Questions about how law firm partnerships work Forum

[Inhousefuture]

Hello,

This topic was discussed in an essay by Georgetown law professor: https://southerncalifornialawreview.com ... 1/88_1.pdf

What's wrong with Law Firms by Jonathan T Mollot. However, I wanted the opinion of some of the people on the board. In this article, he discusses the fact that law firms lack permanent equity, the way most other industries have and the perverse incentives it creates: obsession with short term billing rather than building a business long term.

I will illustrate and sum up the difference:

1. In some other industries like FAANG, non management employees do get some token equity which can grow. In Law Firms, non management employees get no stock period.

2. The way law firm partnership interests work is fundamentally different from the way that partnership interests in other industries work:

A. The Equity that law firm partners have cannot be held passively after law firm partners leave the firm or passed on to their heirs. May sound trivial, but there have been many people in other industries who either inherited equity in companiees or earned equity in the companies they worked for and held on to the equity and resold for a huge multiple

B. The Equity that law firm partners hold does not grow in value like a regular stock. I.E When you put in the capital contributions you get them refunded with interest when you retire, not a huge capital gain even if the firm grows 100 fold.

C. The Equity that law firm partners hold cannot be resold for a profit. I.E If I were a partner in a restaurant chain with 3 friends and we put in 50,000 each, and the restaurant chain eventually netted 10 million a year, making my share of the profits 2.5 million, I could sell my interest to a private equity firm or outside investor for 5 to 10 times my annual profits netting 12.5 million to 25 million. As a bonus, it would be taxed as a capital gain rather than ordinary income. However, If I were in an analogous situation as a law firm partner, and wanted to retire, I could not sell my interest for a huge lump sum windfall Instead, I would just get a refund of 50,000 plus interest and I would simply cease making money as if I were leaving a JOB. My interest would just revert to the other partners.

My questions are:

1. Why is the way in law firm partnership equity structured this way. I.E different from other industries where partners equity can be held passively after retirement, sold for a windfall or passed on to heirs?

2. Do you think this is a good or bad idea?

3. How do you feel about the fact that law firm partners miss out on the possibility of liquidity events (IPO or selling a business windfalls) that most other owners/managers have the possibility of having?

4. Do you think this will ever change?

5. How do you feel about stock options/ RSU's/Phantom stock not being available to law firm employees?

Would be interested in any thoughts you have on this aspect of the legal industry.

Thanks

[Anonymous User]

Isn’t one thing that’s at the root of all your observations the notion that law firms cannot be owned by non-lawyers?

I’m not sure if / where such regulation truly does exist. But if it does, then that would be a massive barrier against partners selling their shares, devising them, etc.

So rather than puzzling over the peculiar features of law firm equity, I would start with that regulatory barrier. I can think of a lot of policy reasons why we might want to have a barrier like that in place — starting with “skin in the game.”

[Anonymous User]

Yeah, I think this is the result of lawyers circling the wagons through ethical rules and not allowing non-lawyers to partake in leadership or management of law firms (which I think is a bad decision, to be honest, but I understand the rationale).

[Anonymous User]

.

[Anonymous User]

The thing is that (big)law firms ARE different from most other business entities. With the widespread adoption of “eat what you kill” and removal of the partner lateral stigma, partners don’t really operate for the greater firm good anymore. Rather than think of firms are one big company, big firms are really better visualized as groups of solos and small law firms loosely organized under one common name. And because it’s in the partners’ interest to keep it this way, it is unlikely to change without significant outside pressure (non-legal ownership may be one pressure, as noted above).

Edit: In other words, firm equity doesn’t exist as much as partner equity does.

[k_moreno]

I honestly think this whole thing is economically incoherent. Corporations raise equity because they need money. If you want to build cars, you need to raise money to build a factory, then you sell the cars and pay back the source of funds (whether equity or debt).

A law firms needs pretty minimal capital to get started, especially when working on defense or transactions. Plaintiff work is different -- there are up-front investments that may not pay off for years, and that's exactly where you do see financing arrangements.

But to just do normal legal work, the amount of stuff you need to buy is not that big, so there's just no role for something like equity. The fact that firms even have "equity" is really mostly a fiction. They're partnerships, and any assignment of equity really just is what you're currently paid.

[tyroneslothrop1]

Far more than in other industries, the value of a law firm is tied up in the particular lawyers practicing there at any given moment. If you start a manufacturing business, you can sell that business to someone else and they can probably continue it and retain the bulk of the value from the business. There is a lot of value in the tangible assets (the building and the equipment). If you sell a law practice, the lawyer who assumes the practice must main the client relationships and business by their own specific talents. Much easier for the value of the business to dissipate.