Case study: Life after lockstep

Lawyers value their personal autonomy especially highly. But with alternative business structures now on the horizon, a number of firms face the need for a more streamlined and transparent management structure. Offshore firm Mourant found getting buy-in for performance-based remuneration posed one of the greatest challenges.

By Nicola Davies, chief executive, Mourant

There are few things that lawyers, or indeed many other professionals, care more passionately about than their remuneration.

However, contrary to the popular image of lawyers as money-obsessed creatures whose sole aim in life is to maximise their personal earnings, most lawyers are in fact motivated not by money, but by a combination of intellectual challenge, a desire for personal autonomy and a need for peer recognition of their professional standing. It is the latter motivator, the need for peer recognition, which becomes confused with the financial one, because the easiest way for lawyers to rate themselves objectively against their peers, is by comparing earning powers.

Lockstep limitations

Given this motivation, it is not difficult to see the attraction of a traditional lockstep profit-sharing arrangement for professional partnerships. The earnings of the lawyers within the firm cease to be a political issue. They are not a badge of how well the individual lawyer has performed or of how he compares to his peers. Financial focus therefore tends to shift to how the magic profit-per-equity-partner figure in a firm compares to that of its competitors – and that focus is probably no bad thing for the business, at least in the short term.

However, the environment in which lawyers operate is changing with unprecedented speed, putting tremendous pressure on the traditional lockstep partnership arrangements. It is becoming apparent to an increasing number of firms that the downsides of a traditional lockstep outweigh the upsides. For these firms, the challenge is therefore how to replace the lockstep with an arrangement that works better from the perspective of the business, without allowing the firm to be torn apart by competitiveness between lawyers and battles over remuneration.

Impact of underperformers

There are a number of reasons for a traditional lockstep model coming under strain. For example, there may be tensions between partners where one individual or a practice area is seen to be underperforming compared to others. Partners will accept a fixed position in a lockstep provided there is a feeling that all partners and practice areas are ‘pulling their weight’ and making a broadly similar financial contribution to the overall success of the business. Firms can ensure this by operating a rigorous approach to ‘de-equitising’, or sacking, partners who are not seen to be performing to an acceptable standard, although this has problems of its own – not least because it leaves the firm no option for accommodating people who would be prepared to take a lesser financial reward in return for a better work-life balance. But the bigger issue is probably not those firms who have a tough policy on tackling underperformance – it is those firms who pay lip-service to doing so while actually ignoring the problem, as this leaves partner tensions to fester, as well as diluting the profitability of the firm.

Multi-jurisdictional strategies

Having a multi-jurisdictional strategy can also have an effect – something many of the bigger firms have adopted in response to rapid globalisation of business. The difficulty is that there are often significant variations in the profitability of different jurisdictions. If a true one-partnership lockstep model is used then this will lead to some jurisdictions subsidising the others (which gives rise to many of the tensions discussed above). The alternative is to have a structure that involves each jurisdiction having its own partnership and not sharing profits centrally – but this has an obvious downside in that it does not encourage truly integrated and collegiate behaviour.

The need for non-lawyers

As law firms become more complex and international businesses the infrastructure starts to demand top-level people to drive and support it. Attracting and retaining the best people in their fields is difficult if there is no possibility of offering an equity interest in the business. On the other hand, if a law firm brings non-lawyers into a lockstep partnership structure, they may well end up significantly overpaying that person relative to their market value. Pressures therefore arise for a structure that allows a much more varied equity-ownership arrangement rather than a one-size-fits-all lockstep model.

Financial flexibility

Law firms are also increasing the capital value of their businesses. Traditionally, however, law firms were not seen as businesses with much in the way of capital value. The lockstep model typically stripped out all or the vast majority of the profits annually and unless a firm was lucky enough to have retained clients, it had to win its business from scratch each year. Therefore, there wasn’t a large capital value attributed to the business. In the offshore context, this changed some 20 or 30 years ago when nearly all of the major law firms established their own trust companies, which very rapidly acquired a significant capital value, and in many cases required capital investment. It quickly became apparent that a traditional lockstep model, which effectively granted a very significant interest in a capital asset on becoming a partner, was problematic. If there was a sale of the business, the new partner would be entitled to a substantial share of the proceeds. Locksteps gradually got longer and longer to try to deal with this, but this in itself caused difficulties as some lawyers were in a position where they were likely to retire before reaching the top. Furthermore, unless a firm had a structure (and available cash resources) to buy out a partner’s capital interest on retirement, there would be a great deal of pressure to sell the trust company prior to retirement to crystallise the value. Although few UK law firms have trust companies on the scale of the offshore law firms, the changing business models in the UK and the advent of the Clementi reforms are likely to bring similar issues to the fore in the future.

Another financial concern lies in increasing long-term investment needs. As previously mentioned, locksteps generally work on the premise that a partner receives a proportion of the income of the business during his tenure, but usually no capital payment (unless there is a sale of the business), or one significantly less than the true value. Where a business wishes to make a long-term investment – whether by making an acquisition of another business, for example, or a significant IT investment – there can be a tension where partners who may be close to retirement are asked to take an income sacrifice in order to finance a longer-term project from which they are unlikely to see the benefit. As law firms become larger and more global, and technology continues to demand ever more costly solutions, this will become an increasingly complex issue. It is vital that law firms have a structure in place that encourages long-term investment for the good of the business.

Structural change at Mourant

Mourant is a firm that began as a Jersey law firm and then developed a vibrant trust and company administration business. It began to see many of these identified factors emerging as problems in the 1980s. It had become a leading name in offshore legal services, the trust company was growing rapidly and it had begun to expand both legal and administration services into other jurisdictions. It was also necessary to be able to attract and retain not only the best lawyers, but also the most talented accountants, IT personnel and many other key roles, in multiple markets and jurisdictions. Finally, the firm also had ambitions to accelerate growth in these overseas jurisdictions by acquiring targeted companies.

By the year 2000 it was becoming clear that a fairly radical change to the ownership structure of the firm was necessary, including remuneration, if Mourant was to achieve its
strategic aims. The following decisions were made:

The overall group holding structure would be changed from a partnership to a company;
A radically different remuneration scheme would be introduced, giving the flexibility to offer packages appropriate for the role and the market in which the individual operated;
A more corporate style of leadership and management would be introduced.

Measuring success

On 1 October 2003, and after almost two years of preparatory work, a unanimous vote of the partners saw Mourant change from a partnership of 24 equity partners to a company with 38 shareholders.

The business turned in three successive years of record growth, with income close to doubling over the two-year period and the valuation of the business increasing by close to 50 per cent in the first two years (the valuation figure for the third year is currently being calculated).

However, another major concern had been whether the new structure, which was so significantly different from a traditional lockstep, would still enable the firm to recruit top class lawyers. In the event, this was not a problem and strong partners continued to be recruited, although it is certainly true to say that in each case it took significant time and effort to explain and make partners comfortable with the new structure. At the same time, we were also able to attract the best people for the administration business – something that would have been more of a struggle without a structure that allowed equity participation.

The new structure also enabled the planned investment and expansion plans. Prior to incorporation there were offices established in Jersey, Guernsey, London and Luxembourg. In the three years post-incorporation, offices were added in the Cayman Islands, Dubai and New York, and the Jersey hedge-fund administration business of a well known bank was acquired. The investment in new jurisdictions and businesses could happen rapidly for two reasons. The new corporate-governance structure enabled the management board to take decisions and implement them quickly, while tensions around investing income in long-term projects were effectively removed. The shareholders knew they would receive their share of the capital value of the business on retirement.

Employee reactions

As a consequence of incorporation the firm was able to introduce an employee benefit trust and give everyone working in the company a small equity participation. Allied to this, there was much more openness regarding the plans for, and financial performance of, the business. Although in cash terms the value of shares awarded was not particularly large, it was hoped that the share scheme and the greater openness would make employees more engaged and interested in the success of the business. Annual staff surveys monitor the engagement levels of everyone in the business, and in the three years following the incorporation, the surveys showed a steady increase. Given there is much research to demonstrate a strong correlation between employee engagement and the success of the business, this is a measure that is taken seriously.

It is true to say that the transition from partnership to a corporate structure was not entirely smooth. No partners were lost as a consequence of incorporation, but there were certainly some concerns voiced about a feeling of ‘disenfranchisement’ as a result of the new corporate-governance structure. My feeling is that this is an almost inevitable function of a growing firm rather than something particular to a corporate structure. Most large partnerships have to put in place structures that effectively mimic corporate management structures in order to be able to take decisions quickly and efficiently without having to involve all of the partners.

The most contentious area, however, was remuneration structure – as might be expected from the beginning of this article. The personal self worth of professionals is often measured with an awareness of ‘market value’ and an evaluation of performance. Bearing in mind the lawyer’s desire for autonomy, it is by no means easy to get people to buy into the concept of performance management at all, nor to persuade them to accept the views of the management board and remuneration committee regarding market values and assessments.

Even where it was possible to demonstrate that a particular individual had benefited in overall earnings from the incorporation relative to what they would have earned under the partnership, there were still issues around their position relative to others. Again, these are not really issues that are peculiar to corporate structures. Many partnerships have introduced an element of performance-related remuneration into their structures and face similarly difficult issues in assessing and putting a value on performance. There is always a fairly steep learning curve involved both for those who are charged with making the assessments, and for those who are subject, perhaps for the first time in their career, to a highly structured performance-management system.

As the years pass and people in the business become more accustomed to the new remuneration and corporate-governance structures, so the issues start to recede and there is a gradual acceptance of the power of a performance-management system that sets targets and rewards specifically aligned to the long-term strategic aims of the business. Of course, the most powerful way for the management team to ensure this happens is to let the statistics speak for themselves. Mourant has seen strong success since the incorporation, with the company having met the majority of its strategic aims as well as out-performing its financial targets.

Nicola Davies is chief executive of Mourant. She can be contacted at nicola.davies@mourant.com