demand by the firm for continued productivity, and exercise of partner-level legal and project/client management skills, and
- Usually, though not always, a limited period of three to four years to prove yourself worthy of promotion to equity.
Many firms failed to execute this concept correctly to begin with, and many more drifted away from it over time. The primary causes of this failure have had more to do with leadership, management and culture than anything else. Leadership lacked the fortitude to resist the calls to promote people who should never have become non-equity or demand true accountability firm wide, management found it impossible to hold lawyers rigorously accountable for continuing progress, and culture made it far easier to “de-equitize” than to actually address any but the most egregious problems of performance at the equity level. The net result is that many firms have, over time, drifted away from a high-performance non-equity model to one that has become a catch-all for a wide variety of different types of lawyers. Yes, there are up-and-coming stars in the mix, but there are also partners who:
- Never should have been promoted to non-equity, but since that wasn’t the “real” promotion point, the firms let them continue working rather than confront the difficult issue of termination.
- Might have met the performance standards for promotion to non-equity partner, but are not capable of making the jump to true ownership performance and are thus “stuck”,
- Are on their way to retirement and are just slowing down and, the worst case,
- Have been de-equitized in recent years because their performance did not meet expectations, but who have been allowed to continue with the firm.
With the exception of the wind-down group, which probably should be classified as “of counsel”, all of these members of the non-equity partnership are the products of failures of discipline, execution and culture, and are often justified by path-of-least-resistance reasoning such as “well, Joe pays for himself and he’s been around here for a long time” or something similar. Many of these lawyers feel trapped, because they are generally fairly well paid and have a lifestyle that requires this to continue. But they don’t belong with the firm, and no one has made the decision to deal with it. (Two other categories of “non-equity partner” also exist but are more a classification problem – high value “technical specialists” in truly unique and necessary areas and laterals the firm wants to get to know before granting equity, but who actually perform like equity partners.)
This issue has been building for several years, but in the context of the current economic climate has become a serious problem. There simply isn’t enough work or money to paper over the issue, and client demands for cost effective service are adding to pressure on the non-equity tier. For the most part, firms have stepped up to the need to deal with excess capacity in the associate ranks, and are working hard to begin addressing the talent model at the younger lawyer level. But many firms have not yet stepped up to the need to address longer term issues, much less excess capacity, in the partner ranks, including the non-equity ranks where much of the problem resides. Unfortunately, there are few good answers to this problem, and all of them are painful.
At this stage, firms are faced with two fundamental alternatives if they want to put themselves back on track:
- Address the problems in the non-equity ranks (i.e. terminate those who are unlikely to ever perform differently than a senior associate) and reestablish strong structural standards for the non-equity program while figuring out how to maintain them through changes in culture and management approach.
- Eliminate or modify the non-equity structure in a way that forces the firm to make the tough decisions at the promotion point, and maintain the discipline to do that long term. It will still be necessary to address the current issues by transitioning them out of the firm. And, for some firms, the right answer may be to go back to a one tier partnership.
In either case, firms will need to change the way they approach decisions about partnership, and the cultures which have over time tended to force bad decisions. Specifically, most firms will need:
- More rigorously defined standards for promotion to partner (both equity, and if appropriate, non-equity)
- Significantly enhanced and centralized evaluation processes, for all lawyers, including the ability to maintain expectations of performance for already promoted partners
- A strong performance-driven culture, where partners at large will be supportive of leadership decisions concerning partnership
- Long-term leadership development processes which assure that firm leaders capable of handling difficult challenges are in place
- A long-term talent management strategy matched to the firm’s strategic positioning, which assures appropriate matching of people with the firm’s strategic needs.
In addition, those firms which have historically fallen into the trap of de-equitizing underperforming equity partners will need to end this practice permanently. This was never a good idea as a general matter, and in only a very rare handful of cases have a de-equitized partners suddenly become motivated to change (it does happen, but not often enough to risk the damage most of these do to the firm). Firms should face the fact that these partners should not be partners, at least at that firm, and help them find a position more suitable to their long term success and happiness. In most cases, the relocated partner will eventually thank them for it.
Fixing the two-tier problem will not be easy or painless – but it must be done. It’s better for the firm, it’s better for the clients and, although it’s hard to see it, better for the affected partners who will ultimately find themselves in better places. This will be one of the harder transition elements for the legal industry, but in the end will leave everyone in far better position. It’s time to get on with this project.
