“I recently met with the managing partner of a mid-tier legal firm to discuss the struggles he was facing in trying to build a successful partnership, including attracting and retaining great people, optimising working capital, maximising tax efficiencies, retiring debt and funding investment. What quickly became evident was that he was focussing on smaller, tactical changes within the partnership framework to encourage growth but hadn’t focussed on the structure itself,” Mr Matthews said.

“At the end of the conversation I proposed that the partnership model might not be the best option for his business.

“This might come as quite a surprise but firms that have traditionally been built upon a partnership model can be just as successful, if not more so, once the shackles of a partnership model are loosened.”

Mr Matthews noted that inherent nature of a partnership is that partners pay tax on all profits, whether they are paid out or not. As such, he noted, there is a reluctance to leave funds in the partnership on which tax has been paid, and therefore practices are funded by either debt or partner capital.

“Considering excessive levels of partner capital can be an impediment to attracting partners, debt is usually the most common funding option,” he said.

“Ramping up debt levels is not a permanent solution, although it can be masked in a growing and seemingly thriving practice. However, when there are changes in business cycles, profitability levels are impacted and cracks can emerge. Banks may want the debt amortised or partners could exit the business – removing their capital and leaving less partners to manage a greater debt.”

In addition, Mr Matthews noted a partnership structure poses a challenge in terms of workplace flexibility.

VIEW ALL

“Yes, there are service trust arrangements but there are also real challenges in optimising the tax efficiencies in accordance with ATO guidelines,” he said.

“Consider that in a partnership model partners pay tax at 47 per cent on profits that are required to be reinvested or used to retire external debt. This kind of inefficient tax outcome for partners can make it more difficult to attract and retain talent at this senior level.”

For those who want to move away from the traditional partnership structure, Mr Matthews recommended to look to models “such as incorporation, a partnership of trusts or an Everett assignment”.

“We are certainly seeing more mid-tier firms incorporating and I know the managing partner I spoke to recently is looking to pursue such a strategy following our discussion,” he noted.

“If you are setting up a legal firm from scratch, then you would almost certainly do so within an incorporated model. If the firm is currently operating as a partnership with a view to considering incorporation there are some threshold issues that would need to be considered first, including tax issues, stamp duty issues and safe harbour provisions.”

In conclusion, Mr Matthews acknowledged that while there are many larger firms, both in accounting and in the law, who benefit from operating under a partnership structure, the model may be more difficult to build success from if it’s a mid-tier or smaller practice.

“Most mid-sized firms work on a different foundation. Partners tend to look to both income and capital value in evaluating the return for risk and effort and expectations arise accordingly,” Mr Matthews explained.

“Trying to emulate the structure of larger firms – no matter how good your partners and your services are – can stop your firm in its tracks.

“However, finding the appropriate structure for your firm can support consistent and sustainable growth, provide security and protection for partners, and attract the right talent to help your firm flourish.”

A new report by Peerpoint, released earlier this month, highlighted that more are moving away from the traditional path to partnership and are opting for other positions within the law, such as consulting gigs.

“The most important measure of success for a lawyer is now having achieved a good work/life balance and having the ability to choose what type of work they want to do,” Peerpoint Asia-Pacific managing director Carolyn Aldous said.

“The conventional partnership model doesn’t necessarily meet the needs of the modern Australian lawyer, who is seeking to build a career in law on their own terms, so we’re anticipating a rise in alternative legal service models such as consulting.”

This very idea was forecast in 2016, with a case made for firms to move away from, at least, the equity partnership model altogether.

Commenting as part of a special Lawyers Weekly feature,Taylor Root partner Tim Fogarty said graduates and junior lawyers who are looking for work are no longer thinking about partnership possibilities.

“Partnership is very much a distant light on the horizon for lots of junior lawyers. And I think many would be happy not to ever get there,” he told Lawyers Weekly at the time.

“It’s surprising the number of lawyers who speak to us about their careers and often partnership is not actually the end game for them, which is quite a change in the mindset of lawyers.”

Mr Fogarty also noted those of the younger generation are thinking more mid-term as opposed to long-term and are keeping their options open.

They are considering in-house roles, government roles, going to the bar, working overseas, and NewLaw-type structures. Many are also turned off by the demands and lifestyle of pursuing partnership.

“Long-term private practice is a very demanding environment because clients expect certain levels of service and some people want to have families or have reduced hours,” Mr Fogarty said.

“Some people want to work part-time, people might have other interests but want to maintain an element of a professional legal career.”

Former CEO of intellectual property firm Wrays, Frank Hurley (now chairman at XTD Limited), first raised alarm bells over the traditional partnership model three years ago.

During his tenure, Mr Hurley decided to adopt a company-like structure to Wrays, dropping partners for executive positions and a board of directors.

“We saw the partnership model as part of the old world,” he said speaking to Lawyers Weekly at the time. “We're now very corporate.”

In what has become a reality in some firms today, Mr Hurley predicted that those who don’t adapt to a new way of doing things may see their profits begin to dwindle.