READERS ACQUAINTED with partnerships and LLPs in professional practices cannot have failed to notice that, during the latter part of 2011, there have been a number of changes in the remuneration and reward structures at some well-known and successful firms.
Such changes within firms, and indeed the variety of structures which exist, are perhaps not surprising given that the freedom and flexibility to determine internal governance has always been one of the great attractions of the partnership model.
However, it is worth considering whether any trends can be discerned or lessons learned from the fact that such changes have been taking place and consider whether all firms ought to be reviewing their internal structures to ensure they are “fit for purpose”.
At first blush, while the publicised changes to remuneration structures at various firms might appear inconsistent – some firms are moving towards a full equity position for all partners while others are introducing different categories of partner – the common objectives which these apparently inconsistent structures seek to achieve are flexibility, recognition of performance and a link between remuneration and performance which is not referable solely to fee generation.
If one assumed, perhaps a little unrealistically, that all firms shared the same broad objectives, why is there such diversity in remuneration and internal governance structures? And one might ask: is there a “perfect structure” which should be embraced by all firms?
To consider these points it is useful to look briefly at the various basic remuneration structures and some of the perceived advantages and disadvantages of each:
At its most simple level this remuneration structure (which, in the absence of agreement between partners, is the default position under the Partnership Act 1890 and the Limited Liability Partnerships Regulations 2001) works on the basis that all partners are entitled to an equal share of the distributable profits of the firm. All partners work together to ensure the business is a success and they all take an equal share of the results of their endeavours.
The perceived advantages are principally that it engenders a sense of collegiality and is a simple system to administer; once distributable profits have been calculated it is a matter of simple mathematics to identify the share of each individual partner.
However, there are perceived disadvantages of such a structure which means that, in practice, a remuneration system based on equality is unusual. Difficulties are likely to arise if there is a disparity between the relative (or perceived) contributions of individuals to the overall success and profitability of the firm and in relation to the potential impact on existing partners of new partners entering the equity structure.
In situations where the first difficulty arises the only solution may be the removal from the equity structure of an individual who is not “pulling their weight”; the second difficulty is essentially that the introduction of a new partner, absent an increase in distributable profit as a result of such introduction, may result in a reduction in remuneration for the existing partners; if the cake doesn’t grow, everyone receives a smaller slice.
Lock-step (or seniority)
The basis of this structure (which it must be said is increasingly rare in its purest form) is that individuals are remunerated with an increasing share of distributable profits the longer they continue to be a partner. Typically partners enter the equity structure at a pre-determined level and move up through the levels year on year for a pre-determined number of years until they reach the top step or “plateau” which represents the highest level of remuneration. Commonly, a “plateau partner” may begin to move down the steps, thus reducing remuneration, as they near retirement and eventually exit from the equity structure.
It is often said by supporters of this structure that the advantages are that, once the structure is established, it is simple to administer and the prospect of increasing remuneration over time encourages loyalty to the firm and consistent performance. It is also said that it encourages a team ethic and reinforces the collegiate nature of the partnership.
Those that are less enamoured of such a structure argue that it has the potential to make the firm unattractive to young “star performers” that the firm might wish to recruit or promote into the partnership structure. A dynamic individual with significant profit generating abilities may feel disinclined to join an equity structure which places them on the first step when they perceive that their personal endeavours are not remunerating them, but rather the individuals on higher steps who are performing less well but are remunerated more handsomely simply by virtue of having been a partner for longer. As with the equality structure, there is also the issue of how to deal with an individual whose contribution to the firm is in decline when the application of a rigid lock-step structure ensures that remuneration will continue to rise. If removal from the equity structure is the only way to address such an issue, is that desirable?
Since 2006, additional issues to be considered are the implications of the age discrimination legislation which renders unlawful direct or indirect discrimination based on age. Although it may be possible to establish a structure which does not result in any breach of the law, the risks are evident when the structure itself may be said to benefit individuals who stay with the firm for longer and who will, almost inevitably, be older than partners entering the structure.
Performance (or merit)
The essence of this structure is that remuneration is determined by actual performance; the better the individual performs, the greater their remuneration.
It may be said that the perceived advantages are obvious: if individuals are remunerated by reference to the results of their personal endeavours they will be incentivised to make greater endeavour. Partners are then rewarded for that endeavour by the structure and the firm as a whole benefits from the profits generated by those individuals. The structure may also prove appealing to the “star performers” that the firm seeks to attract to its equity structure as the prospect of personal reward based on personal endeavour is prized by many individuals.
However, while it may be tempting to regard a performance structure as the ideal model, it is not without its disadvantages. Principle among these are designing a system that reflects the variety of performance elements which are necessary to ensure the successful operation and strategy of the firm, measuring performance against those elements and the management time required to assess individual performance and determine appropriate remuneration. It is also said by some that a structure which encourages and rewards the individual by reference to individual performance runs counter to a collegiate culture and the objective of ensuring the success of the firm as a whole; will some be tempted to do things that are better done by others simply because it reflects in their performance measurement and thus remuneration?
Categories of partners
Although it takes one outside remuneration structures based on all partners being full equity partners, many professional practices have more than one category of partner, where the partners within each category are subject not only to different remuneration regimes but also different rights and obligations within the overall partnership structure. Typically, firms have established a category of “fixed share partner” in which the individuals contribute less capital than their full equity colleagues, receive a fixed share of distributable profits (their share often being a first charge on profits) but have lesser rights in the management of the firm by virtue of reduced voting power.
The establishment of such categories is frequently cited as being beneficial as a means of “moving people up through the ranks” and assessing whether they are to be invited to become part of the full equity group.
The potentially negative consequences of these different categories is often said to be that individuals who are less than full equity do not feel that they are a true partner or that they have a genuine stake in the business.
Having made a whistle stop tour of some basic remuneration structures, we go back to the question: is there a “perfect structure” which should be embraced by all firms? The short answer is no. There cannot realistically be a “one size fits all”, which will operate effectively for every firm without having regard to a host of factors, including the specific objectives of the firm, the number of partners and the market and wider economy in which the firm conducts its business.
While diversity of structures has existed for some time, the recent changes being made to structures at a number of firms are a reminder that remuneration structures must be more than simply the mechanism by which distributable profits are allocated to the current partner group, and must have greater regard to the strategic objectives of the firm and the market and economy in which it operates.
What seems inescapable from the structural changes which have taken place in 2011 is that firms must be receptive to the proposition that, as circumstances change, remuneration structures must be reviewed and, as necessary, revised.
Clive Greenwood and Fergus Payne are partners at Lewis Silkin LLP and joint heads of the partnership & LLP law group
Image credit: Shutterstock
A new head of solutions, Aidan Brennan, has been appointed at KPMG UK
Hundreds of jobs are secure after Spectrum Contracting has been sold out of administration to Minstrell Recruitment by FRP Advisory
Cowgill Holloway and Warings Business Advisors have merged, with a range of growth plans in the North West put in place
The Practitioner discusses their timesheet militancy, and reaction to someone playing it fast and loose with the details...