Role of Leverage in the Law Practice Business Model

Admin — Wed, 05 Sep 2007 17:43:24 GMT

Leverage refers to the use of non-equity fee earners, mostly associates and paralegals, to expand the capability of the firm and thereby increase the income that can be earned by the equity partners. Without leverage, per-partner income is limited to what the partners can bill for their own work. Leverage is achieved by using non-partner fee earners working under the partner’s supervision. Leverage is expressed as a ratio-- for example, if there are two associates for each partner, the ratio is 2-to-1. Leverage is one of five key performance drivers determining the earnings of law firm partners—Leverage, Rate, Utilization, Realization and Margin.

The above mathematical expression illustrating how the five factors impact partner income was first published by David Maister. It is easier to understand when viewed in a more traditional financial statement format:

In the above table, twelve partners share the results of 42 legal professionals (12 partners and 30 non-partner fee earners). The leverage is 2.5 (30 non-partners divided by 12 partners)

The importance of leverage as a driver of per-partner income is illustrated by the following chart taken from the Juris Law Firm Economic Survey for 2005.

The chart divides surveyed law firms into quartiles based on income per partner. The first quartile represents the top performing 25 percent. Those firms earned more than twice the per-partner income of the next highest group.

Effective use of leverage requires prior experience in order for the supervising professional to efficiently instruct, train and mentor the less experienced assigned professional staff. Thus, the opportunity a firm has for leverage will vary with the type and maturity of practice. As a practice area emerges, there are no precedents, no forms, no prior experience, and no accumulated work product. Solutions in such emerging areas have to break new ground. These growth areas typically command the highest fees and clients seek out the law firm because of the firm’s reputation for creativity and for having a smart professional team. Professional work in these trailblazing areas is performed with very little or no leverage. Firms accumulate experience as a practice area matures. They develop work product and increase their ability to use less experienced staff for an increasing portion of the work. Clients seek out these firms because of their successful prior experience handling similar cases. Competition drives prices down. Leverage becomes a more important strategy for achieving a competitive per-partner level. As the practice continues to mature, it will evolve into its transactional phase where the work becomes routine. Prices decline to their lowest level. High leverage combined with high utilization becomes necessary for sound financial performance.

Today most midrange firms are involved in mature and transactional practice areas. Partners have to handle multiple cases or matters at a time. The more effective the partners are at using associates and paralegals to do the work, the higher the firm’s per-partner income will be. Firms that are less efficient at using associates and paralegals will have a lower partner Income. Inefficient acquisition and/or use of leverage in a mature practice area threaten the very continuity of the firm.

Considering the role of leverage in driving partner income, it is surprising that 75 percent of midsized law firms have not successively implementing the strategy. Where AmLaw 200 firms have about three associates for every partner, midsized firms average only a 1-1 ratio. Most do not adequately utilize the small leverage they do have. Partners are logging more billable hours than their associates. Rather than bringing in new business or training others, they are piling up their own billable hours. The result is what you would expect. Midsized firm partners make less income than their counterparts in larger law firms.

The two most noticeable, but related, controllable factors contributing to low leverage are:

Compensation plans that reward partners for doing their own work, and

Partners devoting too little time to new business development

Like the other five variables in the Law Practice Business Model, leverage is too important to leave to an accident of events. It is a strategic issue. The firm partners need to understand the right leverage level for their firm based on its opportunities and income goals of its partners. To find out what can be done, use surveys or benchmarking services like Juris Insight to find out leverage levels being achieved by top performing comparable firms. Second, decide the competitive per-partner income appropriate for your firm. Work with the Law Practice Model to find the achievable mix of price, volume, leverage and margin that will produce your goal level of income.

The list below is a reminder of steps that you can take, among others, to increase leverage and improve per-partner income.

Increase the portion of time partners devote to business development—set individual goals, measure performance and hold people accountable.
Change the firm’s compensation plan to (a) favor supervision versus hoarding of work and (b) replace continuing origination credit with more immediate short term rewards for new business
Centralize the scheduling of non-partner legal talent to eliminate the hoarding of idle resources and to emphasize professional development through work assignments
Improve recruiting to hire more associates and paralegals. Increase lateral hiring to add experienced associates
Reduce the number of partners through retirement and attrition
Lengthen the path to partnership. Raise partnership criteria.
Create or expand layers (titles) of permanent leverage— paralegals, staff associate, senior associate, executive associate, senior council, non-equity partners, etc.
Invest in better business systems to provide business intelligence information. Managing leverage like other key performance indicators takes planning, setting goals, measuring performance and holding people accountable. For that, you need the right tools.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

877/377-3740, e-mail info@juris.com or go to www.Juris.com.

Make More Rain : leverage, policies/ procedures

Role of Leverage in the Law Practice Business Model