Profit or loss?

Before assessing improvement, partners must decide on an appropriate yardstick for measuring profitability.

Commercial lawyers are familiar with corporate performance where various indicators can be used to measure improvement – higher earnings per share, increase in the dividend rate and a straightforward rise in share price.

An increase in a company's profits in absolute terms is no guide. That can be achieved simply by acquiring another profitable business which might not lead to improvement unless it works through into higher earnings per share, etc.

Still less can a company's performance be measured by the rate of increase in workers' remuneration. Indeed, the opposite is likely to be true as higher wage bills reduce the profits of a company and have an adverse effect on other indicators. A pay increase for the workers is not necessarily good for the shareholders.

But partnerships are not corporate entities. Equity partners are both proprietors, more akin to tenants for life than absolute owners, and workers in that they are entitled to income from the business as long as they continue to work there.

A profitability test which indicates an improvement for a partner wearing the proprietor's hat might not look so good when measured in their capacity as a worker – but does this matter for a partner who is both proprietor and worker?

A large investment by partners in a foreign office will reduce current profitability in the hope that future income will increase. The proprietor should not mind as they will benefit from the investment in years to come, but the worker will suffer because his current year's profit will drop. This dichotomy of interests would not be an issue for a sole proprietor who would enjoy the full payback on any investment, but partnerships are not so simple.

It is often said that the profitability of a firm can be doubled overnight by getting rid of half the partners. It is true that earning per partner's share might be doubled in this way but it would be a poor measure of performance if the partners taken as a whole were said to be doing better.

The remaining partners' profitability might be doubled, but the outgoing workers would no longer be entitled to income and the future profitability for them would be disastrous.

From a corporate viewpoint, such a sleight of hand could be compared to persuading shareholders that it is a good idea to double earnings per share by disenfranchising half the shareholders. It would never happen.

This gives us a clue to the true nature of a modern professional partnership and a pointer to how profitability might be measured.

The analogy suggests the proprietorial aspect of today's professional partnerships is a much diminished characteristic. An outgoing partner might be entitled under his partnership agreement to some compensation if he is asked to leave but not to his share of the value of the business when measured in terms of the net present value of the firm's future income stream.

This means the 'worker's' entitlement should be the prime factor in measuring profitability, as a share of the current profit is all that most partners are entitled to.

Subject to making the right investments each year to sustain profits in the future, the yearly draw for all the partners is the true measure of profitability.