Succession planning is an important issue for many law firms, especially as the Boomers and Generation Xers age and the human resource pyramid becomes an irregular shaped box. When you add in the assault on the industry from client competition, alternative service providers, and artificial intelligence, the necessity of doing succession right is more critical than ever.
With all that has been written and discussed about law firm succession planning it is no wonder that firms are focusing on the challenge more than ever. Early attention to the issue, training the next generation of leaders and business generators, and consulting with clients are among the tools used to position firms for the future. All those initiatives are important to tackling succession, but too often these “soft” steps don’t sufficiently address the financial aspects of succession. For a succession plan to work, it must recognize and address financial issues. In sum, a good succession plan is also a good financial plan.
Any succession plan necessarily involves financial considerations that touch on client transition, senior attorney compensation, dealing with owner equity, maintaining working capital, and controlling the annual succession cost. Experience has shown that financial modeling is important in addressing these five fundamental components of law firm succession. Specifically:
Transitioning and Institutionalizing Clients Requires Incentives. On the law firm side of things, transitioning a senior attorney managed client to a junior attorney involves those two plus the firm. Without creating incentives that motivate all three to see transition accomplished, the important objective is merely aspirational. Finding a financial arrangement that encourages the senior attorney to let go and the junior attorney to latch on is critical. Without such a financial arrangement, institutionalized and managed by the firm, failure in client transition is likely.
A Senior Attorney’s Compensation Glidepath Must Be Fair to Everyone. As many senior attorneys get on in age, they slow down and their productivity wanes. Cutting the senior attorney off at the knees at compensation time generally is no more effective than allowing that attorney to be continually overpaid. A firm realistically addressing succession confronts the declining productivity phenomenon and finds a middle ground that appropriately balances recognition of historical contribution and current contribution with the reasonable financial expectations of the other generations.
Old Capital, New Capital and the Value of Existing Owners’ Interests Must Be Addressed. Whether a firm is small or large, the value of an equity owner’s interest in the firm must be addressed as part of succession. Even firms that have a well-defined retirement of capital scheme, it is important that the firm retain sufficient paid-in capital as senior attorneys leave. For firms without an established way to return or retain paid-in capital, especially smaller ones, the advent of senior partner retirement presents the additional issue of whether the remaining owners must pay the looming retiree for the value of his or her equity interest. Solving the capital issues typically is an important financial consideration.
Succession Must Provide Sufficient Working Capital for the Future. The whole idea behind succession is to assure an enduring institution. Keeping an eye on the go-forward working capital needs of the firm is a must when preparing for succession. Succession obligations can’t be allowed to drain a firm of adequate working capital. Any succession strategy must meet the working capital needs of the firm (and its remaining owners) going forward.
The Annual Succession Obligation Must be Regulated. Closely aligned with the need for working capital is the necessity to regulate or cap the payment of succession obligations. This most often comes into play with a return of capital or equity buy-out obligation created as part of a succession plan. Even the best planned succession strategies can impose obligations that outstrip a firm’s ability to pay in down years. Establishing a cap on some of the obligations preserves the firm so that it can pay all the obligations, even if some are delayed.
If pursued thoughtfully, succession planning involves a heavy dose of financial planning. When your firm works on its succession planning, it is sufficiently focused on the financial issues?