Law Potion #9

While traditional Biglaw is splashing cash at its incoming associate classes, a new breed of cloud-based law firms is enticing Biglaw lawyers to jump ship and go digital with promises of a payday. One of my partners recently forwarded a lateral recruiting email to me that touted an Am Law 200 refugee whose compensation allegedly “more than doubled” when they joined a cloud-based firm. We’d all love to double our money, right? So what’s the catch?

Rethinking Compensation

I wrote in this space a few months back about FisherBroyles, the law firm poised to crack the Am Law 200 despite most of its attorneys working out of their houses. FisherBroyles and others, such as Rimon Law, VLP Law Group, Culhane Meadows, and Taylor English are part of a growing trend of high-end legal service providers that, in whole or in part, forgo traditional office space in favor of letting attorneys work wherever they choose. Whatever you call these kinds of law firms, be it “distributed,” “cloud-based,” or virtual law firms, they’re an important driver in our generally stodgy industry. I’ve recently had the opportunity to chat with the managing partners at each of those firms, and I’ll be spending the next few columns teasing out innovations that they’re bringing to the table.

But for all the innovative technology these cloud-based firms utilize, there was one curious common thread that tied them together that has nothing to do with the digital revolution: every one of them relies on a purely objective compensation formula for its attorneys. There are no exceptions. Rimon Law, for example, lets potentially interested lateral partners punch in the details of their book and find out what they’d be bringing home if they moved their practice over.

So why are these next-generation firms, comprised of mostly former Biglaw lawyers, selling comp systems as the magic potion? Hasn’t this battle been fought already?

The potential advantages of objective compensation systems are obvious. First and foremost is efficiency. In subjective compensation systems, leadership can spend weeks or months setting up and defending a compensation scheme. When compensation is based on a formula, theoretically all management has to do is punch in the relevant numbers and cut a check — at least until the fights start up over who receives credit for a given client’s revenue or partners start arguing that the formula is flawed.

Why do a majority of brick-and-mortar Biglaw firms continue to use purely subjective compensation systems, then? Part of it is that it’s harder to implement purely objective systems at traditional firms than at virtual firms. Consider overhead. Allocating overhead is one of those things that can be done fairly, or simply, but arguably not both. Say a firm with 10 partners has $100,000 in annual expenses. The simple allocation is to charge every partner $10,000 a year in overhead. But that means the partner who keeps themselves busy with no support staff is paying the same as the partner with the bigger book, but who maintains three associates, two paralegals, a full-time legal admin, half of the copy room, much of the IT department’s time, and a dedicated file clerk. Incentives become perverse quickly. If I can have a legal administrative assistant or a litigation support clerk who work 90 percent for me, but I’m only paying 10 percent of their salary and benefits, I’ve come out ahead. Simple overhead allocation puts partners in competition with one another, leading to inefficient expenditures of time, money, and emotion.

Assume the partner with no support staff complains they’re subsidizing the other attorney who does. That other partner complains that their larger book of business is subsidizing the smaller partner’s practice by covering a larger percentage of fixed expenses. So, in the name of fairness, we start allocating support staff overhead on a per-attorney basis. This leads to infighting over who keeps what associate busy, and who manages what paralegal. Then the transactional partners complain that they shouldn’t be paying for the firm’s Westlaw subscription, since they don’t use it. The litigators say they don’t want to pay for the new document management system the transactional partners bought. The more granular and fair we try to get with allocating overhead, the messier and more time-consuming the process becomes. Many firms have to add in a subjective component to their compensation just to give management some leverage to use to resolve all these fights.

Virtual law firms get to dodge most of the problems inherent in overhead allocation. They take one of the biggest pieces of overhead, the office lease, off the table. Their attorneys and practice groups also tend to be highly compartmentalized, meaning there isn’t often any dispute over who support personnel work for, and there aren’t many shared expenses that need to be split up. Overhead becomes à la carte; pay for what you use and no more. Lawyers thus have the incentive to be efficient instead of grabbing as much of the common pie as possible.

The distributed law firm model inherently solves a big piece of the overhead allocation problem, which makes purely formula-based compensation that much easier to implement. When you know exactly what every attorney costs, it’s easy to plug that number in.

The Potential Downsides

The virtual firms’ objective systems are not without their weaknesses, though. For starters, a pure eat-what-you-kill system doesn’t include any inherent way to smooth out income for attorneys over time. An attorney that has a great year makes a ton of money. If that attorney’s biggest client dumps them, purely formula-based compensation systems generally don’t provide much of a safety net (though, as some managing partners pointed out, nothing says they can’t).

There’s also the problem with how to reward contributions to the firm that aren’t reflected on a balance sheet. Traditional, more subjective compensation models have the flexibility to compensate attorneys who aren’t necessarily as profitable as the next, but who make big non-monetary contributions such as client care, community outreach, pro bono cases, associate development, or others. These kinds of contributions aren’t just good for developing a firm’s PR image. They’re crucial to establishing firm culture, that elusive, incredibly valuable resource to the firms that are able to cultivate it. If virtual firms don’t have systems in place to reward those who make the firm better, if not richer, then all they have to keep their attorneys around or to attract new ones is a good formula. And when better comp is your only lure, you’re inevitably going to lose out to someone else who’s willing to pay more.

Then again, maybe “firm culture” in the traditional sense doesn’t mean the same thing for a cloud-based firm as it does when you’ve got dozens or hundreds of attorneys sharing an office and needing to find a way to coexist. Maybe those attorneys already have all the culture they need, and are happy for the rest of the firm to leave them alone when they’re not sharing work with one another.

Will Biglaw Follow?

Time will tell if these purely formula-based compensation models used in the virtual law space remain the dominant strategy. If there’s a better model out there, or even just a profitable alternative, someone will probably find it and run with it. It’s built into the DNA of these legal startups; the market is young and hungry. Maybe someone starts a virtual firm with a more subjective comp system baked in, presenting itself as a culture-based, kinder virtual law firm that wants to reward loyalty, pro bono work, or whatever its partnership values in addition to cash.

The virtual firms will figure their comp systems out. The real question is whether the brick-and-mortar firms can overcome inertia and start experimenting using digital Biglaw’s playbook.

---

James Goodnow is an attorney, commentator, and Above the Law columnist. He is a graduate of Harvard Law School and is the managing partner of an NLJ 250 law firm. He is the co-author of Motivating Millennials, which hit number one on Amazon in the business management category. You can connect with James on Twitter (@JamesGoodnow) or by emailing him at [email protected].