With the chances of making equity gradually reducing across the top 100, has the focus on PEP radically changed the structure of partnership?
The old order has been re-established. While the much-contested profit per equity partner (PEP) continues to be an emotionally important metric, it favours those firms that have smaller equity partnerships. Fewer equity partners sharing the pot can boost profits artificially; no wonder that the trend among the top 100 firms over the past five years has been to reduce the proportion of full equity partners.
With PEP notoriously a factor in distorting profit benchmarks, mean earnings per partner (EPP) – the average compensation across all classes of partners – provides a necessary insight into the financial success of a law firm.
And the EPP table this year shows a reassertion of the old hierarchy. It is led by the magic circle and followed by silver circle firms Ashurst, Herbert Smith, Macfarlanes and Travers Smith, all of which still make an average EPP of £500,000. Three firms – Freshfields Bruckhaus Deringer, Linklaters and Slaughter and May – all make over a million on the EPP table.
Much has been written about Freshfields’ extraordinary success in polishing up its margin, but taking a five-year view, Linklaters’ performance is particularly creditable.
In the past half-decade the ratio of equity to non-equity partners has been reduced by 6 per cent at Freshfields, but Linklaters has grown the proportion of equity partners in the partnership by 9.5 per cent, thereby bucking the trend among the top 100 to increase the proportion of fixed-share and salaried partners.
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“We’re quite conscious that there’s some drift away from equity and that what we’re doing bears down on PEP,” says Linklaters managing partner Simon Davies. “But we feel our ratio is the right one. We believe it’s going to drive greater teamworking and cohesion in the partnership. There’s a big difference between a partner and an employee for us, and we felt that ultimately this is the right direction to go in. A client should be getting a true partner of the firm.”
The Lawyer has tracked profit performance on PEP and EPP over the past five years, and within the leading pack the trend in equity partner ratios is marginally downwards over five years. The most marked reshaping has been at Ashurst, where the proportion of equity to non-equity partners has declined by 22 per cent. Other firms that have culled the partnership have stuck broadly to the same ratio with which they are culturally comfortable. Following its restructure in 2008-09, Clifford Chance has exactly the same proportion of equity partners as it had five years ago, while Allen & Overy (A&O) has just 2 per cent fewer – not the actions of firms that want to increase PEP to the exclusion of all else.
But in the process the two firms’ focus on costs has yielded greater rewards firmwide in partner compensation. Clifford Chance has improved EPP, which has risen from £638,000 to £698,000 over five years, while materially A&O has improved the most, with EPP on £695,000 in 2005-06 and £951,000 in 2009-10. Dealing with underperforming partners and faltering business areas has made a dramatic difference.
Among the smaller silver circle players, Travers Smith emerges as having reconfigured its partnership the most. It is 16 per cent down over five years on its proportion of equity partners compared with a drop of 3 per cent at Macfarlanes. However, Travers managing partner Andrew Lilley declares that there is no overarching strategy to reduce the equity, citing the departures of a particular generation of senior partners, such as Christopher Bell and Alasdair Douglas.
“Our ratio will have been jolted by our shift from a norm of two years of junior equity to three years,” he says. “I have no wish at all to create a new two-tier partnership structure here. The hope whenever anybody’s made a junior equity partner is that they reach [full equity]. It’s not indicative that we’re trying to create a different sort of structure here.”
While both Macfarlanes and Travers’ EPP performances are remarkably strong, both firms are still battling to maintain their margins. Over five years Macfarlanes’ EPP has dropped by 23 per cent and Travers’ by 15 per cent.
Further down the table, it is easy to spot the firms where small equity partnerships have boosted PEP.
At DLA Piper, 29 per cent of the partnership is equity, so while EPP is £308,000 its PEP figure is 80 per cent higher at £553,000. However, DLA Piper is by no means the only firm to keep a tight rein on its numbers sharing true profits.
Trowers & Hamlins’ PEP is high at £553,000, but only 24 per cent of its partners are equity. This is reflected in the disparity between its EPP, at £285,000, and PEP, which is nearly double. This is no one-off – on a five-year view, Trowers has been particularly parsimonious in giving people full ownership of the firm. The proportion of equity partners has slumped by 21 per cent in a five-year period.
“Equity’s a very emotive issue,” says Mark Brandon of legal consultancy Motive. “It’s a moral concept – it’s just different being an owner from an employee, however highly paid you are. When people start to manipulate equity they don’t consider how that then affects growth plans and the strategy of the firm.”
Strategic issues, then, also throw some light on firms’ EPP status. Take the current market in transatlantic mergers.
Denton Wilde Sapte, Hammonds and SJ Berwin have all reduced their equity partner ratios in the past five years. This has not helped their profit levels, but may have made their firms easier to sell to potential buyers.
SJ Berwin’s current PEP is smaller than its 2006 EPP – its EPP figure has dropped by 35 per cent since 2005-06, from £504,000 to £329,000, and 37 per cent in PEP, from £711,000 to £447,000. In the same period its ratio of equity partners has reduced by 10 per cent.
Dentons’ PEP over five years has dropped by only 4 per cent – a decent enough performance, but one that has been shored up by a 15 per cent reduction in the equity partner ratio. In 2005-06 60 per cent of its partners were equity, but by 2009-10 that had dropped to 51 per cent. The knock-on effect on its EPP number was to depress it by 12 per cent, from £325,000 to £285,000.
Hammonds’ trimming of its equity has also allowed it to maintain its PEP. In 2005-06 it had 52 per cent equity partners, but by 2009-10 that had slumped to 37 per cent. The difference between the EPP and PEP figure has therefore widened from £216,000 and £328,000 respectively in 2005-06 to £211,000 and £364,000 in 2009-10.
In a similar vein, what the EPP table does is inject some reality into the debate over partner pay, turning the top 100 into a less startlingly profitable group of firms.
In the PEP table there are 20 firms in the £300,000-£399,000 range, beginning with Osborne Clarke at number 45 on £393,000. But on EPP calculations that range shifts upwards to become the dominant profits bracket for the top 50 firms, beginning with Ince & Co with £398,000 at number 15 and ending with DLA Piper on £308,000 in 36th place.
The suspicion that this range is more truly representative of law firm profitability is confirmed with the appearance of three firms that are all-equity, or near to it: Barlow Lyde & Gilbert, Dundas & Wilson and Reynolds Porter Chamberlain.
This dominant £300,000 bracket has not shifted in five years. Despite the upheaval in the profession over the past five years, it seems that this is the benchmark of law firms’ underlying profitability. On that reading, PEP truly is deceptive.
-Four firms in the £300,000 bracket this year have dropped in EPP over five years: Berwin Leighton Paisner (£429,000 in 2005-06); Eversheds (£422,000); Holman Fenwick & Willan (£409,000); and SJ Berwin (£504,000).
-DLA Piper and Ince & Co have climbed from £283,000 and £291,000 respectively.
-Clyde & Co and Norton Rose have increased EPP to £430,000 and £400,000 respectively.
-Firms no longer in the 2005-06 £300,000 bracket include Davies Arnold Cooper (£173,000 in 2009-10); Denton Wilde Sapte (£285,000); Nabarro (£285,000); and Wragge & Co (£260,000).