Focus: Partner Pay - How do you like your stake?

Which firms have the greatest disparity in the pay of their partner ranks? And what impact does that remuneration differential have on the collegiality of firms?

This year’s UK 200 Annual Report once again generated reams of ­statistics highlighting the fact that not every firm across the market is playing on a level field.

For years the firm that has been associated most closely with having a two-tier partnership is DLA Piper. As far back as 2006 (in that year’s UK 200 Annual Report) we highlighted the firm’s tight equity, with just 29 per cent of the entire international LLP’s partnership being full equity ­partners, representing a 2 per cent drop compared with the previous year.

Now, as we reported last month (24 October), it is all-change at DLA Piper. In one of the most remarkable about turns seen in the UK legal ­market, the firm has unveiled plans to move to an all-­equity partnership.

PEP balk

DLA Piper’s structural overhaul invites the question, ’when is a partner not a partner?’. The traditional answer is, ’when they don’t share fully in the equity’.

It is one of the recurring themes among the feedback we receive each time the UK 200 Annual Report is published that the average profit per equity partner (PEP) metric is not a useful measure because the variety of structures firms use means it can be easily manipulated.

As philosophical questions go - at least as far as the legal market is ­concerned - they do not get much more contentious than this.

When firms use the term ’equity’, do they actually mean that? Each year when reporting their financial results a number of firms claim that all their partners are equity, but add that they have ’A’ and ’B’ equity ­classes within the ranks.

In other words, there is a ­separation between status and ­ownership. The former is external-facing, allowing a new partner to go out into the marketplace with added gravitas, clout and credibility.

The latter is an internal mechanism designed to allow more differentiation depending in part on how much a lawyer is contributing.

“Where there’s flexibility in a remuneration structure it can be very ­useful because you can cater for a range of partners,” says Fladgate chief operating officer John Goreing. “The key is that the system’s transparent and fair.”

Equally, a two- or three-tier system can be healthy in terms of clarifying an individual lawyer’s career ­progression.

“I think having a fixed-share ­position can be a very positive stage in a lawyer’s development,” says ­Taylor Wessing managing partner Tim Eyles. “It can work as a ­preparatory stage in anticipation of the prize of full equity status. It’s a useful progression.”

Fuller figures

Nevertheless, for declaration of PEP purposes a firm may only declare the remuneration of ’A’ partners because, frankly, it makes the PEP figure appear higher.

DLA Piper is surely unlikely to sanction the precipitous drop in PEP caused by the entry into its equity of ranks of regional or overseas ­partners. The impact on recruitment alone from seeing PEP plummet by a couple of hundred thousand pounds would be sufficient to ensure that it would introduce some checks and balances to maintain a competitive level.

The results of the consultation will not be known for some time, but one approach DLA Piper may use is a range of internal mechanisms, such as excluding partners whose ­remuneration is currently at least 50 per cent fixed from the calculations.

The firm does say that the changes it is making to its equity structure coincide with a period of increasing profitability, but it is going to have to go some in the current year to match last year’s £564,000 with a full ­equity partnership.

There is precedent here. Olswang, for example, is in the process of ­overhauling its equity structure, introducing a model that will abolish the distinction between fixed-share and full equity partners.

“We’re now moving from two categories of partner to one partnership,” verified Olswang chief executive David Stewart in September (The Lawyer, 5 September).
But for the purposes of reporting average PEP numbers, Olswang will treat only the top three bands as full equity partners.

What maketh the equity partner?

Similarly, Bird & Bird considers all of the partners in its merit-based ­structure as equity, but for PEP ­purposes it only counts those ­partners whose remuneration is ­primarily floating rather than fixed.

Clearly, what is increasingly ­needed is a clear definition of what makes an equity partner. Do you qualify if you get to vote on everything?; or if your remuneration is purely profit share with no salary or fixed element?; or is there some other gauge of the fundamentals?

“The key point is whether the sense of engagement is present across the partnership,” says Eyles. “It may be challenging to generate the same level of engagement - and indeed ownership - where the gap in earnings between a fixed-share and a full equity partner is felt to be too ­significant.”

In other words, firms may say they are full equity, but anyone can still twist the results in any way they like - a fact that continues to make direct comparisons tricky.
“You’re either pregnant or you’re not,” quips Eyles.

Clique practice

When it makes its changes DLA Piper will on paper be joining a small band of increasingly rare all-equity partnerships that featured in the UK 200 list this year. Just five firms - Bristows, Dundas & Wilson, Reynolds Porter Chamberlain, Russell-Cooke and Wragge & Co - maintained ­partnerships that were all equity.

As The Lawyer reported last month (17 October), Scottish heavyweight Dundas & Wilson is dropping its all-equity model and introducing a fixed-share tier into its partnership, reducing the pool of all-equity firms even further.

So the question remains, at what point does a senior lawyer actually become a fully fledged partner in the business? When they are made up? Or when they move beyond the ­various initial tiers of partnership such as salaried, fixed-share or junior equity and become a member of the elite group of full equity partners, whose remuneration is tied entirely and inextricably to the fortunes of the firm.

This is the issue The Lawyer first addressed directly in 2005 when it introduced the earnings per partner (EPP) metric. Thanks to EPP we can reveal what DLA Piper’s PEP would have looked like last year had it already moved to an all-equity model.

The EPP equation is simple. It ­factors in the remuneration of all partners at a firm and then divides that sum by the total number of ­partners.

So at DLA Piper last year, the 647 partners were paid a total of £207.7m. Divide that by 647 and PEP falls from £564,000 to £321,000.

To really highlight the disparity in the DLA Piper ranks you would need to strip out the remuneration of full equity partners and compare it with the pay of those in the lower ranks of partnership, which according to The Lawyer’s research was £213,000.

And as a final pointer to how much of a gap there can be between the richest and ’poorest’ among a ­partnership, the equity spread at DLA Piper last year ran from £225,000 to £1.7m, a gap of £1.47m and the largest in this year’s table.

The sorter margin

The numbers from this year’s UK 200 list throw up plenty more stark disparities between the lot of an ­equity partner and a junior lawyer bearing that job title.
The EPP table above reorders this year’s PEP table and reveals what the ranking of the UK’s largest firms would look like if the ­remuneration of every one of the firms’ partners were added into the ­equation.

Look at the earnings differential table on page 19 to find some ­surprises among the firms listed at, or near, the top of table.

Travers Smith is one. A non-equity partner at Travers last year earned on average £125,000, just 19 per cent of what a full equity partner took home (£650,000). They are, in effect, a fifth of a partner (hence our diminutive figures in the diagram on page 18). Factor in the EPP calculation and the average PEP at Travers falls from £650,000 to £508,000.

Despite being virtually all-equity, the riches on offer to a full equity partner at Slaughter and May means that this blue-blood firm is also high up the charts of this particular table.

The Lawyer estimates that the ­differential between a Slaughters full equity partner on £1.93m and one of the firm’s three non-equity partners (all based overseas) was £1.43m last year. Despite still earning around £500,000, this trio are only quarter of the size of a Slaughters full equity partner.

The gap between the earnings of a full equity partner at Northern ­powerhouse Gordons and lesser mortals who also go by the partner tag is also worth flagging up. The latter took home just 13 per cent of the remuneration of an admittedly extremely well-paid Gordons full equity partner, at £111,000 versus £888,000.

The most glaring example of ­disparity, however, is Parabis Law. The earnings of a Parabis ’salaried ­partner’ were just 6 per cent of those of an ’equity partner’ (actually a ­director) at the insurance firm.

Ensuring full engagement when one is only 6 per cent of a full partner is a problem an increasing number of firms may have to deal with in the post-Legal Services Act regime.

Making the adjustment

Each year the job of compiling the The Lawyer UK 200 Annual Report is becoming increasingly complicated. This year’s was particularly tough.

Please do not interpret this as the unspecific whining of a hard-pressed editorial team - it is a statement of fact. The reason is simple: the firms that make up the list of the UK’s largest by revenue are changing, and radically.

Law ’firms’ such as Parabis Law and Minster Law are limited companies. Legal services providers structured along these more corporate lines have been around for years, but are becoming increasingly common.

Frankly, it is not possible to make a direct comparison between a limited company and the majority of firms in the table that are partnerships.

The chances of there being an immediate rush among many of the UK’s largest firms to float or fully incorporate are probably slim. It will take years for most to go down this route.

But once an increasing number of partners’ remuneration starts being a salary topped up with dividends, a structure that brings with it attendant differences in tax treatments and distribution policies, then comparisons with the performances of traditional general partnerships will become even more complicated.

“Once you have private ABSs and fully listed legal companies, these businesses will account in a variety of ways and partners will be remunerated in a variety of ways,” says Fladgate chairman Charles Wander. “It’s likely that soon it won’t be possible to make meaningful like-for-like comparisons very easily.”

From next year the realities of the Legal Services Act will begin to be felt more sharply in the shape of other providers such as the Co-operative Group, along with a variety of alternative business structures.

These structural changes are making comparing apples with apples increasingly problematic, not least in the ranking of firms by average profit per equity partner.

WHAT’S YOUR FIT? SMALL, MEDIUM OR LARGE?
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