When it is time to let a partner go
JOEL A. HERMAN, CPA
Partners can go through waves of productive and not-so-productive periods. But what should a firm do about those partners who cannot seem to dig out of an unproductive slump — or even worse, do not seem to want to? While it is not the type of situation any managing partner wants to confront, this article looks at why tackling the issue head-on is the best course of action.
How do you define performance?
The definition of underperformance depends, in large part, on your firm’s documented goals along with unwritten expectations, its criteria for evaluating performance and the terms of your partnership agreement. Increasingly, in some firms, senior partners are being labeled as underperformers not because their contributions have changed, but because their firms and the legal marketplace have changed their standards.
To prove underperformance, your firm first needs to define it. In general, underperforming partners:
- Regularly bill fewer hours than their peers;
- Fail to develop a self-sustaining practice, which includes introducing new clients and engagements to the firm;
- Are unable to manage engagements and projects profitably or to the client’s satisfaction;
- Do not adhere to the firm’s recommendations for best practices, let alone policies for standard operating procedures, for client, staff and internal administrative matters; and
- Cannot (or will not) adapt to a more competitive and demanding legal marketplace, to your firm’s changing values and objectives or even to new technologies.
Underperformers also show signs of burnout, exhaustion, anxiety or boredom. Note that unethical behavior or misconduct generally are not considered performance issues. You should address such situations separately.
What is the cost?
It is common for firms to ignore struggling partners, hoping they will find their own way back to productivity — or leave the firm. Neither scenario is likely. Most underperformers realize their shortcomings, but do not know how to fix them. And few people willingly leave a secure job, even one that offers increasingly diminished returns.
In the meantime, underperformers cost your firm in the form of lost work, weakened client confidence and lower staff morale. The partner may even stand in the way of a deserving associate’s promotion, recruitment or practice development opportunities, or a successful merger with another firm.
Try to quantify these costs and present them, as well as other “objective” evidence, such as average profit per partner, to the underperforming attorney during his or her compensation review or in a more informal interim one-on-one meeting. Do not blame or accuse the partner, but instead, express concern and ask how you, other partners and the firm can help him or her.
Can changes be made?
If you believe rehabilitation is possible and the underperforming partner is willing to accept help, develop a performance management plan. Start by setting specific and measurable goals and objectives, such as increasing billable hours by a set percentage or engaging a specific number of new clients in the next year. Then provide the partner with the support he or she needs to achieve them.
Support can include mentoring by your firm’s top rainmaker, continuing legal education, networking, financial management or computer courses. Consider a personal organization or career coach, additional administrative help, or if the issue is burnout, a vacation or a short sabbatical. Meet regularly with the partner to assess progress and discuss possible obstacles. Try to be flexible and patient as you mentor an underperforming partner.
When is it time to leave?
It is important to know when to cut your losses. Not every underperforming partner is capable of — or interested in — making the necessary changes. If the partner exhibits little progress or commitment to change after a predetermined period, it is probably time to change the partner’s role or to part ways from the firm. In such situations, make sure the partner’s transition is handled sensitively.
Passive techniques, such as reducing partners’ shares until they are forced to quit, can be as detrimental as aggressive ones, such as terminating them on short notice. Both can damage firm morale and your reputation with clients, staff and prospective hires. Also, unless partners are guilty of misconduct, you owe formerly trusted colleagues courtesy and respect.
Terminating a partner is a tough decision, but it is in your firm’s best interest to move forward with productive partners. Taking action sooner rather than later will result in less damage to your firm’s profitability, morale and relationships.
Signing on the Dotted Line
Due diligence for law firm mergers
Law firm merger activity dropped sharply in the wake of the COVID-19 outbreak but some struggling firms are reassessing the strategy as a possible life preserver. The pandemic economy makes comprehensive due diligence more important than ever when evaluating potential arrangements. Before signing on the dotted line, both sides need assurance that the numbers add up and no problems are bubbling below sight.
Not surprisingly, the primary emphasis of due diligence is on financial issues. To flush out risks, work with merger and acquisition advisors to hone in on the following:
- Financial Statements
Start by reviewing the other firm’s financial statements for at least the prior two years. While reviewing, give extra care and attention to its general ledgers, accounts receivables and payables, work-in-progress, notes payable, fixed assets, depreciation schedules and nonrecurring income and expenses. Gathering this information will help you estimate the value of the other firm’s net assets. You can use this information to determine the price and terms of a transaction.
The other firm should provide projections on partner buyout costs, impending retirement expenses over the next five to ten years, client retention and billing rates. If not included, request additional information on the assumptions used to form the basis for those projections so that you can determine whether they are reasonable.
- Tax History
Review several years of federal and state income tax returns. Sales and use taxes and commercial rent tax also warrant examination.
Consider both on- and off-balance sheet items, including outstanding liens, unfunded retirement obligations, unpaid tax liabilities, deferred compensation, pending litigation and other contingent liabilities. Look beyond the facts and figures for potential underlying problems.
- Malpractice Claims
Any malpractice history should trigger further research. Defense, damage and settlement costs and their effect on insurance premiums are important, but you also want to know about attorneys with a trail of claims.
- Billing Practices
What payment methods does the firm accept? What are its collections policies and realization rates? Determine if the firm routinely writes down and/or off unpaid invoices, thus rewarding clients for late payments.
- Client Reliance
How much of the other firm’s revenues are attributable to its top 10-15 clients? Determine if there is any risk of losing clients that represent a significant portion of its revenues and the effects of losing those clients.
The structures of the current firm(s) and the merging firm could lead to unpleasant surprises in partners’ tax bills post-merger. The merger agreement will need to address this issue. For example, if both firms are partnerships, some or all of the partners might see accelerated taxable income on their individual tax returns due to the pass-through nature of a partnership.
If a partnership merges with a firm that is at the entity level, taxed as a corporation, the old corporation would liquidate. If this is your situation, consult with your financial advisor to determine the tax implications of a corporate liquidation. Be sure to include all such potential effects in the financial modeling performed to estimate the new firm’s profitability.
Attorneys and staff
The acquisition of reputable, quality attorneys generally is one of the goals of law firm mergers, so you need to know what the firm’s partners and associates bring to the table — the good and bad. Who are the rainmakers and who might leave soon? Are incentives advisable to retain attorneys and, in turn, their clients? Which practice areas are the strongest and weakest? How does compensation break down?
Too often, firms pay attention only to a few key people in the other firm. The better approach is to look at everyone, including non-attorney staff. For the latter, determine their titles, responsibilities and salary histories. For both attorneys and non-attorneys, it is a good idea to run background checks.
Related Read: Merger Fever: Should Your Firm Get Hitched?
Finally, do not let the focus on numbers and similar data distract you from assessing cultural compatibility. Without alignment in values, overall goals and a sense of social responsibility, a deal that looks like a no-brainer on paper can end in failure.
Sidebar: When you decide to move ahead
Even if merging law firms are satisfied with their due diligence results, much planning still remains to facilitate a successful merger. Topics to consider and questions to ask include:
Management and Governance
What will be the management structure of the new firm? How will you structure and integrate practice groups?
Which office locations will be closed and/or combined? How and when?
How will you align your systems for areas such as accounting and finance, document management, practice management, customer relationship management and legal research? How will you combine your databases?
How will you reconcile different policies for issues such as training, performance management and annual compensation adjustments? Will overlapping positions created by the merger force you to lay off workers and, if so, what kind of severance package will you offer? Will you include restrictions such as non-compete and non-solicitation agreements?
To make the transition smooth, tackle these areas as far in advance as possible.