City law firms clamp down on the equity cookie jar
Law firms are tightening access to equity partnerships to protect profits, increasingly reserving the equity pool for top performers, writes Maria Ward-Brennan.
As the Big Four giants dominate the headlines with internal changes, the firms are seeking to regain control of their expanded equity pools amid profitability problems.
These giants are looking to mirror what the legal sector has been quietly doing over the years.
The LLP model, which law firms are structured as, requires people to invest their capital in exchange for a share of future profits (and losses). However, the more people you have in the pool, the more crowded it is when the profits are shared out.
Typical (let’s call them boomer) lawyers got to enjoy a career path of going from associate to equity partner, known as the ‘all-equity’ partnership model. But this system has been in slow decline at major City law firms for some time.
UK firms have now morphed into the system that US law firms have long operated under, the very system English lawyers used to scoff at.
It was Kirkland & Ellis that paved the way for this tightening of the money pool.
Christopher Clark, director at Definitum Search, says, “Years ago, you might hear people in the market say that Kirkland’s non-share partners are ‘not proper partners’, while so many firms were losing talented lawyers that they just couldn’t promote.”
“But the reality is that they gave those who were good enough the title and the freedom to build their business while executing on the equity partners’ business. And if they can do both they get rewarded by full equity,” he added.
The US firms in London (such as Kirkland & Ellis or Latham & Watkins) have, since the 2000s, used a ‘salaried’ partnership as the level-up or level-out stage, with only a tiny fraction of those partners ever reaching the lucrative senior equity level.
And there is a reason for this. “As equity partners divide a firm’s profits amongst themselves, the smaller the equity pool, the less thinly those profits are spread,” explained Charlie Harvey, partner at Harvey and Partners.
In the last financial year alone, Kirkland & Ellis’s average profit per equity partner (PEP) was $11.1m (£8.2m), while Latham & Watkins’ average equity partner took home $8.7m from its profit pool.
Not a bad reward to see landing in your bank account.
Now, the non-equity partner tier has been adopted by Skadden, Freshfields, Sidley Austin, Paul Weiss, and Debevoise & Plimpton, among others.
Though the outlier is Linklaters, which operates with a nearly 100 per cent equity partnership, making it one of the few Magic Circle firms to retain a primarily pure equity structure. Buy-in, however, stands at around £1m.
In its latest financial results, Linklaters PEP stood at £2.2m.
Competition between firms is ‘so fierce’
The legal sector is booming as profits and PEP surge, so much so that the money top lawyers are pocketing is making bankers jealous. But the race for law firms to keep adding to the top line and staying competitive means PEP, which has become a test of how well a firm is doing, needs to continue to rise.
“Competition between law firms is so fierce in London that firms have become laser-focused on keeping their PEP figure as high as they possibly can,” Harvey explained.
Not shockingly, firms are increasingly being selective about who gains access to equity.
Nick Woolf, partner at Woolf&Co, explained, “Firms know they have a small number of true rainmakers and a larger group of service partners, so equity is being used much more sparingly and managed tighter.”
However, as Woolf pointed out, this is not just happening at the very top firms: “equity is often even tighter and more deliberately controlled in firms in the 35–100 bracket”.
The success of US law firms in London has put pressure on UK firms, both elite and mid-level, as a surge in junior salaries has strained their ability to attract and retain talent.
The top ‘starting’ salary in the City currently stands at £180,000, following the increase in NQ pay by US firms Gibson Dunn and Quinn Emanuel last year.
So with these hefty wages to pay at the bottom level, law firms are now more eager than ever to have plenty of ‘rainmakers’.
“Firms are far less willing to dilute [the pool] unless someone is demonstrably moving the dial,” says Woolf. He added that firms now recognise not everyone needs to be in the equity. As a result, they are “building more stable, well-remunerated non-equity tiers”.
Ultimately, gone are the days of automatically entering into a partnership that sees you own a share of the law firm you work for. Firms’ drive to protect profits and remain competitive means you have to be the most exceptional, all-rounded lawyer to get a seat at this table.
Eyes on the Law is a weekly column by Maria Ward-Brennan focused on the legal sector.