Shareholders in Law Firms: An Introduction
Within the structure of a law firm, shareholders exist as a unique component among the membership. Shareholders are business owners: they have a capital interest in the firm, and they receive distributions (bonuses, retirement, etc.) from the firm. Alternatively, partners are essentially employees who have an interest in the future earnings of the firm. So, whereas partners have a piece of the future earnings stream, shareholders own part of the present value of the firm’s earnings stream. The ownership aspects of the two positions are often illustrated with the analogy of real estate: partners rent, shareholders own.
From ownership spring the primary characteristics of shareholder status. Generally, only those members who bring either a high level of business or create or manage the internal structures of the firm will become shareholders. By limiting ownership to only those who offer the greatest value , a law firm can acquire the most capable business generators and greatest managers without sharing the overall pot of future earnings amongst partners who provide the least amount of value. What’s more, the shareholder status can be seen by some law firms as an alternative to partnership that offers the incentive of ownership without taking the risk of making a full partner. Fewer years of seniority or less client development requirements become small barriers to entry but act as enough to distinguish a shareholder from a partner. In this way, a firm can provide reward, recognition, and incentives for existing management and also attract new members who would normally shy away from becoming a partner.
Roles and Responsibilities of Law Firm Shareholders
The specific duties of an ownership group can vary from firm to firm, as well as from one associate to another. However, by and large the following points are illustrative of the general duties a law firm shareholder is expected to undertake: Management duties: these duties involve participation in committee(s) directing firm operations, policies, and management issues as discussed above. Service duties: these duties are not "billable" at 100 percent, but publicly ("fee-generating") or internally are regarded as equally important as billable work. These responsibilities include legal work, with a very generalized level of billable hour quota, but at an expectation that the dollar volume of the billings be significantly higher than that of an associate’s. Business development duties: if you do not currently have a book of business, along with an annual targeted goal for its growth, then you don’t belong in the shareholder group. Shareholder compensation is not based upon an arbitrary percentage of firm net receipts; instead, the firm typically has business development performance requirements which, if not met, will be the proverbial writing on the wall. If you are not hungry, don’t want to eat, then be prepared for the effects of starving. Recruiting duties: if you are not bringing in new talent, then you aren’t doing your job. This does not mean bring in any warm body, but you genuinely must seek the best and brightest, as well as diversity, across the board. And current shareholders are going to expect you to be an excellent vetting resource for the firm on prospective hires, given their risk and reward nature. Remember that shareholders always have a finger on the equity checkbook, with expectations of a good return. Leadership duties: should come naturally when in the company of other concerned owners. This requires an interest in the firm’s overall future, and not just your own day-to-day world. Remain involved in global issues, and you can in time make them yours.
Shareholder Agreements for Law Firms
Shareholders are required to abide by the terms of the shareholder agreement in all matters. In simple terms, shareholder agreements are comparable to an operating agreement of a limited liability company. They set out the rules of the road for the law firm and its shareholders. They govern many lawyer-ownership related issues, such as how profits are divided among the shareholders, how shareholder capital accounts are managed, how the group makes decisions (including what action requires a vote), how much input and decision making power each firm has, whether a shareholder can be removed and how that removal takes place, and many other issues. Many shareholder agreements include these and many other issues, from A-Z. Shareholder agreements are usually more complex, as they often include both standard language, and then very specific language that’s tailored to that particular firm. The latter often becomes the most contentious part of whether there may be a dispute down the road, as you may have certain provisions that are not often encountered and therefore do not have standard language. Generally speaking, though, the more boiler plate language a shareholder agreement has, the more likely it will stand up to challenge. The general provisions in a shareholder agreement are those that are often litigated; the unique provisions are seldom challenged. If you ask any labor and employment attorney that handles employment contract work, they’ve probably found themselves in court on a non-compete or non-solicitation. For lawyer groups, no exception. They routinely include restrictions on how a shareholder can practice law if he or she leaves the firm, and the terms of that non-compete. One frequently overlooked aspect is what happens when the disputed restrictive covenant injunctive relief is sought. Most shareholder agreements have well-drafted terminations bases on certain actions, but they do not anticipate the time and cost that ensues when injunctive relief is sought. And, if the shareholder’s non-compete is found to be overbroad by the state or federal court, removing a shareholder from a non-equity or equity position can prove difficult.
Advantages of Being a Law Firm Shareholder
Becoming a shareholder in a law firm comes with various benefits, which can vary depending on the firm’s structure and culture. One of the most significant benefits is the ability to share in the profits of the firm. As shareholders, they are entitled to a portion of the firm’s profits, which can lead to higher earnings compared to non-shareholder colleagues. This financial benefit can provide a greater sense of security and stability for shareholders.
In addition to profit-sharing, being a shareholder usually comes with increased decision-making power within the firm. Shareholders typically have a greater say in the direction of the firm, from strategic decisions to management and hiring practices. This increased autonomy can be rewarding for individuals who are highly ambitious and driven to make a significant impact on their firm.
Professional growth opportunities are also a common benefit of being a shareholder. Many law firms reward shareholders with professional development programs, networking opportunities, and other resources to help them advance their careers. These resources can help shareholders stay current on industry trends and expand their professional connections.
Moreover, depending on the law firm, shareholders may have enhanced flexibility regarding their work schedule and project assignments, making it easier to achieve an optimal work-life balance.
Overall, becoming a shareholder in a law firm can be a smart move for attorneys seeking to increase their earnings and grow both professionally and personally. However, it is essential to consider the particular benefits offered by each law firm beforehand.
Challenges of Being a Law Firm Shareholder
One of the largest pitfalls of being a law firm shareholder, and the most difficult for me to overcome as a firm’s managing shareholder, is dealing with the financial risks that come with being an owner. It is much easier to spend the firm’s money than it is to spend your own. When you are a shareholder, the money that goes out for overhead is not "firm money" but rather the money that you yourself invested into the firm. This can often lead to resentment among shareholders when expense issues are being considered or debated, as some feel that they should be entitled to special treatment due to their higher investment in the firm. These issues can often lead to a lack of participation in budgeting or other financial discussions amongst shareholders.
These issues can be avoided by simply having open communication between all shareholders. Every shareholder has a right to know where the firm stands and how the costs are being spent. However, once all shareholders have this information, it should be expected that it be considered in each member’s budgeting proposals. Often I see people struggle with their "shareholder status" because they are not aware of the general financial status of the firm, which can lead to a lack of participation in these financial discussions, which can lead to a feel of exclusion, and eventually resentment.
Another challenge is the employment expectations that shareholders have. Once you have become a shareholder, your status is not set in stone. If you are not pulling your weight you can be kicked out. Or, perhaps even worse from my standpoint , people may become resentful that they are the ones who are expected to do all of the work. This happens most frequently when a shareholder is physically present but does not pull their weight. If someone comes into the office at 9 a.m. and leaves at 5 p.m., while the majority of shareholders are working additional hours, that individual may have their status questioned, even if they are performing their job well. I often see that resentment can be mitigated by simply being present with fellow shareholders. Whether that be in the office, a shareholder meeting, or just stopping by someone’s office to say hello. If you are always missing, people begin to think that you don’t care.
Furthermore, people begin to expect from those who are actively engaged, but they also begin to resent the time and effort that has been invested. Speaking from experience as a managing shareholder, you cannot expect to walk into a firm with an established and well-oiled machine and take it over, never looking back, and everyone just continues to do what you say. You have to jump into everything that needs to be done. You have to take the time to meet all of the staff, and then they need to see you again on a regular basis by making time for coffee or lunch. You have to reach out and ask for help from other shareholders when things need to be done; you cannot just assume that everyone is happy that you have jumped in without being expressly told so. The best way to avoid this issue is simple: don’t be presumptuous. This comes back to knowing the people that you work with and communicating with them.
Becoming a Law Firm Shareholder
In the national legal marketplace, it is common for law firms to have a shareholder/partner tier within their structure. Moreover, many practices are requiring an attorney to attain shareholder status in order to be considered in leadership positions. Because of the frequency of the title, it has lost some of the prestige that it once held. Nonetheless, the process and journey to achieving this title should not be overlooked and is oftentimes a dramatic turning point in an attorney’s career. The process of becoming a shareholder, in theory at least, gives the firm an opportunity to review and vet the candidate based upon criteria said to reflect both the firm’s values and the legal community’s standards.
Typically, the process of becoming a shareholder is internal- meaning the steps and requirements are outlined in the firm’s handbook or manual created by the firm itself. The requirements to become a partner for one firm are often inconsistent with an equivalent position from another firm. This inconsistency gives rise to the importance of thoroughly reviewing the firm’s handbook, offers of employment, and strategic plan. Although firms will typically have a standard set of requirements for every lawyer in that band, they will also have leeway to flex those standards based upon the individual’s contributions, length of service, etc. Be sure that you have a clear and accurate picture of these requirements.
The process of becoming a partner takes many forms depending on the firm. For most firms, the process is grueling and long, involving multi-week interviews, a personal review, and perhaps a formal presentation. The purpose of the review and process is to ensure that the candidate meets the firm’s expectations as to quality of work and productivity. Becoming a shareholder or partner, in the eyes of the firm, represents a solidified expectation that the new shareholder will maintain a certain productivity level as an owner, not just as an employee. Of course, a basic examination of the candidate’s individual qualities is also undertaken, covering things such as: interpersonal skills, leadership skills, client base, reliability, emotional quotient (EQ), and financial reports (if applicable). Whether explicitly stated or not, there is also a general expectation that shareholders will be successful rainmakers, and that their business development will help the firm grow over time.
A shareholder’s role is closely related to the individual’s practice and area of expertise. A superior litigator, litigator, estate planner, etc. is expected to start generating their own work and business. This doesn’t mean that a shareholder won’t be able to rely on the work of others, only that they will be expected to produce a certain amount of work on their own once they are ranked amongst owners. In general, becoming a shareholder challenges attorneys to move from the primary position of working for the firm and its clients to developing the work for themselves and others. Whether they like it or not, becoming a shareholder is a big step towards becoming a manager.
Differences Between Law Firm Shareholders and Partners
While shareholding and partnership may sound similar to some, these types of structures can vary a great deal across companies and industries. For example, among law firms, there are commonly used models of both the shareholder corporation and the traditional partnership. Within each type of organization, there are also subcategories.
Partners — and most likely shareholders — of your firm have certain rights to withdrawal under your governing documents. This means they may decide to withdraw from active participation in the firm and still retain their financial interest. In fact, shareholders must receive cash amounts representing their fair value and any distribution paid on account of their share prior to receiving any amount for the interest above the amount of their capital contribution.
There are additional rules that apply, such as
They are similar in that they have voting rights as shareholders and serve management roles within the firm. They are different in that partners do not have stock interests in the firm itself.
Deciding between a shareholder and a partnership structure requires an evaluation of the firm’s objectives and legal basics of each. The first consideration is the need for the firm to limit its liability. If a shareholders’ liability is limited to the amount of their investment in the organization, the benefits of this strong limitation may outweigh other considerations. Another primary consideration is to find out if there is a possibility of going public. If so, a corporation is preferable, as shareholders have the potential to own stock in the organization (and thus participate in an IPO). Partners, on the other hand, do not own an interest in the organization itself. A corporation is often more attractive to outside investors and, while not impossible for a partnership, it is much harder to transfer ownership in a partnership than a corporation. The formalities required for creating and maintaining a corporation can vary significantly from those of a partnership. For example, a partnership must be founded in accordance with the provisions of the partnership agreement, but the process for founding a corporation is set forth in the corporate law of the particular state.
Legal Considerations for Law Firm Shareholders
Owning a law firm can provide certain liability protections, but these protections can be compromised by how closely the owner stays involved in the management of the firm. While owning shares in a law firm does not shield an owner from liability for personal malfeasance or fraud, it may provide some liability protection for actions like malpractice or breach of fiduciary duty.
Because lawyers are licensed based on a specific place of business, many law firm entities elect to form as an LLC or professional corporation instead of a regular corporation. LLC and PC shareholders are protected from personal liability for the debts , obligations and liabilities of the LLC or PC, except when they personally take part in the action that creates the liability or act fraudulently or because of their fundamental failure of responsibility. California even provides an exception to this with its Professional Corporations Law, which allows shareholders to voluntarily agree (and include it in their by-laws) to be responsible for their share of losses or liabilities. The underlying premise of each of these exceptions is that a shareholder cannot distance himself or herself from the actions of his or her law firm. Thus, shareholders should be mindful of their active involvement with the law firm.