Law Firm Compensation Formula by qne14412


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									                              Creating and Capturing
                                      Law Firm Value

By Jerry Schwartz and                           Each law practice has characteristics      Timely recording of your time on files –
                                            that set it apart from its peers. The most     Even time on contingent fee files should
   Jeff Barnes, CFP, CEBS                   profitable are run with a strong dose of       be recorded so the profitability of the case
                                            common sense pervasive throughout the          can be determined at completion. This
                                            firm. The successful not only implement        information can be extremely useful in
                                            the following points but monitor their         determining whether additional staff
                                            accuracy and relevance on a continuous         should be hired or whether certain work
                                            basis. If your firm is not doing these         should be accepted by the office. It pro-
                                            things you may not notice while income         vides the dollars produced for each hour
                                            is up; but, when the outlook is not so rosy,   worked, which can be helpful in project-
                                            you’ll wish you had paid more attention        ing future fees. It will also provide a
                                            to these important tenets. The first part of   chronological record in the event the
                                            this article will focus on smart, common       client decides to change lawyers, the bar
                                            sense measures to be taken by a firm to        or malpractice carrier receives a com-
                                            increase its profitability, while the latter   plaint about your work or if a record is
                                            part of the article will focus on a smart,     needed for the court. Recording time is a
                                            and often overlooked, way for partners to      difficult discipline to learn but has huge
Jerry Schwartz is the president of Legal    capture the value of what they created.        payoffs in the profitability of the practice.
Management Services, Inc. of Memphis
Tennessee, which specializes in prof-               Increasing Profitability
                                                                                           Properly recording the costs associated
itability improvement of law offices. Mr.
                                                                                           with each case – A system should be in
Schwartz serves as the recommended          Profitability in the practice allows the
consultant of The Mississippi Bar,                                                         place to capture the client advances and
                                            firm to accomplish many financial and
which offers the “Law Office Consul-                                                       disbursements in a case. Advances such
                                            personal goals:
tant Program” to all members. Contact                                                      as filing fees, deposition charges and trav-
                                                • Exceptionally serve client needs         el should be charged against the client file
The Mississippi Bar office at 601-948-
4471 or Jerry Schwartz at 901-521-              • Maintain the leading edge in tech-       when incurred and the internal costs such
1554 or by email: jerry@legalmanage               nology and research                      as copies, postage and fax charges should for additional infor-          • Hire the best professional and sup-      be logged and periodically recorded on
mation.                                           port staff                               the file. Maintaining adequate records can
                                                • Provide adequate pay and benefits        be a difficult task but the payoff in
Jeff Barnes, CFP, CEBS is the Director
                                                  to maintain staff                        improved profitability and cash flow is
of Benefits Planning with Thompson
                                                • Maximize partner income and              definitely worth the effort.
Dunavant, LLC in Memphis, TN –
Succession Plans for Partners of                  increase the value of the practice
Service Providers. Mr. Barnes is a                                                         Billing files on a regular basis – A regular
                                            Practiced on a day-to-day basis, these         schedule should be set to review the work
Certified Financial Planner ® and
Certified Employee Benefit Specialist.      practices determine the financial success      in process and bill the client. It is very
He can be reached at 901-685-5575 or        of the law practice and build value for the    important to bill the client on a regular
by email:                partners:
                                                                                                             Continued on next page

The Mississippi Lawyer                                                                                                 June, 2005 45
                basis or when a desired result is accom-
                plished, because clients are happier to
                pay smaller statements or when the value
                of the case is determined.

                Following up on accounts receivables –
                Reminder statements should be sent
                monthly and a firm collection policy
                should be in place to ensure the collection
                of billed files.

                Adequate management and financial
                reports – Monthly management reports
                should be produced for hours worked and
                billed, dollars billed and collected, work
                in process and accounts receivable. The
                monthly financial reports produced
                should be the balance sheet, income state-
                ment and cash flow statement. An annual
                budget should be prepared and compared
                against actual on a periodic basis. The
                firm can only control the profitability of
                the practice if the partners are informed.

                Profitability can produce more annual
                income and can help to build value in the
                firm, which can have huge payoffs.

                     Capturing A Partner’s Value

                     The following is a fairly consistent
                story of many law firms we encounter in
                size and demographic. This firm utilized
                an interesting technique to assist a depart-
                ing partner in realizing value that he built
                while providing a more economically
                beneficial approach for funding this buy-
                out to the remaining partners.
                     Smith & Jones, PLLC, which has five
                partners. John, the oldest partner is 57.
                Three partners are in their late 40’s and
                the youngest is in her early 30’s. The
                three partners in their 40’s provide the
                bulk of the income coming into the firm.
                John, a founding member of this firm is
                still earning a nice income but desires to
                “wind down” his practice by spending
                less time in the office and more with his
                family. He’d like to transition his clients
                to the younger partners and expects to be
                compensated (bought-out) for the value
                created by client origination and the
                launch and growth of the younger part-
                ner’s careers. John, along with his other
                four partners, just paid off a bank note

46 June, 2005                   The Mississippi Lawyer
                            Creating and Capturing Law Firm Value
that was used to buy out his long-time         attorney in the firm whom John would           a 401(k) feature. This allows all partici-
friend and partner 10 years his senior as      like to assist in her career development so    pants the opportunity to defer some of
he transitioned his practice to John and       that she, too, may transition into the part-   their pay and save it into the retirement
his remaining partners. The question was       ner group.                                     plan.
posed, “Is there a better way to do this            We requested data on their current             The plan adopted a Safe Harbor pro-
rather than taking on debt?” We think so       retirement plan, a defined contribution        vision whereby the employer will con-
and here’s how:                                profit sharing plan. The firm had been         tribute 3% of pay, immediately vested to
     First, we discussed what the retiring     making generous contributions to the           the staff.2 This feature allows the partner
partner felt was a fair value for his inter-   plan for many years (Note: Prior Funding       group to save up to $14,000 from salary
est in the firm. This is usually the most      Example). As a percentage of compensa-         in 2005 without restriction.3
delicate issue. Since they had just paid       tion, the firm had been contributing about          The amended plan design also
$150,000 (which was equivalent to his          6% each year allocated to everyone as a        includes an alternative allocation formula
last year’s salary) to the partner that        pro-rated share of compensation. For           (termed a cross tested or new compara-
retired, we had some starting point. A         instance, John’s long time assistant,          bility formula) for the allocation of any
figure of $300,000 was agreed upon by          Alice, who makes about $40,000 a year,         discretionary profit sharing contribu-
all partners. Next, we discussed a time        received the same percentage of profit         tions.4 This differed from the way the
frame for retirement. John said he’d like      sharing allocation as John, who made           plan had been operating where everyone
to practice for another seven to eight         $200,000. (Note: Although the several          received an equal, pro-rated share based
years. He enjoys his work and is in good       partners are earning between $300,000          upon compensation. Now the allocation
health. John has a passion for his work,       and $400,000 annually, for plan testing        will be weighted towards the older, more
is interested in the long-term, financial      purposes, their compensation is capped at      highly compensated participants. The
and personal health of his clients and         $210,000 for 2005 (maximum eligible            Plan permits John’s four partners to not
would like ample time to transition them       compensation).1                                share in any allocation of discretionary
to the remaining partner group. He has a            Here’s what we did. We amended
niece, Stephanie, who is an associate          and restated their existing plan to include                      Continued on next page

The Mississippi Lawyer                                                                                                  June, 2005 47
                profit sharing contributions. The plan is
                designed such that a partner does not
                receive an allocation until he or she
                reaches age 55 and has 10 years of serv-
                ice. This can be amended if needed as
                demographics of the firm change. The
                hired staff must receive some allocation
                of the profit sharing contribution to pass
                the annual plan discrimination testing.
                The adopted formula recognizes age and
                compensation when determining the allo-
                cation of the contribution and John, being
                older and receiving a larger salary,
                receives the lion’s share of the contribu-
                tion. This formula for allocation of the
                discretionary profit sharing contribution
                is similar to the way a defined benefit
                pension plan credits an annual benefit to
                a participant. The older, more highly
                compensated employees receive a larger
                benefit credit due to the shorter number
                of years to retirement and their relative
                higher pay compared to those younger
                employees and those earning less. This is
                the meat of the design in regard to mak-
                ing this work as a mechanism for funding
                a buy-out. This feature requires on-going

48 June, 2005                  The Mississippi Lawyer
    Creating and Capturing Law Firm Value                                                         Elam Consulting, Inc.
monitoring to make sure that we stay in       is designed to start funding a partner’s           Independent Insurance Consultants
compliance in regard to employer contri-      buy-out when a partner reaches 55 and
butions and relative benefits received        has 10 years of service. Steve, Will and                      Since 1988
under the plan.                               Arthur are next “on-deck” and are moti-                        Offering
    With the newly designed plan (Note:       vated to foster an environment of “hand-
Qualified Plan Buy-Sell Funding               ing-off” of clients to the next generation
Example), the staff received another 2%       with 10 to 15 years of time to determine                    INSURANCE
of pay in terms of profit sharing alloca-     which group of partners will inherit their               EXPERT WITNESS
tion for a total of 5% (3% of safe harbor     legacy.                                                         &
and 2% in profit sharing). Although the           This strategy of using the firm’s exist-           LITIGATION SUPPORT
total contribution was 1% of pay less than    ing retirement plan makes sense for
they had grown accustomed to, the addi-       smaller firms that desire a cost effective,
tion of the 401(k) feature outweighed the     creditor-protected approach that fosters a
small change in employer provided con-        long-term sense of value and certainty.
tributions. Also, notice that John’s part-    Good business practices followed by the
ners can still participate in the plan by     firm to maximize profitability enable
saving up to the maximum of $14,000           partners to enjoy acceptable levels of
this year.                                    annual compensation and to build value
    The firm re-drafted their partnership     for retiring partners. I
agreement to account for this agreed                                                                       Eric Elam, President

upon value ($300,000) and recognized          1 26 USC Section 401(a)(17).
                                                                                                     15 Northtown Drive, Box 2
                                              2 26 USC Section 401(k)(12)(C)
the retirement plan as a possible source of                                                              Jackson, MS 39211
                                              3 26 USC Section 402(g)(1)
funds for the eventual buy-out. The plan                                                         Phone 601-952-0403 Fax 601-977-0807
                                              4 26 CFR Section 1.401(a)(4)-8

                                     Qualified Plan Buy-Sell Funding Example
                                                  Annual ‘05         401(k)         Safe Harbor       Profit Sharing
                                                  Estimated          Salary        3% Non-elective      Allocation         Total Owner
                                        Age         Comp            Deferral        Contribution       Cross Tested        Contribution
 John                                    57          200,000              0                  0            40,000                   40,000
 Steve                                   46          210,000         14,000                  0                 0                   14,000
 Will                                    43          210,000         14,000                  0                 0                   14,000
 Arthur                                  41          210,000         14,000                  0                 0                   14,000
 Sarah                                   36          100,000         14,000                  0                 0                   14,000
 Owner Group                                         930,000         56,000                  0            40,000                   96,000

 Associates & Staff
 Melissa                                 32           63,000                   0         1,890             1,260                    3,150
 Stephanie                               30           58,000                   0         1,740             1,160                    2,900
 Drew                                    35           54,000                   0         1,620             1,080                    2,700
 Alice                                   52           41,500                   0         1,245               830                    2,075
 Shondra                                 41           36,700                   0         1,101               734                    1,835
 Susan                                   29           24,500                   0           735               490                    1,225
 Juanita                                 29           23,500                   0           705               470                    1,175
 Jackee                                  40           22,000                   0           660               440                    1,100
 Lisa                                    23           20,500                   0           615               410                    1,025
 Kayce                                   39           20,000                   0           600               400                    1,000
 Patricia                                43           19,500                   0           585               390                      975
 Non Owner Totals                                    383,200                            11,496             7,664                   19,160

 Totals                                            1,313,200        112,000             11,496            46,874                  115,160

 All Partners and Employees (although not depicted) can defer from salary the maximum and catch-ups of $4,000 are allowed for 50+.

The Mississippi Lawyer                                                                                                      June, 2005 49

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