Lauren Kirkwood, The Daily Record Newswire
Whether it happens at a small, local law firm or one with hundreds of attorneys in offices across the country, the move from firm associate to equity partner is much more than a step up the legal career ladder — it’s also a major financial investment.
Before making that jump, it’s important to know the expected capital contribution for a new partner at the firm, as well as how partners typically finance a buy-in, experts told The Daily Record. Beyond that, broader knowledge of the firm’s financial structure and how the change in status will affect the partner’s personal cash flow and tax obligations is equally crucial.
“Like any other investment, you should go into it with your eyes open,” said Sunil Setia, a client adviser in SunTrust Private Wealth Management’s legal specialty group. “There is a liability that gets created when you borrow money, and you just want to be cognizant of it.”
But how much a new partner will be required to contribute — and whether he or she will need to borrow at all — varies widely depending on a host of factors, including the size of the firm, the number of retiring partners, the firm’s age and what type of law its attorneys practice.
“I’ve seen it as little as $30,000, all the way up to $300,000 and sometimes more,” Setia said. “It really depends on how the firm is capitalized.”
A typical range, however, might be 25-to-40 percent of the new partner’s expected compensation for the year, said Steve Manekin, director at Baltimore accounting firm Ellin & Tucker and chair of the firm’s law firm services group.
Different firms, different methods
To finance the capital contribution, larger firms will usually take the new partner to a bank with which the firm has an established relationship to obtain a loan, Setia said.
“That rate is going to be a lot better, because if the partner defaults, if something goes awry, the firm is financially liable,” he said. “The rate is going to be significantly better than somebody who doesn’t have a firm guarantee.”
This arrangement is beneficial to the firm, Manekin said, because the entire contribution goes immediately into the pool of available capital.
“That way, they get their money upfront, and the associate — the new partner — now has skin in the game,” he said. “For the most part, what I see in medium-size and local or regional firms and smaller firms is that they’re not taken to the bank. They’re given some time span to pay in the capital, sometimes three to five years.”
For that reason, it’s less common for associates who make partner at these smaller firms to finance their capital contribution through a bank loan.
It’s also a bit more difficult for bankers to predict the new partner’s financial future at the firm in order to underwrite the loan, said Melaine Levy, vice president and senior relationship banker in M&T Bank’s business and professional banking group.
“The ability to see a broader level of pay scale from the other partners does help us with the larger law firms in being able to see what’s typical,” Levy said. “In terms of specialty, what type of law firm it is can help us determine where this partner is probably going to wind up in five years or 10 years. From a statistical point of view, it gives us the ability to see where the potential is.”
A new partner’s income will also change once he or she begins taking a draw, or a portion of the firm’s profits, instead of making a standard biweekly salary. Partner draws might occur monthly or even less frequently, which impacts the attorney’s personal cash flow — particularly if the firm’s caseload is heavily based on contingent fees.
“Litigation firms, they’re almost another separate kind of animal,” Setia said. “They’re kind of a feast or famine business, especially if they’re basically doing a bunch of contingency basis cases, where if they pan out, the firm can have great years. They tend to be a little more financially conservative, because their business can vary so much.”
Final considerations
Dealing with the change in cash flow can be made easier with a few precautions, Setia said.
“One thing I almost always recommend is to have an emergency fund you’ve built up, or have a bank do an unsecured line of credit for you,” he said.
Setia said he also often advises clients to talk with an accountant, because a partner’s tax obligations are very different from an associate’s.
“You don’t have that paycheck; you have that draw at the end of the month. You’re no longer getting a W-2 [tax form], you’ll get a K-1,” Manekin said. “You have to pay quarterly estimates and self-employment tax.”
Aside from personal finances, new partners should have a solid grasp of the firm’s financial footing, including its structure, its debts and how many partners have recently retired or plan to retire soon, experts said.
“We’ve had several cases of firms that have dissolved, and when firms dissolve and they’re not able to repay the capital, you still have an obligation for that capital to the bank, so that’s something you want to be careful with,” Setia said.
And because some partners don’t plan to spend their career at one firm, it’s important to realize they likely won’t receive their full capital contribution back in one lump sum when they leave, which can be a problem if the attorney is looking to make a lateral move and needs to buy into another firm.
“Most of them try to break it out over two or three years,” Setia said. “If you have a firm where a large number of partners start departing, that can create a cash crunch for the firm.”
