Partners Contribute Hidden Capital

December 9th, 2007 by Jim Cotterman

Law firm partner compensation is comprised of pay, profit and reinvested capital.  Few law firms distinguish between the three and it may be fair to say few partners even think of their compensation in this way.  However, if the partners took this view they might pay better attention to how each of these elements affects what they take home.  Here are the elements with a brief comment on each.

1.  The fair exchange for one’s labor—partners are very much active workers in the business.  They must be productive in fee generation both as an originator and as a timekeeper.  And they must undertake a host of non-billable activities for a modern law firm to operate well (manage, train, supervise and marketing are among a few on that list).  This is their true pay.

2.  PLUS profits from the labors of others—all other timekeepers should be profitable (generally even non-equity partners).  They are consistently and significantly profitable in the top firms.  This is their true profit.  For an interesting and related IRS view on this see my article on Unreasonable Compensation For PC Shareholders.

3.  LESS investment for growth—new people, offices, practices and markets are often funded out of current cash flow.  Since firms deduct these expenses currently they are the hidden capital invested by owners to grow the business.

4.  LESS investment for capitalized assets—items shown on the asset side of the balance sheet when there is no corresponding third party obligation for funding those assets (debt or capitalized lease obligations).

5.  LESS investment in working capital—higher salaries for associates being a prime example of a limited duration cash gap often funded by initially lower equity partner compensation.

This entry was posted on Sunday, December 9th, 2007 at 2:58 pm and is filed under Economics, Capital, Partner compensation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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