Two-tier partnerships have become increasingly popular in the legal industry over the last few years. This partnership allows law firms to expand their business without bringing in more partners. While there are many benefits to two-tiered partnerships, there are also some drawbacks that employers and law firms should be aware of before entering into this type of agreement. In this article, we will discuss the benefits and drawbacks of two-tier partnerships so that you can make an informed decision about whether or not this type of partnership is right for your business.
Many law firms have adopted a two-tier business structure but continue to operate under an "up or out" policy. This means that all non-equity partners must eventually meet the criteria for equity partnership or leave the firm. This can limit the long-term prospects for good lawyers who lack business development skills or equity partnership interests.
As the competition for talent increases and profit expectations rise, more of our clients are asking how to deal with lawyers who don't have the ability or desire to become firm owners. What are the benefits and drawbacks of creating a non-equity career path? What are successful firms doing to manage non-equity partnership opportunities effectively?
Defining Two-Tier Partnership Structures
A two-tier structure consists of two different types of partner positions and related roles and responsibilities: equity partners and income partners.
Equity partners are actual owners of the firm. They have a say in how the firm is run and share in the firm's profits and losses of the business. Some of the roles of an equity partner include:
- Make a capital contribution;
- Participate directly in the profits of the firm;
- Liable for the business debts; and
- Exercise ultimate control over the policies and direction of the firm.
On the other hand, income partners do not have an ownership stake in the firm. They are typically paid a salary and may also receive bonuses, but they do not share in the profits or losses of the business.
Income partners may also be responsible for bringing in new business, but their primary responsibility is to generate billable hours and work on client matters. Many attorneys move to another firm later in their career, bringing their book of business to become an income partner. Not all partners in a two-tier partnership share ownership of the firm equally. Some partners may have more ownership than others.
Below are some of the partners in a typical two-tier partnership structure:
Managing Partner (CEO)
This is the firm's leader responsible for its overall vision and strategy. The managing partner is responsible for the overall operation of the law firm. They may be an equity partner, income partner, staff partner, or senior associate.
Operations Partner (COO)
This partner is responsible for the firm's day-to-day operations, such as human resources, finances, and marketing.
The firm employs this attorney but does not have an ownership stake. Staff partners are typically paid a salary and may also receive bonuses, but they do not share in the profits or losses of the business. They can charge partner billing rates.
Clients often prefer working with law firms with a named partner, creating a sense of stability and trust. Of course, this may not be as important if you are working with a large law firm with the resources to provide excellent service. In general, smaller and medium-sized firms tend to be bound by these rules more so than larger firms.
Benefits of Two-Tier Partnership Structures
The general purpose of establishing a two-tier structure is to create a partner-type position whereby the firm can retain lawyers who make capital contributions to the company but who are not currently or, in some cases, ever willing or able to meet all the requirements of equity partnership. In doing so, the firm and the associate are offered an alternative to unnecessarily terminating a profitable and productive working relationship.
For many successful businesses, adopting a two-tiered structure eliminates the need for an "up or out" policy. This allows firms to retain many benefits associated with two tiers while avoiding the frustration and distrust from associates and non-equity partners who feel this policy is merely a way to prolong the equity partner career track.
There is a perception that firms adopt tiered structures simply to improve their Profit Per Equity Partner rankings. While this may be true for some firms, the majority do so to recognize changes in the profession.
- As the legal profession becomes increasingly competitive, it should be more difficult- not easier- to become an owner of a successful law firm.
- An increasing number of skilled lawyers are not currently interested in becoming equity partners but rather wish to keep their options open to make that commitment down the road.
Despite what many companies claim, providing the same benefits of a two-tier structure is challenging without having an explicit two-tier system. This is because it is difficult to control compensation and ensure everyone has an equal say in decision-making without a clear structure. Having a two-tier system makes it easier to manage these things and keep everyone on the same page.
Career Paths for Non-Equity Partners
Offering an alternative career path to high-value lawyers is a way for firms to show that they understand that not all lawyers want to or need to become equity owners. This can provide greater flexibility in a profession often seen as inflexible. It also allows lawyers to make lifestyle choices that work better for them.
To become an equity partner at your firm, it's essential to establish relationships with clients as a non-equity partner. This will give you the time you need to bring in new business and meet other requirements without the extra pressure of meeting numerical targets.
The non-equity partner track at a law firm allows you to develop business skills without the financial risk of becoming an equity partner. This track enables you to bring in new clients and grow your business without having to shoulder the responsibilities of equity partnership. As a result, you can focus on developing your skills and expanding your business knowledge without worrying about the financial risks associated with becoming an equity partner.
Benefits of Non-Equity Partnerships in Law Firms
- Helps to improve a firm's economic viability and market competitiveness: By maintaining higher equity partnership standards and associated business development expectations, firms ensure that those in equity partner roles are fully committed to investing in what it takes to grow profitability. Additionally, although income partners are well compensated, most firms maintain a clear gap between income and equity compensation, so the returns to the equity partners reflect their additional commitment and contributions to the firm's success.
- Serves to redefine the roles and responsibilities of "partnership" more rigorously. By adopting a two-tier structure, firms are forced to define equity and non-equity partnership more clearly. In particular, firms take a hard look at the capital and other contributions required of equity owners of the firm. Sometimes firms find that years of complacency or laissez-faire management have allowed deterioration in the level of these contributions.
- Eases the personnel challenges and expenses associated with an up-or-out system: As many firms are well aware, there are innumerable costs associated with forcing out a high-quality lawyer simply because they lack some of the skills or ambition required to become an equity partner. In many cases, such lawyers prove to be valuable assets to a firm in non-equity roles, acting as substantive experts, assisting in training associates, or managing quality control.
- Enables lawyers to maintain 'partner' status with the external community: This is particularly valuable in cases of senior, experienced lawyers who have deep substantive expertise but may lack business development capabilities. Partnership status allows such individuals to present themselves to clients and the public as senior members of the firm while reducing partnership obligations and expectations they may be unable to meet.
- Many young attorneys find they are more productive and profitable outside a traditional partnership track. This allows them to have a more flexible lifestyle and avoid being office-bound.
- As a non-equity partner, clients will see you as equal to equity partners. This gives you the authority to manage client relationships and pursue new business opportunities.
Drawbacks of Two-Tier Partnerships in Law Firms
Some have argued that two-tier systems are inherently unfair because they allow firms to have their cake and eat it too- they can retain the benefits of having experienced, knowledgeable partners without sharing profits equally.
Here are some of the drawbacks of two-tier partnerships:
- Two-tier systems can create a sense of hierarchy and division within a firm.
- They can be challenging to implement and maintain, mainly if a firm has not clearly defined equity and non-equity partnerships.
- Some lawyers may feel like they are being relegated to a lower status, which can affect morale and motivation.
- Two-tier systems can confuse clients, who may not understand the different levels of partners and what it means for them.
- Some have argued that two-tier systems ultimately hurt a firm's bottom line by discouraging talented lawyers from staying with the firm or joining in the first place.
- Two-tier systems can also create a sense of entitlement among equity partners, who may feel entitled to a more significant share of profits simply because they are equity partners.
- In the worst cases of two-tier law firms, we often see non-equity partner positions become places where lawyers with serious weaknesses are placed. This can be because of personality problems or quality issues. These firms might avoid having a difficult conversation to try and fix the problem. However, de-equitizing these partners is not always the right solution. In our experience, at least half of all firms that use a two-tier structure have this problem.
- Some companies think that having a longer career track and making income partnership status a requirement makes it harder to compete for top talent. However, most firms in the middle market and above use a two-tier structure, which provides fewer opportunities for associates to look for other firms with shorter career tracks.
- Finally, two-tier systems can complicate succession planning and make it difficult for firms to groom future leaders.
Two-tier law firms that are managed well can help to alleviate both of the issues mentioned above by being clear about partnership criteria, communicating openly and regularly with both partners and associates about the firm's structure and two-tiered partnership requirements, and holding partners accountable for meeting equity and non-equity partnership expectations. Additionally, by taking the time to consider and evaluate individual lawyers' unique career path opportunities and developmental needs, firms can ensure that their highest achievers receive appropriate advancement opportunities and that those with weaknesses or limitations are given effective coaching and mentoring.
While two-tier ownership structures may present some challenges, they ultimately enable firms to deal openly and effectively with lawyers pursuing a non-equity career path. In a well-managed firm, the benefits associated with retaining high-value lawyers through such a structure far outweigh the potential drawbacks. As such, firms should carefully consider implementing a two-tier ownership structure to reap its many benefits.