Income partners: The next group hit by the changing economy

First it was associates, but these days it'sincome partners who are feeling the pain of layoffs. Once considered to be a position with all of the advantages and few of the risks of equity partnership, some Chicago firms have been reducing the number of income partners they have or, in some cases, eliminating the category by asking for capital contributions.

A few years ago, a major Chicago firm began laying the groundwork for the cuts, re-evaluating income partners to see just how critical they are to the operation and demanding that they not only handle client matters, but that they also do their part to generate business.

In cases where they don't measure up, income partners may find themselves in a vulnerable position, perhaps facing salary cuts or layoffs. Some are jumping ship, joining smaller firms where they can charge lower rates and increase their books of business. Others are taking in-house positions or starting their own practices.

The idea of a two-tiered partner system got its start in Chicago about 20 years ago, according to legal consultant Joel Henning, who runs Chicago-based Joel Henning & Associates.

"Chicago firms took the lead," he said. "The idea was to increase the firm's leverage by extending the time that employed lawyers or associates would remain in that category. True income partners do not share in the equity of the firm, and that gave some of the larger firms better leverage, increasing their profitability when times were good.

"Over time, their salaries went up and it was no longer the profitable way to go," he said. To make matters worse, the recent downturn created a need for firms to have more capital. "DLA Piper asked some of its income partners to contribute. Of course, once that happens, they are no longer income partners."

Audrey H. Rubin, president of Chicago-based Rubin Solutions Ltd., said income or nonequity partners are "the second most likely group, next to brand-new associates, to be terminated. Many are excellent lawyers and handle all the same matters as their equity counterparts, but they do not have their own books of business.

"What made them so attractive is that they were paid at high associate rates, and yet the firm could bill clients at partner rates," Rubin said. "However, with the downturn it is hard for the firm to keep paying them at those rates, and it is even harder to get the clients to pay them."

James D. Cotterman, a principal at Altman Weil Inc., said until recently this group of attorneys had the best of both worlds.

"As a whole, they were highly compensated and faced little risk because they usually did not contribute capital to the firm," he said. "Their incomes were largely guaranteed, and they got paid before equity partners."

Though it may seem logical to trace the problems to the start of the downturn, Robert Wilson, founder and president of the executive development and career services firm High Potential Inc., said it really started about three years ago.

That is when one major Chicago firm created a three-phase test for income partners: "Do they generate or have the ability to generate business? Is their practice area or specialty critically important to the firm? Do they have crucial contacts with major firm clients?"

"If they did not meet most of these criteria, they became vulnerable," Wilson said. "With application of this metric, Big Law in Chicago began thinning the ranks of its nonequity partners."

Wilson said that last year two other major Chicago-based firms developed similar criteria, and though it was not identical, it was designed to identify those who "were perceived to not have the right stuff to become partner."

"It is no longer enough to simply be a "good lawyer," Wilson said.

"When American Lawyer created the profits-per-partner standard, the practice of law quickly began to evolve into a business model," he said. "There are essentially three categories of attorneys at most firms: Finders, who generate the business; Minders, who serve clients; and Grinders, who do research, discovery and prepare pleadings.

"Those who are viewed to be at the low end of the totem pole, and that includes some partners, are finding they may have to leave the firm or accept diminished economic rewards," Wilson said.

Certainly there are large discrepancies between equity and income partner numbers at some Chicago firms.

According to the Chicago Lawyer 2010 survey of the largest law firms in Illinois, Mayer Brown had 30 income partners to 153 equity partners. Vedder Price reported having 16 income partners and 103 equity partners, and Seyfarth Shaw had 42 income partners and 93 equity partners. The numbers were dramatically reversed at Hinshaw & Culbertson, where there were 114 income partners and 69 equity partners.

Whether the numbers are directly related to the downturn or not, Wilson said more firms are offering alternatives to their partners.

"One of the smaller firms we work with asked equity and income partners to take a 15 percent pay cut, and some have suggested that a capital contribution could be requested at the non-partner level, with the money being returned when the attorney leaves the firm," he said.

He also noted that there has been an increase in lateral movement among attorneys. "Some of the senior people are going in-house or finding opportunities at smaller firms, where they may have to take a pay cut."

Wilson said he sees a significant trend of smaller firms hiring high-quality laterals to staff strategically important practice areas. "A year from now, it's possible many of the larger firms may look around and find they do not have enough people."

William A. Rudnick, managing partner of the Chicago office of DLA Piper, said his firm eliminated the category of income partner in the last quarter of 2008.

"It was not tied to the downturn, it was about instituting a better business model," he said. "If we are going to expect people to act like partners, then we should treat them like partners and align their interests with the firm. We did this by asking them to contribute capital, and by connecting their compensation to the firm's performance."

Levenfeld Pearlstein managing partner Bryan I. Schwartz said his firm has laid off less than 10 income partners, the bulk in 2008 and 2009.

"From a practical matter, business has gone down everywhere, so firms are looking closely at their people," he said. "We looked at every category - staff people, associates and income and equity partners - and asked: Are these people going to be here in five years?

"It does not matter who they are, but as you move down on the food chain, they have either less business or client relationships," he said. "In our firm we stress middle- to upper-middle market business. While I will allow a partner to go after low-market fruit for a while, if I believe that's where the person will end up, I may choose to part ways now."

Schwartz said when the economy first went sour, he evaluated every area of the firm, taking a long, hard look at the firm's business and methodically deciding where cuts needed to be made.

"What often happens is that a firm shaves off too many of its associates and then has no leverage because during stressful economic times, clients don't want three partners working on a matter," he said.

"You can't have a short-term focus. We are not the stock market, and we can't keep everyone when we have less business. We are not like a family business. Sometimes you have to institute layoffs for the good of everyone."

Mark E. Rust, managing partner of Barnes & Thornburg's Chicago office, said his firm has yet to lay off anyone as a result of the downturn. About 20 of the firm's 55 partners hold the nonequity status.

"We do not do a lot of business in the areas most affected, like real estate," he said. "We also had a dramatic increase in revenue from clients migrating from very high-cost firms to a firm like ours, which has a moderate rate structure.

"Income partners are valuable because of their expertise, and, if we did have problems, we would probably look to compensation adjustments as opposed to layoffs, which we've never actually done."

Fox, Hefter, Swibel, Levin & Carroll has also added to its roster of qualified income partners. According to co-managing partner Daniel S. Hefter, some lawyers came over because they want to grow their business by offering clients more reasonable rates than they can at large firms.

"We are a beneficiary of the high-rate structure of the large firms," he said. "We've been seeing people who may have a half-million dollars of business, which is very respectable at our firm, and are looking to grow their business from there. We are happy to have them.

"I can't comment on how anyone else runs their business," Hefter said, "but many of the people we're seeing are highly talented lawyers and we're happy to have people like that who can help us continue to build our practice."

Right now the boutique business law firm has 30 attorneys, including six income partners and five of counsel. The firm hired its newest income partner about a year ago.

Chicago attorney Martin D. Snyder is among those laid off as a result of the downturn. The former Wildman Harrold income partner left in April 2009.

"The firm did not have enough business to support the number of attorneys it had," he said. "The ax fell on a number of income partners. I had heard of this happening elsewhere, but I was surprised when it happened at Wildman.

"I, like some of the other income partners, had a small book of business. Letting us go gives the firm the most bang for its buck since we have high salaries and relatively low profitability."

Snyder landed a job at a smaller firm, but said the firm did not fit what he was looking to do. "I wanted to charge lower rates so I could develop my own book of business, but that was not possible, so I left and started my own practice."

The civil litigator opened the Law Offices of Martin Snyder on March 1, and said he has been doing pretty well. "My price range is attractive, and I think that is what is helping," said Snyder, who shares space in a suite in Chicago with other attorneys to hold down expenses.

"My advice to income partners is to triple your marketing efforts when you make partner," Snyder said. " There is a feeling that once you do so, even if you are an income partner, you have made it, but, really, you have to start developing your own book of business as soon as possible. If you do so, you give yourself more options."

Sherrie Travis, a former contract attorney, has also set up her own practice. She left a large Chicago law firm in February 2009 after one of her pro bono clients offered her a chance to do a substantial amount of work at a much lower rate than she could offer as a member of the firm. Since leaving, some of her other clients have used her services as well.

"The firm had no problem letting them go with me," said the owner of Sherrie Travis & Associates. "Many of them were nonprofits and were not able to pay big-firm rates.

"I feel like I am more in control of my own destiny now. Had I stayed at the firm and my clients dried up, I might be in a different position," Travis said.

The desire to bill at more affordable rates is why Peg M. Anderson left Locke Lord Bissell & Liddell to join Fox, Hefter, Swibel, Levin & Carroll. When she left in July 2008 she was an equity partner handling bankruptcy matters.

"I was under a lot of pressure to raise my rates, and I thought if I could move to a firm where I could decrease my rates that I would be able to increase my business," she said. Anderson joined Fox as an income partner, but is now an equity partner.

"The switch has been wonderful. I brought all my clients with me, lowered my rates, and my business has increased."

Although Anderson chose to leave her firm, she said the poor economy forces out many younger partners at large firms.

"I think firms are focusing too much on the short term and not thinking about the long-term consequences," she said. "A lot of firms are laying off people who are beginning their peak years of practice. When their business rebounds, some of these firms may not have the appropriate number of attorneys with the right experience."

Commercial litigator Matthew J. O'Hara left his job as a partner and a deputy general counsel at Reed Smith for similar reasons to take a nonequity partner position at Hinshaw & Culbertson.

"There's a lot of realignment going on at large firms, particularly in light of the recession, and I was looking for a better platform for my practice," he said. "At Hinshaw it's easier for me to accommodate my middle-market and entrepreneurial clients because they have a more flexible rate structure."

Some income partners are leaving big law firms to embrace jobs as in-house counsel. One corporate attorney who specialized in mergers and acquisitions quit his job in mid-2009 to join the ranks of a major corporation in the Chicago area.

"I was approaching the stage of my career where I needed to ramp up a book of business in the next two or three years," he said.

"For someone in my situation jumping to another firm was not going to help, but I knew if I could find a good opportunity at a large company that as long as I serviced my client well, I would not need to worry about developing other business. In-house positions are more difficult to come by because they are sporadic, and companies are usually looking to fill a single spot. However, it can be a good opportunity for those who don't have a huge book of business."

While hiring is beginning to pick up, Wilson said certain transactional areas like real estate and mergers and acquisitions are likely to remain slow for a while, making attorneys in those specialties more vulnerable to layoffs.

He is advising attorneys to build strong client alliances and focus on generating business.

"Income partners need to recognize that they may have to make some type of adjustment," said Nicole Nehama Auerbach, who left Katten Muchin Rosenman in 2008 after nearly 15 years to start the Valorem Law Group, which provides alternative-fee arrangements to clients.

"When my partners and I told people what we were doing, they thought we were crazy to leave secure partner positions. Shortly after, the downturn hit, making our venture seem almost conservative," Auerbach said.

"The concept of the income partner itself is under review," Henning said. "Whereas it used to make sound business sense, firms are now re-evaluating the idea."

"[Income partners] are good lawyers and are good for clients because they get senior people working on their matters," James Cotterman said. "However, when you have a large group of high-level fixed-income people that means the equity partners have to generate business for everyone, including themselves, the income partners and the associates. With the downturn, that is harder to do and that is when the model is examined."

"A person who offers great client service is almost always safe," Schwartz said. "The key for income partners is to develop strong client relationships even if it is not business you originate. The trouble is, many attorneys don't see the person as a client, but as a legal problem. This is a client business. You can't just say I like the law; you have to take care of your clients. If you take care of your clients, most good firms will want to retain you."