What is the profit-sharing ratio of a partnership firm?

Jan 04, 2023

Written By Annabel Gooden

The profit-sharing ratio, i.e. the way profit is divided up between equity partners, varies from firm to firm. Some systems prioritise the longest-serving partners. Others give preference to the individuals generating the most revenue:

How do law firms operate commercially?

Law firms operate by charging fees to their clients. Those fees are calculated at different rates, with the most senior lawyers charging the highest. Lawyers are required to record chargeable hours so that client fees can be accurately calculated. Many law firms set target hours for fee-earners to meet and therefore ensure profitability.

Fee earners are essentially all the people in a law firm who charge for their time in this way. This includes paralegals, trainees, solicitors and partners but not support staff. All fee earners receive fixed salaries apart from equity partners. A firm may have salaried partners who would also fit into this category. These salaries are, along with other business costs, included in the law firm’s overheads.

Once overheads are deducted from revenue, profits are divided among equity partners. These are the most senior lawyers whose earnings are calculated as a share of profits rather than being given as a fixed salary.

When a lawyer becomes an equity partner, they invest in the firm in return for a share of the profit, therefore also becoming shareholders. The division of profit is often quoted as PEP, or profit per equity partner.

How are profits shared?

There are a range of different profit-sharing models: The first model is the most common and is known as lockstep. It is the traditional profit-sharing model for partnership law firms. The system is often carried through to associates whose salaries rise year-on-year at the same rate as their peers.

Two solicitors who both joined their firm seven years ago know that they will both be paid the same salary, and that this will be higher than a solicitor with less time under their belt. It is designed to create fairness and transparency.

The second model, more often seen at US firms, is merit-based. Perhaps alarmingly, it is often called the ‘eat what you kill’ model. It tries to ensure fairness in another way. The partners who make the most money for the firm receive the largest pay packets. However this can be controversial as it is seen to breed competitiveness and harm a firm’s culture.

Many law firms with a lockstep model are increasingly adding merit-based elements, though more often than not these remain linked to firmwide rather than individual performance. For example, Weil, Gotshal & Manges awarded bonuses of 6% to all NQs in 2021. Similar Covid bonuses were given out by many other firms, including Shoosmiths, whose NQs received a bonus of 7.7%.

In fact, bonuses are commonplace in private practice. According to a report by the Law Society, 49% of solicitors received a bonus in 2018, ranging on average between £5,000 and £10,275. Amounts tend to be higher at US firms.

How much money do law firms make?

The Law Society, who surveys firms of varying sizes across the UK, reported that the average equity partner took home £130,000 in 2018. The figure increases when you look at the largest City firms. The law tends to be a resilient sector in economic downturns.

Many law firms did well during the Covid-19 pandemic. In 2021, Simmons & Simmons reported a profit increase of 35%, reaching £171 million. As a result, profit per equity partner came close to £1 million. At Allen & Overy, partner profits approached double that figure. Smaller firms report more modest but still sizable profits.

How do law firms distribute revenue to non-profit sharing lawyers?

Typically, partners at firms with the highest revenues will make the most money. However, higher revenue does not always correspond to higher profit for partners.

Firms have faced recent pressures such as requests for salary increases for more junior staff as well as investments in technology.

The more revenue that is spent on these kinds of costs, the smaller the pot of profit that gets distributed to partners. While many would argue that increasing the pay of junior lawyers is a fair re-distribution of revenue, it can occassionally prompt partner complaints. Certainly, at some firms, profit per equity partner has slowed as a result.

Challenges to the traditional partnership model

While the legal sector is a long way from a revolution in terms of profit distribution, there have been some interesting developments by more enterprising law firms.

A small number of firms have listed on the stock market. While Mishcon de Reya reportedly spent £12 million before deciding against their IPO, other firms such as Gateley and DWF have had more success. Interestingly, Gately has also brought in an employee share ownership scheme, allowing all staff to buy into the business.

Inspired by the so-called John Lewis approach, liberalising share ownership is touted as a way of incentivising employees. This may encourage higher retention rates among junior lawyers and encourage them to develop business acumen earlier on in their careers. Time will tell whether this represents a more widespread challenge to traditional partnership models.

Law Firm Structure