Lower Realization -- Sometimes an Acceptable Tradeoff

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Managing Partners; Practice Group Leaders
From:	Mike Marget
Date:	January 9, 2013
Re:	Lower Realization – Sometimes an Acceptable Tradeoff

Since the onset of the recession, clients have gained the advantage in fee negotiations.  Yet Legal Industrial Complex firms still managed to increase their hourly rates in 2012.  According to a survey published last month by The National Law Journal, median partner rates jumped 4.5% to $517 an hour and median associate rates increased 3.5% to $323.  The survey covered 55 firms ranging in size from 128 to 3,000+ lawyers.

While these rates may not resonate with your particular practice, it is a prudent business exercise to review pricing issues from time-to-time.  

Over the years I’ve had “discussions” with partners and practice group leaders who prided themselves on high realization.  They seldom needed to write-down time, collecting 98%-99% as compared to their standard hourly rates.  High realization percentages are wonderful when you are absolutely certain those rates are at the ceiling as to what the market will bear.  But such certainty, you should be bold and sacrifice a few realization percentage points in a quest for higher aggregate fees.  Let me demonstrate how this is important.

Assume you work 1,800 billable hours a year; have a $250 standard hourly rate; and enjoy 98% realization.  You will collect $441,000 on your work. [1,800 x $250 x 98% = $441,000]  Digging into the details of your practice reveals 900 of those hours are worked and collected at your standard $250 hourly rate, while the balance is for more rate-sensitive clients who are charged $240.  (This is illustrated in Example 1.) 

Then further assume, you decide to test drive a 4% rate increase on your standard rate, pushing it to $260 an hour. 

What is the worst that could happen?  Your rate-sensitive clients balk at the increase, so those hours remain at $240.  Theoretically, you could lose the other 900 hours if the new $260 rate is too high.  But in the real world, you are a lawyer and everything is negotiable.  If necessary, you’ll discount the new $260 standard rate with the pitch, “My standard rate is $260, but for you … $250.”  As illustrated in Example 2, you will still generate $441,000 in revenue even though your realization has dropped to 94.2%.  In essence, you enjoy the same revenue stream despite a lower realization statistic. 

On the other hand, if you manage just 1 additional hour at a rate higher than $250, you are ahead.

What is the best case scenario?  Assume you get the 4% increase on all your time currently billed at $250 an hour.  This is illustrated in Example 3.  The additional $10 an hour jumps your total revenue up to $450,000.  However, due to the $20 an hour negative spread between your new standard rate of $260 and the $240-an-hour cap on half your time, your realization drops to 96.2%.  Again, you achieve higher revenue despite the lower realization rate.

There is also an alternative almost-best case scenario.  Assume you cannot replace all 900 hours at the new higher standard rate?  Instead of 900 billable hours at $260 an hour, you produce only 865.  No worries, I’d still call this a win.  See Example 4.  With these numbers you are still generating the same $441,000 of revenue, but need to work only 1,765 billable hours in the process.  Sure, your realization drops to 96.1%, but the lower number of billable hours provides you 35 additional hours without any revenue decline.  That’s 35 free hours to devote to business development efforts which will eventually generate new work and create incremental revenue.

	Example 1	Example 2	Example 3	Example 4
Standard hourly rate	$250	$260	$260	$260
$240/hr clients
Billable hours	900	900	900	900
Effective hourly rate	$240	$240	$240	$240
Fee revenue generated	$ 216,000	$ 216,000	$ 216,000	$ 216,000
Other clients
Billable hours	900	900	900	865
Effective hourly rate	$250	$250	$260	$260
Fee revenue generated	$ 225,000	$ 225,000	$ 234,000	$ 225,000
Result
Billable hours	1800	1800	1800	1765
Effective hourly rate	$245	$245	$250	$ 250
Fee revenue generated	$ 441,000	$ 441,000	$ 450,000	$ 441,000
Realization rate	98.0%	94.2%	96.2%	96.1%

Now, I’m not about to paraphrase Dick Cheney and say “realization rates don’t matter.”  Rather, the point is realization rates, like deficits, need to be evaluated in a larger economic context.  Higher rates may mean higher write-offs and lower billable hours – but what is important is the bottom line. 

Maybe a higher standard rate for new clients simply becomes a starting point for fee discussion in 2013.  After all, a 10% discount from $260 an hour is preferable to discounting from $250.  Like the aphorism says, “If you don’t ask, you don’t get.”  Sometimes you do get! 

Time to Evaluate Billing Rates?

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Managing Partners; Practice Group Leaders
From:	Mike Marget
Date:	January 9, 2013
Re:	Time to Evaluate Billing Rates?  What to Consider

        Although this may have no application to your particular practice, Big Law raised their hourly rates in 2012 despite all the chatter about clients having the upper-hand in fee negotiations.  According to 55 Legal Industrial Complex firms surveyed by The National Law Journal, the median partner hourly rate increased by 4.5% to $517 and the median associate rate jumped 3.5% to $323. 

        If your firm has been thinking about tweaking billing rates – whether across-the-board, for specific individuals, applicable to a specific practice area or just for new clients or new matters opened from some date forward – here are a few things you might want to consider: 

1.   Can some of the partner rates be increased to narrow the gap between them and the partner with the highest hourly rate?

2.   Can individual associate rates be increased to reflect increased seniority, experience and efficiencies?

3.   Is the gap between the lowest partner rate and highest associate rate appropriate for what each individual brings to the table?

4.   Are paralegal rates generating sufficient “profit” for the firm (e.g., there is an old adage that paralegal productivity should be 1/3 comp and benefits; 1/3 to cover overhead; and 1/3 contributed to partner profits)?

5.   Will “the market” permit increases for lesser-productive timekeepers to narrow the pay-versus-performance gaps?

 

Increasing rates is always a sensitive matter, but remember:  You can always negotiate downward and a 10% discount from $260 an hour is preferable to a 10% haircut from $250.

1099 Reporting Decision Flowchart

Parsley Sage Rosemary & Ginsburg LLP

Always a reasonable result for a reasonable fee, always.

MEMORANDUM

TO:	1099 Accountants Everywhere
FROM:	Mike Marget
DATE:	January 8, 2013
SUBJECT:	1099 Decision Flowchart

Among my annual New Year’s Resolutions is a pledge to keep current with respect to 1099 reporting requirements to avoid extra work at year-end.  Then, by the end of January I have both quit the gym and stopped thinking about Forms W-9 and 1099, only to regret neglecting both as January approaches.  Someday I will keep those resolutions.  My physical and mental health will be much the better for it.

Internal Revenue Code Section 6041(a)

Pursuant to I.R.C. §6041(a), each year:
·         law firms because they are engaged in a “trade or practice”
·         must report to the IRS
·         payments for rent, contractor services, interest and a whole lot more unless specifically exempted pursuant to some other I.R.C. section
·         made in amounts of $600 or more ($10 or more in the case of interest or royalty payments) made during the preceding calendar year
·         setting forth the amount paid and name, address and tax id number of the recipient. 

The IRS provides Forms 1099-MISC and 1099-INT for these purposes.  It also has created Form W-9 to formally request the name, address and tax id information from people and entities we pay. 

The compliance deadlines are:

·         January 31 to provide the Forms 1099 to payee/recipients; and
·         February 28 to provide the Forms to the IRS or April 1 if such IRS filing is to be made electronically.

The 1099 reporting rules are many and nuanced.  The best explanations of the rules as to which payees and payments must be reported (and those which may be omitted) are found at www.irs.gov.  The 2013 Instructions for Form 1099-MISC and General Instructions forCertain Information Returns are particularly helpful.

Stiff penalties may apply for non-compliance with the 1099 reporting rules.

To help me remember the rules, a few years ago I developed a flowchart, supported by some explanatory Notes.  Maybe this information will be useful to you.

Chart I of II (the flowchart)


Note 1. The reporting requirements apply to all bank accounts – firm money and trust money. The fact that a third party’s tax id number might be assigned to the bank account (e.g., an IOLTA-type trust account) has no bearing on the situation. If the bank account is controlled by the law firm, include those transactions in the 1099 review.

Note 2. Interest reporting applies to amounts earned in trust accounts which are credited to the client’s trust account balance. Interest earned on IOLTA-type accounts paid to the State Bar or similar organization is not reportable. Interest payments to a W-2 employee are reportable on Form 1099-INT. So-called “interest” earned by a K-1 partner or member are reported on Schedule K-1.
Note 3. For 1099 reporting purposes, the term “rent” encompasses office lease payments (including real estate tax and operating costs), rental equipment, meeting rooms, banquet halls and booth space; but not space in a storage facility.
Note 4. The term “services” includes both (A) payments for work effort or labor and (B) products, materials and/or parts supplied in connection with the work effort (unless such costs are separately substantiated substantiated by receipts).[i]

Chart II of II -- Medical/Legal Service Providers

---

[i] The definition of “services” and the aggregation of payments for products, materials and parts (if necessary) are challenging in the 1099 reporting context. The term "services" includes such things as:

Independent Contractors Broker’s fees (insurance; real estate) Consulting services/expert witness Food, meals, catering performed on site or severed by payee staff Placement or recruiting fees Professional services Repairs and maintenance Transportation costs Registration fees for seminars, conferences, CLE

Advertising or marketing materials when design services or other work is involved Honorarium of speaker’s fee, but not transportation/lodging costs if original receipts provided Office supplies and related where the fir’s logo or other customization occurs Retirement payments to former partners or employees (not a QRP)

 Example 1. Firm purchases generic office supplies from vendor not otherwise exempt from 1099 reporting requirements – no 1099 reporting required since office supplies had no work or labor component.
Example 2. Firm purchases office supplies from same vendor to which firm’s name or logo is affixed – since labor is involved, purchases from vendor require 1099 reporting.
Example 3. Firm’s outside IT consultant provides services and parts/supplies. 1099 reporting is required for the paid services and for the paid parts/supplies unless parts/supplies separately substantiated by original receipts.
Example 4. A scholarship is provided by firm. No 1099 reporting required provided no labor or work is provided in exchange for the scholarship.

Top 10 Non-theological Questions about the Afterlife

Parsley Sage Rosemary & Ginsburg LLP

“Always a reasonable result for a reasonable fee, always”

MEMORANDUM

To:	Top 10 File
From:	Mike Marget
Date:	January 9, 2013
Re:	Top 10 Non-theological Questions about the Afterlife

10. – Does eternity last longer if calculated in dog years?

 9. – How is it possible for my French-speaking ancestors to communicate with me through an English language Ouija board?

 8. – If my home mortgage is underwater when I die, will it affect my credit rating in the hereafter?

 7. – Does the existence of the U.S. Congress suggest life continues even in the absence of higher level brain activity?

 6. – Have celestial real estate values skyrocketed since people started storing everything in the clouds?

 5. – If my spouse and I die in an automobile accident, can we travel toward the light using the 2+ HOV lane?

 4. – If I see dead relatives with their hands out, is it a welcome or are they about to hit me up for money?

 3. – In the afterlife, how much importance will attach to billable hours?

 2. – If you are an accountant in this lifetime, must you be accountant in the next world, too?

 1. – Should we expect over-crowding once those Obamacare death panels become operational?