Is It Better to Be an Equity Partner or Non-Equity Partner?

All things considered, an equity partnership is still likely to be more lucrative in most cases. But for lawyers in certain circumstances, non-equity arrangements can have a strong appeal. As such, we’re going to delve into those implications and challenges the traditional assumption that an equity partnership is necessarily more attractive than a non-equity partnership.

Benefits of Equity

Lawyer

Many lawyers still aspire to become equity partners and for good reason. Equity partnership spots are becoming increasingly scarce, and in a profession where status and prestige are paramount, earning partnership shares is seen as the pinnacle. Equity partners in a profitable and growing company can take home an outsized share of the financial rewards. Ownership of equity shares also gives a partner a greater say in the firm’s management in the form of voting rights.
Partner compensation and voting rights are often closely linked. For instance, the origination credit contributes to the equity partnership receiving a higher-than-average share of compensation. It is common for law firms to design origination credit formulas to reward equity partners more than their non-equity counterparts. Older attorneys often seek the opportunity to become equity partners to receive more origination credit than their non-equity counterparts. One example of the potential value of voting rights is the ability to have a say in how the formulas for awarding origination credits are designed.

Downsides of Equity

It is easy to focus on the considerable benefits associated with becoming an equity partner but some genuine disadvantages should not be overlooked. First and foremost, the status gain that comes with being named an equity partner comes with a significant financial burden in the form of a required capital contribution. This contribution is generally between 25 and 35 percent of annual compensation, but it can be 50 percent or more in some companies. Regardless, it’s a lot of money to give over to the firm, especially for attorneys who are relatively early in employment. And getting the money invested back may not be so easy. Under the terms of many partnership agreements, the firm is not obligated to repay the money until years after an equity partner leaves. Less important but still worth noting, equity partners must foot the bill for their own benefits.
Another point to consider is that equity partners’ voting rights are diminishing in many companies. In the past, a vote of the entire equity partnership was required for a wide range of decisions, from hiring laterals into the partnership to renewing office leases. As partnerships have grown geographically and in size, many firms have found that it is more practical to delegate most decisions to a small committee or even to the sole discretion of the firm’s chair. From an efficiency standpoint, this is largely a positive development but a side effect is the reduced influence of equity partners who do not hold leadership positions. With respect to an increasingly broad range of issues, these partners are treated more like employees than owners.

When Is Non-Equity Best?

A partnership with no equity investment appears relatively attractive in some scenarios when weighing the pros and cons. The ability to avoid a significant capital contribution may be a selling point for both the youngest and oldest partners. At the younger end of the spectrum, partners may not yet have built up enough capital to feel comfortable committing such a large sum to an illiquid investment in the business.
At the older end of the spectrum, a retiring equity partner who wants to spend a short time at another firm before retirement may appeal to a non-equity arrangement’s simplicity. Partners in this position have nothing to prove when they become equity partners again. Instead, they may place more value on the flexibility to invest the capital contribution they receive back from their former firm elsewhere. Another benefit is the ability not to be liable for the new firm’s debt.
A partnership without equity investment may make more sense for partners in specific niche practices that do not have an extensive standalone business. Practices such as Tax and Trust & Estate often act as service providers to other practices in the firm, so the firm’s origination credit formulas may not particularly reward partners who specialize in these niche areas. A non-equity partnership agreement that properly recognizes the contributions of these partners may be the right solution.

A Compromise Approach: From Non-Equity to Equity

For many partners, it may be best to split the difference by pursuing opportunities for a non-equity partnership that will likely lead to an equity partnership later. In this way, the partner can delay the capital contribution while retaining the ability to fully leverage customer relationships as the partner’s business grows. A partner who wants to go this route must first consider whether the business offers a genuine and viable track from non-equity to equity. Where this pathway does exist, it can offer the best of both worlds.

In the comment section below, let us know if you prefer equity or non-equity partnership.