Attaining partnership is often seen as the key moment in the development of a private practice lawyer's career. A marker for the day they made it, after years of toil.
Naturally, a commercial deal lies beneath the ceremony of the occasion. Typically, one's entrance as an equity partner requires the payment of an "equity buy-in", as it is called. And while this commercial practice bears some examination, it is surprising how rarely that actually happens.
Before we get into "Why do we do it?" (spoiler alert, CITO does not do this), it is helpful to first ask "What is wrong with it?".
From the outside, an equity buy-in seems reasonable enough. The firm has costs that need to be defrayed, and the equity partners are ultimately responsible for those costs. But this is where the proposition starts to break down.
Unlike an equity injection in an ordinary business, equity buy-in funds are not typically used as working capital to cover expenses, pay for R&D or build up a new business line. This begs the question – "What does the firm need the money for?".
Evidence of a Bad Culture or Bad Financial Management?
If the answer were "to cover basic expenses", the partner candidate should pause to consider the risk of investing in a business that does not pay its expenses from receipts.
If the answer were "because we do not trust any current partners to pony up", the partner candidate should question the wisdom of joining a group of untrustworthy or paranoid partners.
If the answer were "we do absolutely nothing with the money", the partner candidate should wonder whether the buy-in was essentially a ransom fund designed to bind the candidate to the firm – or an expensive entry fee to the higher salary club – or both.
If the answer were "we just want to hand that money around to the existing partners", the partner candidate should conclude that the business is simply a franchise operation. The candidate might feel like a new McDonald's location going into the suburbs.
If the answer were "we need it to return the equity of some outgoing partners", the partner candidate should immediately ask "what outgoing partners?". If those partners were real performers about to exit stage left, that would represent an undisclosed risk to the business. If those partners were squeezed out to shore up each remaining partner's return, then the candidate should wonder about the firm culture and the inevitability of becoming the next squeeze-out target.
Any way you slice it, the answers do not seem to logically add up. In fact, most of the answers signal underlying issues with office culture or financial management – or both.
Is It an Equity Investment, Really?
At best, an equity interest in a law firm is akin to a shareholding in private company. A very, very private company, where a regulator oversees your shareholder status, and no one wants to buy your shares when you retire. And also, you do not get to do any diligence before closing.
In all honesty, would any solicitor you know recommend this deal to a client? This leads us to the question "Why do we do it?".
We suspect the equity buy-in remains prevalent simply because that is the way things have always been done. While tradition can indicate well-proven stability, it is also human nature to sometimes follow others without questioning why. Obviously, the merits of each equity buy-in are case dependent, but it seems potentially irrational to merely follow convention on such an important question and with so much money on the table.
A Different Way?
What would 'different' look like in the law firm world? For starters, a firm might consider only taking capital from its partners when those funds are actually required; a capital contribution that is tied to a specific need and dedicated to a specific use. This approach would incentivize firms to instead place the financial focus on cost (overhead) reduction, the growth of receipts and cash flow management – tenants of prudent fiscal management.
On the culture side of the equation, a firm that did not take equity buy-in funds would not be tempted to engage in the "franchise" approach to law. Nor would it message "credit risk" or "ransom" to its new partners.
In this age of Covid-19 and low oil prices, some traditional firms are financially strained by shrinking revenues and high operating costs. With or without cultural issues compounding the problem, principled partners with a good book may be motivated to look for an opportunity to jump a sinking ship. So might talented, hardworking senior associates on the cusp of partnership.
With a few sinking ships in the market, a firm that does not present an inbound, financial obstacle to entry has a competitive advantage in the recruitment of top performers. In addition, because such a firm is not asking for (or in need of) an equity investment, it has the freedom to be more choosy about the qualifications of the partner candidate – and their impact on firm culture – both of which are what really matter.
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