New Firm Partners: Voting and Buy-In Requirements
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In Central Europe, I have witnessed a strong trend of newly established law firms possessing high-growth potential due to the exceptional track record of their founding partners. As these firms strive to maintain their rapid upwards trajectory, many of them look towards recruiting to their firms additional partners with impressive books of business.
Based on our fortune in consulting on a few of these partnership additions, I have identified two issues that such firms should consider before they decide to start into discussions with partner candidates. In particular, they should address the following:
What should be the voting requirement?
How to address the buy-in requirement?
I. What should be the voting requirement?
When you admit new partners to your firm, you are making probably one of the greatest (and potentially riskiest) decisions in your partnership’s life. For this reason, most firms believe that new partners should not be added on a simple majority vote. Most of the time, and especially in small and mid-market law firms, such a decision requires a unanimous vote or at least a three-quarters vote.
If your firm utilizes a management committee, you will also want to consider its voting role in the recruitment process. For example, the following language might prove useful for addressing two-tiered voting:
“An affirmative vote of a (…) majority of the members of the Management Committee and of at least (…) of the Partners (voting in number and not by points) is required to admit a new Partner, upon such terms as shall be established by the Management Committee.”
II. How to address the buy-in requirement for new partners?
If your firm is utilizing a simple one-tier partnership, you should be establishing a buy-in requirement for new partners. This buy-in is necessary to compensate the existing partners for their previous and current contributions to the partnership, including:
Their initial investment
Their “sweat equity” (i.e. their time working for the firm)
The growth of the firm from the time that they joined the partnership
Besides setting the amount of the buy-in, firms also should take into consideration the time period for the buy-in as well as the compensation formula for departing partners. In most cases, new partners aren’t able to pay for a buy-in immediately, but rather they are permitted to perform their buy-in in installments over a period of time (e.g. 3-5 years). Regarding departing partners, the firm typically will set up a payment formula for compensating the partners for their previous investments in the firm.
There is one exception to the above buy-in expectation for one-tier law firms. Some firms have been following a trend in the legal industry called the “free in, free out” partnership system. Under this regime, you don’t require a buy-in from new partners. At the same time, when you leave or retire from the firm, you don’t receive a payment either.
Although we see most new firms adopting a one-tier approach, there are also law firms with a two-tier partnership. In this system, the partnership agreement differentiates between partners on many levels including:
Ownership interest in the firm
Voting rights
Compensation methodology
For two-tier firms, new partners are not required to make a buy-in unless they are accepted to the first tier (and this almost never happens). When new partners are admitted into the second tier, they are typically saved from the requirement to make a buy-in, but at the same time, they receive relatively weak partnership rights.
Summary
Although law firms can utilize the addition of new partners as a valuable growth strategy, they need to be careful to ensure that they don’t unintentionally sabotage their strategy by stepping on the feet of either their existing partners or their new partner recruit. For this reason, firms should remember to think carefully about (i) how to set a fair voting requirement for their partners as well as (ii) if applicable, the best approach for setting and communicating the buy-in requirement for new partners.