Equity partnerships. Paying the price of partnership

In the old days, the golden carrot was equity partnership. You were expected to work long hours at slave labour rates on the basis that, one day, you would inherit the practice and a licence to print money. The hard work was worth it – the benefits of partnership far outweighed the burden.

The boom years of the 1980s lulled most of the profession into a false sense of security. Profits were high and firms recruited and tooled up for an ever increasing flow of work. Consequently, when boom turned to bust the profession was a sitting duck for the onslaught of the recession.

Firms down-sized and the dole queues were upsized by qualified solicitors. Individual voluntary arrangements were frequent, and bankruptcy was not unknown. Firms dissolved and re-formed with bewildering rapidity.

All this flipped the partnership situation on its head. Partnership meant liability for losses, negligence law suits, which became common, and any other of the multitude of problems which were assaulting the profession.

The trend among young lawyers in the early 1990s was, therefore, not to accept equity at any price, even if it was offered. And, often, existing partners could not afford to take on new ones, so invitations became few and far between. The big question facing lawyers was: “Why should I take on unlimited liability, when I can draw my salary, go home, and sleep at night?”

Then suddenly, the profession woke up in the late 1990s to find a different world. The economic sun was shining, and most lawyers were busy again. Now firms which were busy sacking a couple of years ago are recruiting at an ever-increasing rate, and new leases are being signed to provide the additional office space required.

But the costs of staffing up to increase production are heavy, with much of the new income being eaten by recruitment agencies. It will take two years to translate the present capital and income outlay into profit. If, by then, we are back in recession, this profit will remain elusive.

However, memories are short and, once again, partnerships are being offered. Junior lawyers have to decide whether or not to sign on the dotted line with the concomitant need to raise capital to put into their firms, coupled with the spectre of unlimited liability.

So what questions should prospective equity partners be asking of their firms and what should they be looking for in a partnership?

First and foremost, lawyers considering partnership should be students of history. They must decide whether the game is worth the candle. They must look at the profession in the round and ask: “What price its future?” Then question how well the firm has done over the past 10 years.

The answer should be very well during the 1980s, but it is the level of survival during the 1990s which is all important. Many of the firms that got through those difficult recession years did so by adopting an adult attitude at partnership level, so that sacrifices were made personally in the interest of the firm's survival. The firms that did not survive were often those where partners would not face reality. The ostrich mentality produced the attitude: “Cut everything you like, but don't touch my drawings.” Such firms are now history.

How well a firm is managed can be critical. If another recession strikes, have the lessons been learned from the past?

The composition of the firm can also be important. What are the sources of the work? Is 'rain-making' concentrated in very few hands? The possibility that firms' star performers will be poached must always be considered.

Taking a good close look at the partnership deed is recommended. A contract will never provide cohesion if the parties' desires are elsewhere, but it can provide a deterrent, and a strong covenant will be upheld. It can also may make partners think twice before leaving.

The ideal firm has a number of partners who are responsible for introducing work as well as nurturing the clients. It is all very well to bring clients into a practice, but the best firms have a client-care strategy to keep them there.

Next comes the conflict between boutique and generalisation. A number of firms have been very successful in the short term by concentrating on one or more specialities. But new legislation and economic change have seen off many formerly lucrative specialities.

Preferably, a firm will have more than one string to its bow. We are told that general practices are threatened – that they are legal dinosaurs. But don't be so sure. As one door closes, another opens. Currently, commercial property seems to be booming. Those with long memories will recall its practitioners tearing their hair out in frustration at the lack of work not so long ago. So there is a lot to be said for a broad base.

It is probably better to avoid putting all your eggs in one basket in terms of clients as well. Becoming over-dependent on a few clients for fee income does not take into account that death, insolvency, and takeover can strike at any time.

The long-term liabilities of a firm must also be considered before taking up a partnership. For example, is the lease a millstone? A recurring recession may still cause problems for a firm with excessive commitments. As a rough guide only, premises expenses should be no more than 10 per cent of gross fees.

It is also a good idea to ask yourself why the firm is offering you a partnership. Is the invitation flattery, or are you merely being asked to make up the numbers and share the liabilities? Finding out how existing and previous partners have been treated can go some way to answering this. The recent comings and goings within the partnership should be checked out. There are firms today which adopt a revolving door principle, where first in could mean first out. Others require greater stability.

It is useful to find the reasons behind the previous partner's departure. And don't just take the party line – pick up the phone and ask individuals for their side of the story.

At the end of the day it is important to feel comfortable with your partners. The assumption of equity is a form of growth into adulthood. If, at that late stage, you are not going to be treated as a grown up, or if you personally do not feel ready to be treated in that way, then perhaps the offer of equity is premature. If it is, do not grab at it, as you will merely feel uncomfortable. There is a time and a place. You may know yourself better than those people making the offer.

On the basis that the profession is in a state of flux, there are firms that keep the equity within a few hands only and inflate their partnership numbers with salaried partners.

Conversely, there are others that do not have the status of salaried partner at all. Juniors who are coming into the partnership ranks, on the other hand, generally start with a small slice of the equity.

Salaried partners have a chance to test the water before diving in headlong, but are not guaranteed equity. The disadvantage of immediately becoming an equity partner is that the probationary period is lost, and with it, the opportunity for both sides to assess each other.

Those accepting the invitation to equity in 1997 may turn out to be a privileged class. You could be putting your toe on the bottom rung of a well-established ladder, and if professional earnings increase regularly over the next 10 years, and there are few economic blips, you may be thankful for being given the opportunity to take up equity at a relatively low starting cost.

On the other hand, as with some who acquired equity in the late 1980s and early 1990s, you may in fact be putting your foot on the head of a snake. The future may consist of nothing but a downward slide where you lose the capital invested in the firm and you only gain a share of your firm's – or former firm's – liabilities.

Our predecessors would be horrified to hear the contemporary profession described as a game of snakes and ladders. To them, stability and wealth creation are all. But for us, the future offers nothing but uncertainty. You must decide if you want to roll the dice.