Equity Partner Remuneration in the Law Firm P&L

Back by popular demand* - the law firm P&L!

Previously I presented a simplified P&L account for a law firm, with a plea to focus on improving the big numbers above the gross profit line

For simplicity, that P&L ignored equity partner remuneration within gross profit and margin

For very small firms, or teams, this can work well enough, but if you have (1) multiple partners, (2) with substantive fee earning/matter delivery responsibilities then we need to introduce a little more sophistication in order to better manage financial performance

Thus - the intermediate P&L

This is just a presentational change in how we show equity partner remuneration - it has no impact on how much anyone is getting paid, but it enables us to more accurately assess the costs in delivering the fee income for the team, or firm as a whole

We do this so that we can better compare the financial performance of different teams, better tie equity partner remuneration to the performance of their teams, and identify which teams would benefit from greater investment

But in doing so, we're confronted with some choices about how we measure equity partner remuneration. Broadly, there are two options:

1. Actual partner remuneration

2. Notional remuneration

(1) Would typically be partner drawings charged to the P&L in the period in which they occur. This has the notable advantage of being the simplest and easiest to understand, but with trade offs around matching the cash drawings in a given period with the fee income billed and movement in WIP in the same period

In short, it works well where both drawings and WIP balances are stable. It struggles when they are not. To address this, we might look at historic remuneration over a longer period of time to smooth this out

However, we are treating all partner rem as a direct delivery cost, when it isn't

Equity partner rem is typically an aggregate of three major components: remuneration for fee earning, remuneration for winning work, and return on equity. By using the total partner remuneration, we overstate the direct delivery costs, understate team profitability and then consequently run the risk of mismanaging work allocation and pricing

Which leads us to (2)

To clarify, by "notional", I do mean "made up" 🙂

Ultimately, here we are trying to isolate the cost of delivering the work from the cost of winning that work and the return on equity

If you're keen, you can spend a lot of time on making up a better number. I am rarely keen

Pragmatically, I would take the average remuneration of the top quartile of the most senior, non-partner fee earners in the team and then add, say, 20%

Tweak it up or down as you see fit, and then apply it consistently across teams and over time

Footnote on terminology - fee income less fee earner costs = gross profit. If we then deduct equity partner remuneration we are left with gross contribution (as shown below)

*thanks Mum

Intermediate law firm P&L, including equity partner remuneration