One Tiny Number Shows Why More Firms Want Nonequity Partners

Welcome back to the Big Law Business column. I’m Roy Strom, and today we look at how a dwindling pyramid may explain why some firms are looking to add nonequity partners. Sign up to receive this column in your Inbox on Thursday mornings.

Law firms are often described as pyramids.

The base is made up of associates. Every firm is a little different in the middle, but all are designed for money to flow to a relatively small group of equity partners at the very top.

Some prestigious New York firms are starting to have pyramid envy. That’s because of a simple truth: Wider pyramids generally are more profitable.

The big news this week was Cravath, Swaine & Moore’s 2021 decision to add a tier of nonequity partners for this first time in the firm’s 200-year history. Another prestigious firm, Paul Weiss, reportedly has been considering doing the same.

Partners in the new category won’t get a share of their firms’ profits. They will get a fancy title that lets the firms bill clients at a higher rate for the lawyers’ work.

The changes are meant to send more revenue to the top of the pyramids. That will let the firms pay more money to their most important equity partners, presumably keeping them happy and making them less likely to leave.

This is the mechanism firms are describing when they simply say they want to “retain” talented lawyers.

Simpson Thacher and Willkie Farr added their first non-equity partners in the last three or four years. Others, like Cleary Gottlieb and Davis Polk, have opted to stick to a single tier of equity partners.

Law firm financial stories are usually focused on figures in the millions and billions range, but one tiny number goes a long way to contextualize the individual decisions made by the six aforementioned firms.

The number is called “leverage,” and it is usually somewhere between three and six. It’s calculated by dividing a firm’s lawyer headcount by its equity partner total. The larger the number, the wider the pyramid.

“Leverage is a very important driver in the rapidly growing profitability of many rising competitors,” said Kent Zimmermann, a partner at law firm consultancy Zeughauser Group.

The above chart looks complicated. But if you pick a law firm from the top and follow its dot down the years, you can get a sense of how certain pyramids have shifted over time.

Start with Paul Weiss and Cravath, the firms tinkering with partner tiers to broaden their pyramids.

Paul Weiss had long been a champion of leverage.

The firm’s wide pyramid has made it one of the wealthiest partnerships in the country. Peak width for Paul Weiss came in 2018, when more than six lawyers toiled for every single equity partner.

The firm has since seen its leverage thinned. That’s largely because Paul Weiss has been willing to grow its equity partner ranks, even as its overall headcount stayed mostly flat.

The firm was 25% skinnier, on a leverage basis, in 2022 than it was four years earlier. It had about 1.5 fewer lawyers working under each equity partner, on average.

(I’ve said before that a firm’s willingness to make equity partners should be seen as an important indicator of overall health.)

The story is similar at Cravath, where the firm’s leverage topped out in 2018 with 5.25 lawyers working under each equity partner. The number fell below 4.0 by the end of last year.

Like Paul Weiss, Cravath’s pyramid has become about 25% skinnier over that stretch.

So, what’s likely to happen at these two firms after adding a tier of nonequity partners?

Simpson Thacher and Willkie offer some clues.

Simpson Thacher had managed a pretty stable pyramid coming out of the Great Recession, before going the nonequity route. Its leverage number reached 4.27 lawyers per equity partner in 2018.

That figure has only grown since the firm introduced a nonequity tier. By the end of last year, 5.44 lawyers worked under every equity partner. It had become one-third wider over the course of four years.

The firm ramped up its leverage by limiting equity partner growth to 6% over roughly the same time frame, sending 54 lawyers into the new nonequity category. Simpson Thacher’s overall headcount jumped by 30% during that time.

Its profits per equity partner were up by 44%.

Willkie is a similar story with a twist.

The firm’s pyramid grew about 20% wider by 2022, compared to the year before it introduced a nonequity partner tier. Willkie’s profits per equity partner went up 24% from 2017 to 2022.

Unlike Simpson Thacher, Willkie accomplished this while also being relatively generous with its equity partnership. That group expanded by more than 35% during the same time.

Why did Davis Polk and Cleary opt against adding nonequity partners?

The simple answer may be that they haven’t seen their pyramids shrink, so far. Both firms have had more than five lawyers working under every equity partner from 2017 through last year.

As with most discussions about law firm competition today, Kirkland & Ellis is the elephant in the room.

The world’s highest-grossing law firm has rocketed to the top of the profits per equity partner rankings, even overtaking Wachtell last year.

(For what it’s worth, Wachtell’s profitability is truly an outlier. Despite one of the skinniest pyramids, about 2 lawyers per equity partner, it was long the most profitable firm.)

Kirkland has accomplished this by creating a much wider pyramid, thanks to a huge cohort of nonequity partners.

Last year, there were 5.76 lawyers working under every equity partner at Kirkland. That’s up nearly 40% compared to 2017. Kirkland has not been stingy with its equity partnership, either. It has added 117 equity partners since 2017—growing its top tier by 30%.

That’s more than the 97 total equity partners at Cravath.

Managing a law firm’s talent stack is a tricky business. Adding nonequity partners is not a panacea. The position can be seen as a roadblock to equity for ambitious, talented lawyers. And it can become a costly waystation for underperforming attorneys eventually on their way out the door.

Those appear to be risks more law firms are willing to take.

All in the name of building a wider pyramid.

Worth Your Time

On Wachtell: The longtime leader in partner profits has two new co-chairs, Andrew Nussbaum and William Savitt.

On Big Law Salaries: Milbank LLP may have kicked off a new Big Law salary war, raising associate pay by $10,000 and announcing annual bonuses in-line with those from last year, Meghan Tribe reports.

On Kirkland: Kirkland is representing WeWork Inc. in its Chapter 11 filing in New Jersey that’s already drawn in firms including Davis Polk, Weil Gotshal & Manges, Greenberg Traurig, Cole Schotz and Toronto-based Goodmans, Brian Baxter reports.

Thanks for reading and please send me your thoughts, critiques, and tips.