Cotterman on Compensation:
Retirement and Succession
Retirement Is Not a Moment in Time
May 1st, 2014 by Jim Cotterman
The evolving role of a senior partner as s/he transitions away from the private practice of law takes many paths. Some are specific and short – “In a year I shall retire to my cabin in the woods.” Others are longer duration – “I would like to slow down and phase out over the next five to seven years.” And still others are indefinite – “I want to maintain a part-time practice with a few of my cherished clients as long as I can.” Obviously, there are many permutations on these. And what works best depends on the specific path taken. It is likely that each firm will have multiple paths in process and thus require flexibility in dealing with these differing situations. Compensating senior partners requires a view that considers that chosen path and recognizes that most partner compensation arrangements are designed not for this transitional role, but rather for the full on partner.
Generally, what a partner leaves behind is the client and referral relationships built up over a career. Those relationships have value if the successors can retain them and maintain/grow the revenues and profits from them. There are variables to consider. For example, founders may have some additional value attributed to the risk and start-up costs that successors do not incur with an established business. The area of the law may also alter what and how value is recognized. For example, an estate practice has value in the will bank and contingent fee practices have significant investment locked up in cases that can span years. It is appropriate to consider if and how to deal with the compensation deferred by virtue of a start-up and/or locked up in unique practice assets.
Another key financial aspect of retirement is the return of capital. Senior partners carry disproportionate amounts of the total capital invested in the firm. With buy-outs that tend to occur faster than buy-ins, it is easy to foresee the stress retiring boomer partners are likely to have on capital structures. Add to this mix additional stress points such as the increased use of non-equity partner, thus delaying or eliminating potential future sources of capital, as well as the generally increasing capital needs of law firms. Law firm financial leaders need to be conversant with capital planning.
Beyond the valuation and compensation aspects of retirement, thought should be given to how to transfer the intangible value of senior partners – their wealth of legal, business and life knowledge; their leader, manager, mentor and steward roles; as well as their client, referral and market relationships. This requires some internal discussion as well as discussion with the clients/referrals. Professional service firm relationships are often trust-based; thus, they are harder to transfer than skill-based relationships. It takes a number of touch points (face-to-face interactions) to affect a transition of trust. And the changing nature of practice delivery has and will continue to decrease the opportunity for face-to-face interaction. This is the succession planning that firms refer to — working in a coordinated and thoughtful way towards retirement and well in advance of that retirement.
Ideally one would like the retiring partner to have worked him/herself out of a job on their last day at the firm. Good concept, but devilishly tricky to accomplish.
July 25th, 2011 by Jim Cotterman
The common wisdom is that defined benefit (DB) plans have largely been replaced by defined contribution (DC) plans such as the 401(k). While generally true, DB plans are still being adopted. According to the GAO’s March 2011 Private Pensions report, “most new DB plans were started by highly paid, middle-aged professionals who run small businesses and were looking for ways to put as much tax-deferred income aside for retirement as possible.” The top three business classifications sponsoring new DB plans have been doctors, dentists and lawyers. Doctor and dentist offices are uniquely well suited because of their advantageous business model. Law firms are a bit less well suited, but there are still reasons to consider a DB plan in the right circumstances. The report’s data is for years 2003 – 2007 where 14,150 small DB plans (those with fewer than 100 members) were newly formed representing 8% of the total number of all plans created. Of those, approximately 1,000 were for law firms.
The GAO goes further to point out that these new DB plans are sometimes sponsored to supplement an existing DC plan that has reached its statutory contribution limits. Using a combination of plans can greatly enhance the ability to save for retirement. The attractiveness of securing retirement savings on a tax deferred basis is significant with a GAO estimate of 18% improvement in after tax retirement income after 10 years and 40% after 20 years.
Unfortunately, even with significant tax advantages, the private plan participation remains stalled at roughly half of the private sector workforce. Plan formation just barely surpassed plan terminations. And this was prior to the recession. Now un- and under-employment remain stubbornly high, with particular note to the growing problem of the long-term unemployed. The consequences of all this on participation rates and asset accumulation are still largely unknown.
Unfunded Retirement Program Changes
November 5th, 2010 by Jim Cotterman
Unfunded retirement provisions will continue to change from the universally applied look-back programs typical two decades ago. Factors that undoubtedly influence such changes are:
1. Qualified retirement programs: The tax advantages and asset protection offered by such plans is superb. It has been about two decades since the US tax laws for such programs changed and allowed significant retirement asset accumulation for partners. Thus, anyone who was in their early 40s then benefited greatly from the advantages of compounded growth over time. These partners should, if diligent and careful, have accumulated substantial retirement accounts. Older partners needed to rely more on the unfunded programs because they had less time to benefit from their use.
2. Changing law firm structure/market: Unfunded programs are essentially pay-as-you-go schemes that work well when they are first put into place. However, as they mature and the underlying demographics change, they tend to turn upside down — the contributions made exceed the benefits received. The US Social Security system is a reasonably good proxy and the analysis of it (Understanding Social Security Reform) published by the AICPA demonstrates this characteristic. Unfortunately for many law firms this demographically led change in the Social Security system is directly applicable to the likely demographic changes in the legal profession. The economic rationale that supported such programs is broken — the programs are maturing and the underlying leverage and growth in firm size and profits are unlikely to support their continuation in all but a few firms.
3. Lawyer mobility: Lawyers who have key relationships and can influence where clients will place significant legal work are attractive in the market. Accordingly, firms will seek to acquire, by one means or another, such individuals. The use of self-funded programs where a lawyer can benefit from the success of transitioning relationships within a firm will open a new era in the strategic use of non-qualified retirement programs as part of the recruitment/retention arsenal of growth-oriented firms.
November 5th, 2010 by Jim Cotterman
October 27th, 2010 by Jim Cotterman
CPAs are well organized at outreach to former colleagues. Their alumni programs are extensive and maintain relationships about as well as any university or professional school. Law firms would benefit from such activities, particularly with retirees. Following are four activities that are easy to implement:
1. Consider regular communications that update alumni about professional topics, events at the firm and the like.
2. Including alumni in firm activities where they have an opportunity to associate with former colleagues and clients.
3. Firm support for charitable and community events that alumni are leading.
4. Participation in continuing education sponsored by the firm.
Retirees may want to stop working, but many still want to continue associations and relationships.
Mandatory Retirement Is Back on Management’s Agenda
October 14th, 2010 by Jim Cotterman
Retirement, succession and transition are getting more attention in law firms again. And mandatory retirement provisions are one of the central topics at many firms. Hopefully this is a good sign that firms feel reasonably confident about their economics to turn to other important issues.
Our last research on these issues were a 2007 flash survey and the 2008 Retirement and Withdrawal Survey (which is now owned by ALM Legal Intelligence). The 2007 flash survey indicated that while 50% of participants had mandatory retirement provisions, only 38% agreed with enforcing those provisions. The 2008 survey looked at, among many retirement topics, succession readiness. Interestingly nearly half of those firms indicated that they had not done any succession planning and did not consider it an issue.
We believe that the profession will move away from mandatory retirement. Three factors support this conclusion.
1. Profession expectations: The 2007 New York State Bar Association (April) and American Bar Association (August) statements strongly urged its members to abandon mandatory retirement.
2. Regulatory enforcement: The October 2007 US EEOC consent decree with Sidley Austin on an age discrimination claim the EEOC filed on behalf of 32 former partners establishes the EEOC’s interest and willingness to apply employment law provisions to partners in law firms.
3. Competitive pressures: Partners approaching mandatory retirement age, who wish to continue their practice and have a sufficient client following, are going to seek those firms where they are welcomed. Admittedly this will require more robust partner evaluations to ensure that partners meet reasonable professional and performance expectations. But those challenges can be met.
The profession will need to carefully consider its senior partners in terms of their best roles in the firm, community and clients. Some of the value these practitioners contribute will require changes in what is compensated and how to seamlessly integrate this into the expectations of younger partners and firm culture.
What Ever Happened to Mandatory Retirement?
October 29th, 2009 by Jim Cotterman
Whatever happened to mandatory retirement? Just two years ago in 2007 the New York State Bar Association (NYSBA) and the American Bar Association (ABA) developed position statements urging abandonment of mandatory retirement. According to the NYSBA report, “We do not suggest that partnership is, or should be, a guarantee of life tenure, and we are well aware of the economics of law firm practice and the need for senior partners to pass on client responsibilities to younger partners.” Then the ABA recommended that law firms evaluate their older partners on the basis of individual performance. “The time has come for law firms to put mandatory age-based retirement policies out to pasture.”
In September 2007 Altman Weil’s Flash Survey on Lawyer Retirement, a survey of managing partners in law firms with more than 50 lawyers, found that while 50% of those responding had mandatory retirement provisions only 38% agreed with enforcing such policies.
Following closely in October 2007 on a separate but related issue was the EEOC v. Sidley Austin LLP age discrimination case. Here a federal judge approved a $27.5 million consent decree with the EEOC involving partners allegedly forced from the partnership because of age.
Several firms have since announced that they support ending mandatory retirement. And we expected that the stage was set for a great many more firms to begin a dialogue about how to handle senior partners in a manner that complied with best practices and served the needs of the firm, clients and individual partners. Unfortunately, along came the credit crisis and great recession. Many important leadership issues had to be set aside temporarily. But now as we sense that we have found economic bottom (absent some destabilizing event), it may be very appropriate to re-engage on these issues.
The clock does not stop for recessions and the economic tsunami that has swept the globe has ravaged personal financial and real estate assets — the foundations of our retirements. The profession and society continue aging. And although the recent improvement in asset values is certainly welcome there remains a long road ahead. Many partners are going to want to continue the practice of law well beyond the years typically associated with mandatory retirement. Many will still hold solid relationships with key clients, be prominent in their communities and still enjoy advising and representing clients.
It is our view that the EEOC clearly signaled its desire to extend employment protections to self-employed partners under certain facts and circumstances. We do not believe that is likely to change. We think that mandatory retirement will be replaced with more actively managed programs that involve transitions from leadership, management, ownership and eventually the practice of law. We suspect that there will be career oriented performance and quality standards put into effect along with a rigorous evaluation process for partners. Compensation and return of capital arrangements will provide a means for varying transition programs, even within a single firm. There may even be a return to deferred compensation arrangements, but these will almost certainly be self-funding and selectively available.
Selling Your Law Practice to Retire? — Address the Buyer’s Needs
April 15th, 2009 by Jim Cotterman
Retiring lawyers are well served if they approach selling their practice by thinking like a buyer, a client and possibly an employee. No, we are not suggesting that you negotiate against your own interests. This is not about offers, due diligence, deal terms or the specific writing that memorializes the transaction. This is about putting in place the means for the buyer to realize their objectives — client and possibly personnel retention. The clients are the essence of the deal when a seller is retiring. Without clients there is no value to the buyer. And depending on the specific situation, there might be value in retaining the associates, paralegals and support staff who service those clients. Buyers think about integrating the acquired practice into their firm. This includes preserving current relationships and forging new relationships among clients and employees. Find ways to accommodate those needs to have a successful deal. Understand if your buyer has experience in integrating an acquired practice or if this new to them as well. The buyer needs to be part of the transition efforts and the seller needs to devote time specifically to transition.
Clients select counsel for a variety of reasons. Trust in the lawyer and the firm’s ability to handle their legal matters is high on that list. In today’s market, value and price paid have taken on even more importance than they traditionally held. Continuity in service is also an issue that is generally raised in connection with succession issues but is also seen in those firms where there is a high turnover amongst the delivery team (associates, paralegals and staff). That high turnover may be due to partner relocations and/or internal firm realignments. Either way, clients grow weary at the thought of training new people to their business, culture and priorities.
Employees worry about jobs, pay and benefits first. After that they worry about changes in reporting relationships, duties, work policies and the like. For most, this is a first-time experience. They will be nervous because most acquisitions that are covered in the press focus on the redundancies and efficiencies that mergers create. And the one thing they are certain of is that things are going to be different. Change may not be bad, but it is generally not well received initially because of the many unknowns that precede it.
Communication is the first element to consider. Make sure your employees hear about the transaction from you before they hear about it from someone outside the firm or even worse from the announcements to clients and others. Tell them yourself and in person if it is feasible to do so. That has become much easier with video and audio conferencing. Be honest and upbeat about the upcoming changes. Have a carefully thought through message and don’t try to wing it. Consider what questions the staff will have when putting the message together. Identify positive changes and benefits to the employees. During Q&A, admit if you don’t have a good response to a question and promise to get back to everyone once you do (make sure you actually do this).
Equally important is the communication to clients. They should hear of the transaction before the general public. While a personal visit or call is most appropriate, either may not be practical for all of your clients. For some clients this may not be a surprise, but rather the culmination of a collaborative process where the client knows you have been putting into place a transition plan. Again, the message is of vital importance. Key to the clients is continuity during the transition and long-term benefits of the deal. This begins the introduction of the successor to the client. While it may be delivered as introducing new resources and capabilities initially; eventually it will be about building trust in a successor.
Talking about Succession and Transition
February 17th, 2009 by Jim Cotterman
Business continuity (succession and transition) is important to both clients and their law firms. Although many law firms may not be fully aware of its importance to clients. At some point the client who has a relationship with the aging senior partner will start to wonder about who will be there if and when… This leads to topics that many of us are uncomfortable discussing. But for each of us there will be a point where the practice will extend beyond our participation.
The client may look for a way to open the dialogue with the partner. If that happens the partner should welcome the conversation and begin planning for continuity. Your concern should be that the client may find the conversation too uncomfortable to take the first step. They may take the easier path and respond to one or more of the many competitors looking to get an opportunity. It is critical that the partners look ahead and take affirmative actions to discuss and plan for the transition.
Younger partners may also be wary of initiating the conversation about client transition with their senior partners. This is usually for the reasons cited above as well as for the respect we hold for seniors — the very people who mentored us along the way. The risk that younger partners may look for other opportunities is directly related to the comfort they have that client relationships will be shared. This leads to compensation issues currently and over the intermediate horizon, but more importantly business continuity issues longer term. Again, if the younger partners raise the issue, embrace the opportunity to begin a conversation. And also again, the senior partners should not wait for this to happen, they should be leading the dialogue.
Let’s also look at this from the client side, but with a slightly different twist. That client, business owner or executive, will someday move on just as you will. Have you discussed with them what their business continuity program looks like? The client has their own business continuity concerns that should be addressed. Concurrently you want to make sure the relationship you have with the client includes those who are being groomed for promotion in the client organization.
Succession by Acquisition
February 10th, 2009 by Jim Cotterman
One of the expected drivers of law firm acquisitions is the succession and exit strategy needs of smaller firms, particularly law firms with under 20 lawyers, although this certainly this will affect law firms of any size.
Many of these deals are being done because the senior group looks around and finds that they are short on talent immediately behind them who have the “right stuff” to carry the business forward. There may be some rising stars further down the line, but they may not be ready in time and they may not stay very long if their assessment is the same as yours. The best opportunity to monetize their interests (realize their buy-out expectations) may be to secure a deal with another firm. Other viable options may also exist, but they will take resources and time to implement that a deal will not.
Yet there still needs to be a real strategic benefit beyond business continuity for doing a deal. That benefit may be improved scope and/or scale. Deals where one is simply “buying” clients, even when there is no “consideration” involved are risky to the buyer. Note that most of these deals are not acquisitions in the traditional corporate sense where cash, notes and stock are used as the primary consideration. Here the primary consideration is most often a compensation guarantee currently and possibly in the future upon exiting. But I digress. The very reason discussed above that may have prompted the senior partners to look for a deal is a warning to the buyer. The buyer needs to understand the increased risk of acquiring a firm where the senior partners are moving out immediately or shortly after the deal closes if the rationale is along the lines described above.
Spending Those Retirement Savings
August 15th, 2008 by Jim Cotterman
Much effort is made to encourage a work career of disciplined retirement saving using proper investment techniques. Now that Boomers are approaching retirement it might be a good time to think about how to make those savings last a lifetime or two. This is the central concern of many retirees and a significant concern for those approaching that milestone.
The accepted rule of thumb suggests a 4% withdrawal rate will safely provide for a thirty-year retirement. This level of understanding may be sufficient for much of your work life. However, as you near retirement a deeper appreciation of the assumptions and variables is prudent. A three-decade retirement will likely require many course corrections along the way to navigate the vagaries of investment markets, inflation and government policy.
A number of articles have been written on safe withdrawal rates. A new entry by William Reichenstein, CFA, provides a solid review of two prior works and what can be learned from the numerous studies on this topic. The article appeared in the July issue of AAII (American Association of Individual Investors) and is entitled Will Your Savings Last? What the Withdrawal Rate Studies Show.
Mandatory Retirement — Ongoing Discussion
April 21st, 2008 by Jim Cotterman
Premise: You are on the Executive Committee of a large law firm with a mandatory decompression and retirement provision and the authority to grant waivers (although that authority has never been used). A senior partner two years out from mandatory retirement requests a waiver. This partner has close personal relationships with several key clients in your firm’s core practice area of securitized finance. Do you grant the request?
This is one of several fact scenarios a six-member panel of experts discussed at a recent New York City Bar event. The moderator was Dean Joan Wexler and the event was co-sponsored by the Committee on Senior Lawyers and the Public Service Committee of the Federal Bar Counsel. The event is part of the ongoing awareness efforts stemming from the NYSBA report on mandatory retirement and the NYCB report on the use of lawyers of retirement age in pro bono practices.
The Committee debated the effects of an ad hoc approach to waivers; the potential consequences of a waiver precedent on other senior partners approaching and in the decompression program; the possible adverse reaction of younger partners who enthusiastically support the policy; the likelihood that no waiver might force the withdrawal of that senior partner along with the key clients and associated revenues; client reaction either way; the ABA position on mandatory retirement and the potential legal issues that might arise out of the Sidley Austin case coupled with the announcements of several law firms regarding changes to their own provisions.
Clearly this topic requires further discussion within firms as an aging, but largely active, lawyer population approaches the traditional retirement years. There are competing interests involved. However, I agree with the NYSBA report’s consensus view that “…mandatory age-based retirement is inconsistent with accepted employment practices in this country…” and that “such practices are against the best interests of law firms, clients and the professions…”
Now is a good time for law firms to engage in a dialogue about their own provisions and what is in the long-term best interests of their firm, partners and clients. More information can be found at the NYSBA Special Committee on Age Discrimination in the Profession website.
Retirement – At What Age?
November 2nd, 2007 by Jim Cotterman
Retirement is a topic generating some buzz in the news. In October 2007, the U.S. Equal Employment Opportunity Commission settled an age discrimination case against U.S. law firm Sidley Austin LLP on behalf of 32 former partners. The firm paid $27.5 million dollars and entered into a consent decree. In August the American Bar Association at its annual meeting recommended that law firms end mandatory retirement policies and urged that law firms evaluate their older partners on the basis of individual performance. Led by action in April by the New York State Bar Association which separately had adopted a similar position. A comment to the Welcome post in this blog about the EU retirement perspective further highlights the issue as broader than just our US interests. More on the EU in a moment.
In September we conducted a flash survey of Managing Partners in US law firms with more than 50 lawyers – the Altman Weil Flash Survey on Lawyer Retirement – which found that only 38% of lawyers agreed with the enforcement of mandatory retirement provisions in law firms. However, fifty percent of respondents reported that their firms currently have mandatory retirement policies.
As the Baby Boom generation nears retirement, many have already had a change in perspective. Clearly the landscape has changed since these policies were put into place. The EEOC is willing to extend its reach to law firm partnerships, partners are living longer and healthier lives and are eager to continue the practice of law, and finally law firms are more aggressively seeking well connected lawyers to help grow their firms. The time has come for further dialog among firm partners to sort out how best to move forward.
Now back to the EU comment mentioned earlier. I asked our colleague in the UK, Tony Williams of Jomati Consultants, LLP, if he would provide his perspective. His thoughts follow:
“I think the reason for partners retiring early are various but let me summarize them:
1. UK firms particularly over the last five years have been far more performance orientated. As a result, the pressures on partners have continued to be pretty relentless and the possibility of easing off as one approaches one’s mid to late 50s is generally not an option. This is exacerbated by the fact that most of the major UK based firms operate on a lockstep remuneration system. Accordingly, if you cannot sustain a level of billings which justifies your place on the lockstep then you go. Some firms have introduced some flexibility to their lockstep but this tends to be very limited and very short term.
2. This pressure has caused a number of partners in their mid-50s to reconsider their positions and particularly in view of the high level of earnings over the last few years to decide that they want out. Some retire completely, others remain in a consultancy capacity and some may move across to become general counsel etc.
3. Until relatively recently partners were able to make very tax efficient pension contributions and so many are in a sufficiently comfortable financial position to be able to retire. This is particularly the case for those that have significant London properties as property price increases in London have been significant over the last ten years and, if on retirement the partner is trading down, they are able to release significant amounts of capital tax free.
4. That being said, there is some evidence of a more flexible approach being adopted. It is quite clear that firms are wanting to keep and remain motivated the best older partners. This is particularly an issue as the baby boomers are starting to retire because they do have a range of experience and client connections built up over a significant period of time which are increasingly valuable. Furthermore, if partners have a young family or a second family there is often a financial imperative to continue working. In addition, recent changes to pensions law has limited the tax efficient ability to save in a pension fund. That combined with lower interest rates and longer life expectancy has reduced the yield on pensions by well over half over the last ten years.
5. A further factor is that this year the UK introduced age discrimination legislation which clearly applies to law firm partnerships. As a result, the older partners are no longer seen as the soft option and the issue of partner performance is being addressed across the entire age range of partners. As you may have seen, Freshfields was recently involved in the first high profile age discrimination case which it won. It is interesting however that many of the partners that they have eased out in London over the last year have moved to other firms to continue their careers albeit at significantly lower income levels. The major UK firms have seen it as a pressing need to get their profitability up to a level which is more comparable to the major US firms (partly because they want to grow in New York but mainly to remain competitive as US firms are more aggressively hiring in London). As a result, they have been much more ruthless in relation to partner performance and are holding their equity much tighter than ever before. Most firms have now introduced a non-equity partner status to effectively defer the granting of equity and to ensure that equity is only given to partners who will grow the business and perform at an appropriate level.”
A Path to Retirement
October 17th, 2007 by Jim Cotterman
A recent Wall Street Journal article (9/24/07) “A Stingier Job Market Awaits New Attorneys” discussed some of the less reported aspects of beginning a career in law — that most new lawyers do not get the top salaries currently being written about ($160,000), many finding employment elusive and law school debt burdens that run $50,000 to $80,000 or more. Add to that consumer debt and you have a significant fiscal challenge very early on in life.
I read the WSJ article just after reading an excellent article entitled “Personal Financial Ratios: An Elegant Road Map to Financial Health and Retirement” in the Journal of Financial Planning authored by Charles J. Farrell. The Farrell article uses simple ratios to demonstrate how lifestyle (living expenses, debt repayment and savings rates) can be monitored to achieve retirement goals. He explains the underlying assumptions, provides a realistic budget, and exhorts fiscal discipline. Be warned, this frank depiction of what it takes to reach retirement debt free and with sufficient savings may shock those who listen to the traditional wisdom of how much debt someone can afford and still accumulate wealth.
Bringing these two articles together suggests that many law students should plan more conservative lifestyles. Expensive cars and vacations, frequent entertainment (dining out, theater, etc.) may need to be deferred until income, savings and debt are brought in line. Unspoken in Farrell’s article, but certainly a possibility is that social security and Medicare will not provide for recent graduates when they reach retirement in the same manner that those programs do for current retirees. If those social programs were to materially change for the worse; the more aggressive scenario presented in the article would become a much more important consideration.
Cotterman on Compensation
First launched in 2007, Cotterman on Compensation is a blog authored by Altman Weil’s Jim Cotterman, the preeminent expert on law firm compensation in the United States. For 30 years, Mr. Cotterman has advised law firms on compensation system design, capital structure and other economic issues. He is the lead author of the definitive book on law firm compensation, ABA’s Compensation Plans for Law Firms.