Which is preferable, having equity or none at all?
Advantages of equity
For good reason, a lot of attorneys still want to be equity partners. Equity partnership seats are becoming more and more limited, and in a field that places a high emphasis on status and prestige, getting partnership shares is seen as the ultimate goal. An increasing percentage of the financial gains in a profitable and expanding company should go to the equity partners. A partner with stock also has voting rights, which gives them a bigger say in how the company is run.
Partner compensation and voting rights are sometimes closely related. Origination credit, for instance, is a determinant in the equity partnership’s disproportionate compensation share. Origination credit formulas are frequently designed by businesses to give equity partners a higher payout than non-equity partners. In order to get more origination credit for their work, senior attorneys frequently look for equity partner options. Voting rights have the potential to be valuable in that they allow for input into the formulae used to give origination credit.
Disadvantages of equity
While it’s simple to concentrate on the many advantages of being an equity partner, there are some significant drawbacks as well that should not be disregarded. The most notable financial penalty associated with becoming an equity partner is the mandatory capital commitment, which comes along with the rise in status. Usually, this payment makes up 25 to 35 percent of the yearly salary, but at other companies, it can reach 50 percent or higher. In any case, it’s a substantial sum of money to give to the firm, particularly for attorneys who are still in their early stages of practice. Recouping the capital commitment can also be more difficult.
The fact that many companies are reducing the voting rights of equity partners is another thing to take into account. Traditionally, the entire equity partnership had to vote on a wide range of issues, from office lease renewals to lateral partnership recruitment. Many firms have found that it is more practicable to leave most decisions to the exclusive discretion of the firm’s chair, or to a small committee as the size and geographic reach of partnerships have grown. Overall, this is a good improvement in terms of efficiency, but a drawback is that equity partners without senior leadership positions would have less impact. These partners are viewed more like employees than owners with regard to an ever-widening range of challenges. Grasping the essence of becoming an equity partner at a law firm is crucial for anyone considering their career advancement choices.
When does non-equity work best?
When the advantages and disadvantages are considered, non-equity partnerships appear to be a reasonable option in some situations. The youngest and oldest partners may find it appealing to avoid making a sizable capital investment. Younger partners might not have accumulated a sufficient investment portfolio to feel at ease contributing such a substantial amount to an illiquid firm investment.
On the older end of the scale, the simplicity of a non-equity arrangement can entice a departing equity partner who is considering a brief second employment before retiring. In this scenario, partners have nothing to lose by returning as equity partners.
Non-equity partnerships might also make more sense for partners in certain specialist activities that do not require a sizable freestanding book of business. The partners who specialize in these specialized areas may not receive much compensation from the firm’s origination credit formulae because practices like tax and trusts & estates frequently serve as service providers to other practices within the firm. Perhaps the best solution is a non-equity partnership structure that appropriately recognizes the contributions made by these partners.
A middle-ground strategy: moving from non-equity to equity
Splitting the difference by pursuing non-equity partnership options that eventually lead to equity partnerships may be the best course of action for many partners. As a result, the partner can postpone the capital contribution hit and yet take advantage of the chance to fully profit from customer connections as their book of business grows. A partner wishing to pursue this option must, of course, first determine if the company provides a genuine and feasible path from non-equity to equity. In cases where this pathway is actually present, it can provide the best of both scenarios.
Disadvantages of Equity Partner
Over the last few years, much of the focus in this debate has been placed on the advantages that come along with being an equity partner, and that makes sense: the benefits are, as we have seen, both significant and numerous. First, however, let’s take a glance at some of the often-overlooked downsides to becoming an equity partner. First, the initial reputation bonus that is achieved comes along with a formidable economic hit: this is known as a capital contribution.
A required capital contribution paid back to the firm can generally take up 25-35% of a partner’s annual salary. But did you know that it can go up to 50% or more at some firms? That is no small contribution and will impact earnings in a significant manner. On the other hand, this is a good amount of cash to pay back to the firm, especially for an attorney who is still forging his or her career path. Plus, getting this contribution returned is not as simple as the firm may make it seem. Many partnership agreements stipulate that the law firm does not need to return the money for years after the partner has left the firm.
There are other factors to consider as well. For example, equity partners must pay for their own benefits, which can also cut out a sizeable chunk of revenue. Additionally, equity partners’ rights to vote have been on the decline for years at many law firms. Why? It used to be that all different decisions at the firm, from office leases to hiring, required votes from every equity partner. But, now that partnerships have grown in size and spread out, many law firms decided that the majority of decisions should be left to the firm’s chair or a smaller committee. This is a practical decision based on law firm efficiency, yet it signals less influence and power for equity partners who have just joined and have not become leaders yet. The key here is that a lawyer can become an equity partner and then feel not like a leader or a key player. Instead, he or she might feel as though they are simply an employee who is working longer hours and paying the firm a lot of money out of their hard-earned paycheck.
The Optimal Time for Non-Equity Partnership
Now that we’ve identified some of the advantages and disadvantages, it becomes clear that a non-equity partnership can appear appealing in some situations. One significant advantage becomes apparent quickly: the avoidance of paying a significant capital contribution to the firm. This can be appealing to older and younger partners because everyone wants to save more money these days.
It is often the case for younger partners that they have not yet accrued enough of an investment portfolio to accept giving back so much to the firm. For senior partners who are debating a short stint at a firm of their choice before the rest and relaxation of retirement, a non-equity partnership is an attractive, simple option with no strings attached. Senior partners who have already had illustrious and productive careers have nothing to prove and seek the chance to invest differently than back into the firm. Also, this specific group of partners can look forward to avoiding the assumption of liability for their new firm’s debts—yet another key benefit to being a non-equity partner this late in the game.
There also exists a third group of partners who may find non-equity partnerships an intelligent choice. Partners in practices that are seen as “niche” can find this type of partnership advantageous because they do not get a lot of standalone business. For example, a Trusts and Estates lawyer provides a specific service to other firm practices. Therefore, the origination credit formula really does not apply here since it does not truly reward the partners who practice in these niche areas. For these attorneys, a non-equity partnership might be the correct answer, though obviously, this choice is best left up to the individual, their means, and their goals.
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