Pep show

The Lawyer's groundbreaking research into average partner compensation will overturn many long-held assumptions about law firm financial management.

It will no longer be enough to rely on equity partners' profits to measure the health of the business. With non-equity partners (NEPs) an increasingly vocal constituency, and in many cases making up the majority of partnerships, it is time to include their compensation within overall calculations of how well a firm is doing. We took 30 of the UK's biggest firms to illustrate this.

The NEPs (whether you call them fixed-share, local, national, mezzanine or junior equity) are regarded by different firms in different ways. Most firms will say that any partner made up to this level is expected to progress to full equity. In the vast majority of cases it will be three years, but the requirements for full equity are much more stringent as firms have started to introduce more rigour into their promotions.

The limited-liability partnership (LLP) model will mean that law firms will have to be more transparent about remuneration. When you look at Allen & Overy's (A&O) accounts - exclusively revealed two weeks ago in The Lawyer - the amount of money allocated for NEPs is clear to see. Addleshaw Goddard managing partner Mark Jones welcomes the figures, saying: "Once you create a table of average earnings, it starts to lift the veil on the fudge that can otherwise go on with different partnership structures."

We followed that method in our calculations.

NEP remuneration is notoriously difficult to calculate. Our research found that NEPs are usually paid a salary plus a small share of the profits, and in many cases an extra bonus on top of that. Earnings can vary within each firm (NEPs based in the regions at DLA Piper Rudnick Gray Cary, for example, will be paid less than those in London).

However, in virtually all cases, the firms surveyed here were happy to give us a working figure representing average compensation per NEP. Multiply that by the number of NEPs and add that figure to the firm's net distributable profit for equity partners. That total figure is then divided by the global number of partners, to give the average profit per partner (APP).

The calculation is easy enough, but the results, which form part of The Lawyer UK 100 Annual Report, are stunning.

The magic circle

Freshfields Bruckhaus Deringer partners should take heart. It was bested by Linklaters in the average profit per equity partner (PEP) stakes by £145,000 - something that caused much gnashing of teeth at the Fleet Street firm. However, our table shows that taking all partner compensation into account means that Freshfields narrows the gap with Linklaters to £56,000, and its profit margin of 45 per cent even beats Slaughter and May - a magnificent achievement.

However, Freshfields partners should not be too complacent. The fact that turnover barely grew to £780m, while Linklaters' gross fees shot to £805m should be a cause for concern. Linklaters' APP figure may have dropped by £89,000 to £756,000, but it is still the second most remunerative firm in the UK after Slaughters.

Clifford Chance partners should be watching these figures closely - and should be getting used to disappointment. If the firm does decide to vote for an all-equity partnership, then it will have to steel itself for an average PEP of around £530,000 - our calculation of its APP. That is nearly £100,000 behind A&O. Compare that with Clifford Chance's current PEP of £644,000, which is only £26,000 behind A&O's.

What should concern Clifford Chance even more is that its already woeful margin of 26.7 per cent only rises to 33.5 per cent - way behind its magic circle competitors. Even Lovells outguns it on margin by this reckoning. You can deduce from this that the US is a horrible drain on the global practice; no other magic circle firm has that amount of cost.

The APP figure even slightly downgrades The Lawyer's Law Firm of the Year, Slaughter and May. In many ways, everyone's favourite elite firm follows the simplest of models. Many people would be surprised to see it having NEPs - they are located mostly in Slaughters' few foreign offices. But Slaughters has such a simple, pure model that even on The Lawyer's new calculations its partners are scraping by on an average of £998,000, which is £242,000 more than its nearest rival Linklaters.

The chasing pack

Ashurst, Herbert Smith and Lovells have all seen drops. Herbert Smith has 57 per cent of its partners enjoying full equity. Its PEP figure of £809,000 plummets 33 per cent to £538,000. But the firm still comes in above Clifford Chance and just pips that pocket dynamo of a firm Travers Smith (£529,000). Herbert Smith's margin, on the new figure, rises from 35 per cent to a very strong 41.2 per cent - better than A&O. Its top 10 rivals will be delighted to see its APP dive, but that profit margin still displays a well-run business.

At £411,000, Lovells has some work to do on APP. However, its relative position on this calculation looks slightly healthier than its detractors might imagine.

The mid-tier

The Lawyer has argued that the £400,000-plus barrier has become the benchmark of success in PEP. But when you look at the APP figure, there is a striking number of firms congregating around the £300,000-plus mark: Addleshaw Goddard, Barlow Lyde & Gilbert, Berwin Leighton Paisner (BLP), Clyde & Co, CMS Cameron McKenna, DLA Piper, Lawrence Graham, Nabarro Nathanson, Norton Rose, Olswang, Taylor Wessing and Wragge & Co. Many of those firms had been in the £400,000-plus or even £500,000-plus range before APP had been taken into account.

On this basis, we can see how well SJ Berwin does. There are only two firms that remain in the £400,000-plus bracket on adjusted APP: Lovells and SJ Berwin. Even more creditably, SJ Berwin's profit margin rises to the highest in the land at 46.7 per cent, up from 37.7 per cent.

This dramatic rise in the margin is mirrored by DLA Piper. Its earnings figure for all partners drops 44 per cent, from £535,000 to £300,000 - something jealous rivals will no doubt leap upon. Yet once the NEP pay is taken out from the cost side, the profit margin leaps from 20.9 per cent to 40 per cent - the same as A&O. That is still good going by any standard. DLA Piper managing partner Nigel Knowles says: "It's an interesting number. But our profits are based on a business model which works well for DLA and is not capable of comparison with any other firm." Having said that, the NEPs' average earnings figure of £210,000 is on the generous side, which will have aided DLA Piper's performance in these tables.

And here comes the almost inevitable: Macfarlanes and Travers Smith still enjoy splendid figures even after adjustment. Macfarlanes' PEP stands at £810,000, while APP stands at £660,000 - the highest of the £400,000-plus firms. Travers Smith, with only seven non-equity partners, dips slightly from £575,000 to £529,000.

Indeed, it is notable that the top 10 most profitable firms in both tables remain largely the same - it's just the order which changes.

National firms

National firms are under considerably more pressure than others. Costs of multi-site operations are inevitably higher, while differential pay (lower in most regions outside London) will depress APP. Addleshaws (APP of £322,000), DLA Piper (£300,000) and Wragges (£307,000) are entirely comparable.

While the above trio post strong performances, the clutch of national firms in these tables include four much weaker players: Eversheds, Halliwells, Hammonds and Pinsents. Halliwells at least has momentum on its side, and its APP of £217,000 is decent enough for a firm whose business is still mostly based outside London.

Pinsents is not really shaping up at all well. Its average PEP was disappointing enough at £234,000, but when all partner earnings are taken into account, it slides to an embarrassing £171,000. Even when the costs of its 126 non-equity partners are taken out of the calculation, it can only manage a profit margin of 28 per cent. That said, Eversheds will be disappointed in its APP of £234,000 (down from £350,000) and adjusted profit margin of 26 per cent. Hammonds' awful story has been widely covered elsewhere.

The Lawyer's APP calculations give a more rounded picture of a law firm's performance. But one thing is indisputable: however tight you hold the equity, the bottom line remains running the business efficiently.

The all-equity partnerships

There are four all-equity partnerships covered in The Lawyer's research: Barlow Lyde & Gilbert (BLG), CMS Cameron McKenna, Freshfields Bruckhaus Deringer and Wragge & Co. But such all-equity partnerships are not the same animal. Wragges' profit distribution structure is merit-based, meaning that in any given year the management can change a partner's profit share according to any number of criteria.

BLG, Camerons and Wragges operate a simple model with few sites outside London (Camerons' international spread is based on alliances, for example). All credit to Freshfields, therefore, for maintaining an all-equity lockstep with global spread - something that is fiendishly difficult. Yet that has caused problems in terms of investment in less remunerative jurisdictions and has arguably led to a certain amount of cultural inflexibility.

The Lawyer UK 100 Annual Report is published in September

Table: The APP Revealed