Saying Goodbye: The Financial Impact of Compensating Retiring Law Firm Partners

Transcription

1 May 19-22, 2014, Toronto ON Canada Saying Goodbye: The Financial Impact of Compensating Retiring Law Firm Partners Presented by Kristin Stark, MBA FM24 5/20/2014 3:30 PM - 4:30 PM The handouts and presentations attached are copyright and trademark protected and provided for individual use only.

2 ALA Annual Conference Saying Goodbye: The Financial Impact of Compensating Retiring Law Firm Partners Kristin Stark Principal, Fairfax Associates May 2014 Page 0 About Fairfax Fairfax Associates provides strategy consultancy to law firms We help our clients to improve their competitiveness and achieve their strategic aims by identifying, planning and executing the practical actions that make a material contribution to their success. Fairfax supports our clients in four key areas of their business: Strategy & Direction, Merger, Performance & Compensation, and Governance & Management. Strategy & Direction Merger Performance & Compensation Governance & Management Strategy Development and Implementation Merger Strategy Partner Performance and Compensation Governance and Management Practice Strategy Merger Search Firm Performance and Profitability Improvement Operational Structures & Reviews Market and Sector Research Merger Negotiation and Structure Pricing Partnership Structure Client Research and Key Client Development Merger Integration Process Improvement Alternative Business Models Page 1 1

3 Topics for Discussion Retirement trends Developing a partner retirement planning process Managing and structuring compensation for retiring partners Managing and structuring capital account payouts and unfunded partner obligations Page 2 The Retirement Challenge Bulge in baby boomer generation retirements Firms of all sizes facing large number of retirees over the next years 40-50% of current lawyer composition (or more) in a number of firms Aging rainmakers and partnership group present challenges Succession Clients, leadership, rainmaking, expertise, ownership structure Compensation Capital repayments Unfunded obligations Page 3 2

4 Why a Retirement Planning Process is Necessary Compensation alone doesn t solve the problem Mis or unmanaged phase downs/phase outs Typically result in firms losing money Often result in lost clients, market position, and/or expertise Absorb a disproportionate share of firm profits and voting rights Communicates a mixed or negative message to junior attorneys/potential lateral hires Page 4 Benefits of a Retirement Planning Process Provides a framework/process to facilitate retirement planning dialogue Combats resistance to directly addressing the issue Age trigger for initiation of planning process Requires defining an equity partner s expected contributions Ensures a written plan for transition for partners and key clients Supports/enables effective succession planning Client transition Expertise transition Partner (leaders/owner/business generator) transition Clearly defines a path for partners in phase down Allows for the firm and the partner to plan for the financial impact of retirement Defines and aligns expectations on both sides Page 5 3

5 Compensating Retiring Partners Typically, most appropriately tied to graduated reduction in contribution level Supports gradual transition and allows succession implementation Allows firm and partner to better manage financial impact Range of compensation approaches applied Purely subjective/merit based compensation allocation 80, 60, 40 graduated reduction approach Formula based compensation arrangement Most effective approach ensures clarity and alignment in expectations, while allowing flexibility Define goals/expectations for retiring partner Communicate about anticipated compensation for fulfillment of goals Create flexibility through a bonus to reward those who go above and beyond to contribute to long run health of the firm Page 6 Capital Account Repayments Definition of capital accounts Post tax dollars (typically) contributed by partners to the partnership to fund operations or asset acquisition Constraints State specific regulations Partnership agreements Potential strategies for managing waves of repayments: Timing Limitation of payments provision Cap on total annual payments Page 7 4

6 Other Unfunded Partner Obligations Dramatic shift away from unfunded retirement plans since mid-1980s Common years ago, but today, only 1 in 5 firms retains an unfunded plan Also pertains to other forms of unfunded obligations Buy outs, founders funds, etc. Underlying problem? Diversion of current income to retired/departed partners, reducing income of current partners Most problematic after current generation retires Highly active lateral market drives inflated compensation which exacerbates tensions Major hurdle in merger discussions, lateral acquisitions Page 8 Other Unfunded Partner Obligations Risks? De-stabilization as retirements take place, and payments reduce income levels Losses of partners at junior or mid-levels, leading to domino effect I won t be the last one standing 1 in 5 most typical root causes of law firm dissolution Page 9 5

7 Addressing Unfunded Partner Obligations Cold Turkey Solution Grandfather/ Discontinue Grandfather at Age Threshold Grandfather With Benefit Reduction Terminate the program, discontinue benefit for all partners Grandfather all partners into the program, but discontinue the benefit for all future partners Grandfather everyone above a given age threshold (e.g., 55), and terminate benefit for all below that age Grandfather all partners into the program, disallow participation for all future partners, and freeze the value of the benefit as of a set date Those close to retirement may be relying on such funds as a source of retirement income Those currently receiving payments grandfathered Difficult but most equitable to current equities Acts as a disincentive to upcoming partners and laterals Immediate payments reduce the burden on future partners, forcing current partners to bear some cost of the benefit Founders Benefit, available only to those who took the extraordinary risks in starting the firm Acts as a disincentive to junior lawyers and laterals Reduce the overall benefit at a fraction of current value in order to minimize the objections of future partners Other nuanced variations in approach: Limitation of payments provision No survivor benefits Discounting of benefits or graduated reduction of benefits Page 10 Current and Best Practices in Partner Retirement Planning 1. Talk about succession early, often, and openly 2. Structure and get partner buy-in on a process for retiring or phasing down 3. Develop a written plan for transition for specific partners and key clients Ensure the plan addresses expectations for contributions and anticipated approach/financial impact of retirement payments (if they exist) 4. Drive retirement plan implementation through frequent follow up 5. Align incentives c. Addressing Succession, July Fairfax Associates Page 11 6

8 Questions & Contact Information Your opinion matters! Please take a moment now to evaluate this session. Thank You! Kristin Stark Principal, Fairfax Associates Kristin.Stark@FairfaxAssociates.com (415) London Washington DC California Fairfax Associates 2014 This presentation may not be circulated, quoted, or reproduced for distribution without the written permission of Fairfax Associates. This material formed part of an oral presentation and is not a complete record of the discussion. Page 12 7