Friday, September 21, 2012

No 4th Quarter Lateral Hiring! (Subject to Exceptions)

Parsley Sage Rosemary & Ginsburg llp
“Always a reasonable result for a reasonable fee, always”
MEMORANDUM

To:
Management Committee
From:
Mike Marget
Date:
September 21, 2012
Re:
No 4th Quarter Lateral Hiring! (Subject to Exceptions)

There is never a bad time to add a lateral partner; especially someone with a big book of business, whose practice fits the firm’s culture, and who will be accretive to the financial bottom line.  However, certain times are better than others – early (in the fiscal year) is much, much better than later.

At a prior firm, we had a rule – no lateral hiring in the 4th quarter.  Being a law firm, there were many exceptions to this rule.  One permitted filling vacancies when short-handed or when special expertise was needed for an active matter.  Another was crafted for the proverbial “lateral too good to” turndown; somebody certain to be snatched up by another firm if we don’t act immediately; the “let’s thank our lucky stars and ignore the calendar” candidate (“L2G2” for too good to…).

The rationale for the 4th quarter lateral hiring freeze is simple arithmetic.  Assume the following:

a)     L2G2 joins New Law Firm (“NLF”) effective October 1, 2012, agreeing to the same 2012 compensation package as at Old Law Firm (“OLF”) – $300,000 annually: monthly draws of $15,000, plus deferred comp of $120,000 payable as a year-end distribution.

b)     L2G2’s October production at NLF is subpar due to transition issues – delays in transferring files, obtaining conflict waivers and the like.[i]

c)      The headhunter’s invoice (15%-to-20% of one year’s compensation) is paid before year-end.

d)     Invoices for October time are issued by mid-November, and then scheduled for payment on a 45-to-60-day cycle by L2G2’s clients.  November time is billed in December.  Little or no revenue is received in 2012 from L2G2’s clients or L2G2’s work on other firm clients. 


 The negative financial impact to NLF’s legacy partners is fairly easy to calculate.  NLF will generate virtually no incremental cash-basis revenue to cover L2G2’s 2012 compensation and the recruitment fee.  As a result, NLF will have roughly $210,000 less net income available to distribute to legacy partners when it comes time to make the year-end distributions.[iii]  The $210,000 “loss” represents the investment NLF is making in L2G2.

cost to NLF
paid by OLF
L2G2 total 2012 comp
 NLF revenue from L2G2 
 $      --0--          

 3 monthly draws
 $       45,000
 $     45,000
 9 months draws
 $    135,000
      135,000
 year-end distribution
         120,000
      120,000
 recruitment fee (15%)
           45,000
 L2G2 2013 Compensation
 
 
 $  300,000
 total expenses
 $    210,000
 $  135,000
 NLF Net Income (Loss)
$ (210,000)

Note:  The financial loss is greater if L2G2 joins NLF with a supporting cast (staff and/or other timekeepers) or if NLF incurs other incremental costs (e.g., higher insurance premiums).[iv]

With any lateral partner candidate – but especially those who must join the firm in the 4th quarter – there are two questions to be answered after due diligence is completed and financial terms and projections made:

1.      Are the partners willing to relinquish current year compensation in exchange for projections of higher earnings in future periods?

2.      If the answer to the first question is “yes”, then how much current year compensation for what magnitude of return?

These two questions will be explored in future Management Committee Memos focused on:
  • Creative accounting[v] for lateral partner investments, and 
  • Financial due diligence/financial projections for potential lateral partners.

[i] Lateral partners invariably assure me they will “hit the ground running;” their initial month’s billable hours will be exceptionally high; all client files will be transferred on Day 1.  It never happens that way. 
[ii] L2G2 worked 9 months of 2012 (January through September) at OLF, but forfeited the accumulated deferred comp by joining NLF.  In order to make up the difference to L2G2, NLF is on the hook for the entire $120,000.  The subject of Making a Lateral Partner “Whole” is discussed at length in a previous Management Committee Memo.
[iii] In an effort to reduce the 2012 “loss,” some law firms might structure L2G2’s compensation so the $120,000 make-whole payment is paid in 2013 against the 2013 budget, rather than as a 2012 payment.  L2G2 might be amenable to this structure – deferring taxable income on $120,000 for a year has some merit assuming tax rates are unlikely to increase.  However, I don’t think this is the best approach.  How to “cover” compensation “hit” to legacy partners will be covered in the promised future “creative accounting for investment in lateral partners” memo.
[iv] Despite the fact I really love footnotes, this is point is too important to bury in one.
[v] Creative lawyering is a good thing.  Creative accounting is a bad thing.  I sometimes find this troubling. 

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