The Truth Behind Profits Per Equity Partner: Why Some Partners Make Far More Than the Average

Introduction

In the world of law firms, few metrics hold as much weight as Profits Per Equity Partner (PEP). PEP is often regarded as the gold standard for assessing the profitability and financial health of a law firm. It’s a figure that can attract top talent, boost a firm’s prestige, and serve as a benchmark for success.

However, while PEP provides a snapshot of a firm’s profitability, it doesn’t tell the whole story. Not all equity partners at a law firm earn the same amount, and some partners make far in excess of the average PEP. This disparity in earnings can be attributed to a variety of factors, including different profit-sharing models, origination credits, business development prowess, leadership roles, bonus structures, equity share differences, and special compensation arrangements.

In this article, we will explore these factors in detail, uncovering why some partners earn far more than the average PEP and what this means for the legal profession.

Understanding Profits Per Equity Partner (PEP)

What is PEP?

Profits Per Equity Partner (PEP) is a key financial metric used in law firms to indicate the average profit distributed to each equity partner in a given year. It is calculated by taking the total profits of the firm and dividing it by the number of equity partners. The resulting figure represents the share of the firm’s profits that each equity partner would receive, on average.

PEP is a crucial figure in the legal industry as it is often used to attract and retain top talent, as well as to compare the financial performance of different firms. Higher PEP figures generally indicate a more profitable firm and can be a significant factor in a lawyer’s decision to join or stay with a firm.

Is PEP the Total Amount a Partner Makes?

For equity partners, PEP represents the amount they typically make from the firm’s profits. In many firms, equity partners do not receive a separate salary; their compensation is derived primarily from their share of the firm’s profits, as reflected by PEP. The actual amount an equity partner takes home can vary depending on the firm’s profit-sharing structure, seniority, and individual performance.

Non-equity partners, on the other hand, usually receive a fixed salary, potentially with bonuses, but do not participate in the profit distribution as equity partners do. Therefore, PEP does not apply to non-equity partners, as they are not sharing in the firm’s profits.

Compensation Structure for Equity Partners

Equity partners’ total compensation is generally made up of their share of the firm’s profits, which is reflected in the PEP. In firms with a lockstep compensation system, equity partners may receive profits based on seniority or tenure. In firms with a merit-based system, partners’ compensation may also be tied to their individual performance, client contributions, or other metrics.

Some firms may also provide equity partners with additional compensation, such as bonuses for extraordinary performance, contributions to client acquisition, or firm leadership roles. However, the bulk of an equity partner’s income typically comes from their share of the firm’s profits, as indicated by the PEP.

Why Some Partners Make Far More Than the PEP Amount

While PEP provides a useful average for understanding the profitability of a law firm, it doesn’t fully capture the range of earnings among equity partners. Several factors contribute to why some partners make far more than the average PEP. These factors include different profit-sharing models, origination credits, business development and rainmaking abilities, leadership roles, bonus structures, equity share differences, and special compensation arrangements. Let’s explore each of these in detail.

1. Different Profit-Sharing Models

Lockstep Model

In a traditional lockstep system, partners’ earnings increase with seniority. Under this model, all partners start with the same share of the profits when they first make partner, and their share increases over time as they gain seniority within the firm. The lockstep model is designed to promote teamwork and collaboration by ensuring that partners are not competing against each other for a larger share of the profits.

However, this model also means that more senior partners earn more than junior equity partners, even if their individual contributions to the firm’s revenue are not significantly higher. While the lockstep model is less common today, it is still used by some firms, particularly those with a strong emphasis on firm culture and long-term client relationships.

Modified Lockstep

Some firms use a modified lockstep system where progression is based on a combination of seniority and performance. In this model, partners are still rewarded for their years of service, but their progression through the lockstep is accelerated or decelerated based on their individual performance. This allows firms to retain the collaborative benefits of the lockstep model while also incentivizing high performers.

Partners who excel in business development, client retention, or other key metrics can progress faster and earn more than their peers. This can lead to significant disparities in earnings among partners, with top performers earning far more than the average PEP.

Eat-What-You-Kill (Merit-Based) Model

In an “eat-what-you-kill” model, partners are compensated based on the revenue they generate. This model is highly individualized and rewards partners who bring in more business or handle larger, more lucrative cases or clients. Under this model, there is no fixed share of profits; instead, each partner’s compensation is directly tied to their individual contributions to the firm’s revenue.

The eat-what-you-kill model can lead to significant earnings disparities among partners, with top rainmakers earning far more than their peers. While this model can be highly lucrative for top performers, it can also create a competitive environment within the firm, potentially undermining collaboration and teamwork.

Hybrid Models

Many firms use a combination of these models, allowing for some baseline profit distribution while also rewarding high-performing partners with additional compensation. In a hybrid model, partners may receive a base share of the profits based on seniority or tenure, with additional compensation based on individual performance, business development success, or other metrics.

Hybrid models offer flexibility for firms to reward top performers while still maintaining a sense of equity among partners. However, they can also lead to significant disparities in earnings, with some partners earning far more than the average PEP.

2. Origination Credit

Client Origination

Origination credit refers to the credit that partners receive for originating clients and bringing in new business. In many firms, partners who are responsible for bringing in high-revenue clients receive a share of the profits generated by those clients. This origination credit can significantly increase a partner’s earnings, especially if they are responsible for large, high-revenue clients.

For example, a partner who brings in a major corporate client that generates millions of dollars in revenue for the firm each year may receive a substantial share of the profits generated by that client, in addition to their base share of the firm’s profits. This can lead to earnings that far exceed the average PEP.

Team Origination

In some firms, partners may also receive a share of the profits generated by the clients they originate, even if other partners or teams handle the work. This is known as team origination. In this model, the originating partner receives a share of the profits generated by the work done by other partners or teams on the client’s behalf.

Team origination can be particularly lucrative for partners who are skilled at bringing in new business but may not be directly involved in the day-to-day work on the client’s matters. It allows them to benefit financially from the work done by others, leading to earnings that exceed the average PEP.

3. Business Development and Rainmaking

Rainmakers

In the legal industry, rainmakers are partners who consistently bring in a significant amount of business for the firm. These partners are highly valued for their ability to drive firm revenue and attract high-profile clients. Rainmakers often have strong relationships with major corporate clients, high-net-worth individuals, or other key stakeholders, making them indispensable to the firm’s financial success.

Because of their ability to generate substantial revenue, rainmakers are often compensated well above the PEP. Their compensation may include a larger share of the profits, performance bonuses, and other incentives designed to retain their services. In some cases, rainmakers may even negotiate special compensation arrangements, such as guaranteed bonuses or increased profit shares, to ensure they are adequately rewarded for their contributions.

Premium Billing Rates

Partners who can command higher billing rates due to their expertise, reputation, or client base can also earn more than the average PEP. For example, partners who specialize in high-stakes litigation, international arbitration, mergers and acquisitions, or intellectual property may be able to charge premium rates for their services, leading to higher overall revenue.

When these partners bring in more revenue through higher billing rates, they may receive a larger share of the firm’s profits, resulting in earnings that exceed the average PEP. Additionally, firms may offer these partners additional incentives, such as bonuses or increased equity shares, to retain their services and ensure they continue to generate high levels of revenue.

4. Leadership Roles

Management and Leadership Positions

Partners who hold leadership roles within the firm, such as managing partner, practice group leader, or executive committee member, often receive additional compensation for these responsibilities. These roles typically involve overseeing the firm’s operations, managing teams, setting strategic direction, and making key business decisions.

Because of the additional responsibilities associated with leadership roles, firms often provide these partners with extra compensation on top of their share of the firm’s profits. This compensation may come in the form of a higher share of the profits, performance bonuses, or other incentives designed to reward their leadership contributions.

Strategic Roles

Partners involved in strategic initiatives, such as mergers, firm expansions, or key client account management, may also receive additional compensation for their contributions. These roles are critical to the firm’s growth and success, and partners who excel in these areas are often rewarded with bonuses, increased equity stakes, or other financial incentives.

For example, a partner who successfully leads a merger with another firm may receive a substantial bonus or an increase in their equity share as a reward for their efforts. Similarly, partners who manage the firm’s relationships with key clients, ensuring continued business and revenue, may receive additional compensation for their strategic contributions.

5. Bonus Structures

Performance Bonuses

Many firms offer bonuses to partners based on individual or firm-wide performance metrics. These bonuses can be tied to factors such as client satisfaction, business development success, or the achievement of specific strategic goals. For example, a firm may offer bonuses to partners who exceed their revenue targets, bring in new high-revenue clients, or successfully lead major cases or transactions.

Performance bonuses can significantly increase a partner’s earnings, especially if they consistently meet or exceed their performance targets. In some cases, performance bonuses can be substantial, leading to total compensation that far exceeds the average PEP.

Profitability Bonuses

Some firms distribute additional profits as bonuses if the firm exceeds its financial targets for the year. These profitability bonuses are typically distributed to all equity partners, but high-performing partners may receive a larger share of these bonuses based on their individual contributions to the firm’s success.

For example, if a firm has a particularly profitable year, it may choose to distribute a portion of the excess profits as bonuses to its partners. Partners who have played a key role in the firm’s profitability, such as those who have brought in significant business or managed major cases, may receive a larger share of these bonuses, leading to earnings that exceed the average PEP.

6. Equity Share Differences

Variable Equity Stakes

Not all equity partners hold the same amount of equity in the firm. In many firms, equity partners’ shares of the firm’s profits are determined by their equity stakes, which can vary based on factors such as seniority, performance, or contributions to the firm. Partners with larger equity stakes receive a greater share of the firm’s profits, leading to earnings well above the average PEP.

For example, a senior partner who holds a larger equity stake in the firm may receive a higher share of the profits than a junior partner with a smaller equity stake. This can result in significant disparities in earnings, with senior or high-performing partners earning far more than the average PEP.

Senior vs. Junior Partners

Senior partners or founding partners may hold more equity than newer equity partners, resulting in higher payouts. This is particularly common in firms that have a lockstep or modified lockstep compensation model, where partners’ equity shares increase with seniority.

In addition to their larger equity shares, senior partners may also receive additional compensation for their leadership roles or contributions to the firm’s success. This can lead to earnings that far exceed the average PEP, particularly for senior partners who have been with the firm for many years and hold significant equity stakes.

7. Special Arrangements

Lateral Hires

Partners who join a firm laterally (from another firm) often negotiate special compensation arrangements, including guarantees, bonuses, or higher equity shares, to match or exceed their previous earnings. These arrangements are designed to attract top talent and ensure that lateral hires are adequately compensated for their experience and client base.

For example, a lateral hire who brings a significant book of business to the firm may negotiate a guaranteed bonus or an increased equity share as part of their compensation package. This can lead to earnings that exceed the average PEP, particularly if the lateral hire continues to generate substantial revenue for the firm.

Retention Agreements

High-performing or strategically important partners might be offered special retention agreements to keep them at the firm. These agreements can include additional bonuses, increased profit shares, or other financial incentives designed to retain top talent and prevent them from leaving for a competitor.

For example, a firm may offer a retention bonus to a rainmaker partner who is responsible for a significant portion of the firm’s revenue. This bonus may be structured as a one-time payment or as a series of payments over several years, ensuring that the partner remains with the firm and continues to contribute to its success.

Retention agreements can also include non-financial incentives, such as leadership opportunities, increased decision-making power, or support for business development initiatives. These incentives can further enhance a partner’s earnings and make them more likely to stay with the firm, even if their total compensation exceeds the average PEP.

Conclusion

While PEP provides a useful average for understanding the profitability of a law firm, it doesn’t fully capture the range of earnings among equity partners. Partners who excel in business development, hold significant equity stakes, or take on leadership roles can earn far more than the average PEP due to the various compensation models and incentives that law firms use to attract, retain, and reward top talent.

Understanding the factors that contribute to these earnings disparities is crucial for anyone considering or negotiating an equity partnership. Whether it’s through different profit-sharing models, origination credits, business development success, leadership roles, bonus structures, equity share differences, or special compensation arrangements, there are many ways for partners to maximize their earnings and achieve financial success in the legal industry.

As the legal profession continues to evolve, it’s likely that these factors will play an even greater role in determining partners’ compensation. Firms that can effectively balance these incentives while maintaining a collaborative and supportive culture will be well-positioned to attract and retain top talent, ensuring their long-term success and profitability.