Profit per Equity Partner (PEP)

1 Sep 2014

The PEP debate has re-emerged as a consequence of Dentons decision not to publish their PEP figures and their reaction to a critical article in The American Lawyer’s. Dentons described PEP as a ‘meaningless’ figure but how useful is it in measuring the profitability and success of a law firm?

Is PEP a good representation of equity partners?

PEP, is one method of indicating a firms profitability, as PEP records the average profit per equity partner. 

It must be emphasised that this figure is an average and not a range of partner pay and can be manipulated to an extent, depending on who a firm classes as an equity partner. Firms can also increase apparent profit by reducing the number of equity partners. The American Lawyer reported that they are aware of the stigma attached to using PEP as a tool to assess the health of a law firm. For instance, that PEP as a measure has caused lawyers to become money-obsessed, increased competitiveness amongst colleagues and revealed too much to law firm clients about the magnitude of their lawyers’ pay cheques 2.

Dentons described PEP as a ‘meaningless’ figure, but sceptics may think that Dentons are actually embarrassed, if they are under-performing in comparison to their competitors. On the other side of the coin, people could also assume that they are worried that their clients may perceive them as overpaid considering the service they offer. Yet, according to The Lawyer, very few clients concern themselves with the wages of their lawyers, what they are concerned with however is the price that their services cost 4.

The Lawyer highlights that Dentons’ decision is perhaps skewed by it’s position in the American legal market, where PEP has become a sign of enterprise and power. Because American firms don’t lawfully have to report their PEP figures, the firms that do are more likely to manipulate their values to maintain a high PEP and so portray the impression that their firm is more profitable than it truthfully is 4.

Is the trend of PEP important?

The Lawyer recognises that PEP becomes much more of an accurate representation when put in the context of several years, rather than just one year, as any successful law firm can still have “a bad year.” The media can also manipulate the PEP data by evaluating singular PEP values out of the context of several years worth of PEP figures. One value cannot show whether a firm is reporting honestly and is successfully fulfilling a coherent strategy 4.

The Lawyer reported that “according to [Dentons] UK LLP accounts, their PEP was £175,000 in 2010/11, £262,000 in 2011/12 and £241,000 in 2012/13. The most recent figure would have placed them 84th in The Lawyer UK200 PEP table between Freeth Cartwright and Ashfords” 4.

How does it relate to overall profit?

The American Lawyer states that publishing annual PEP results is essential in their commitment to the transparency of law firms. Their methodology of measuring earnings per-partner or per-lawyer as a standard unit, allows a direct comparison of firms regardless of size 2.

Dentons retorted by saying that, “measuring law firms by their profit per equity partner is at best misleading and at worst detrimental to the profession.”3.

Of course, PEP values the majority of the time are not a direct reflection of a firms revenue. The Lawyer’s UK top 100 according to PEP demonstrates numerous examples where this is true. For instance within 2012/13: Dickson Minto was ranked 4th in terms of PEP (£1.3m) and 73rd in terms of revenue (£35.3m); Gordons was ranked 9th in terms of PEP (£967k) and 93rd in terms of revenue (£25.82m); and Sackers was ranked 14th in terms of PEP (£765k) and 96th in terms of revenue (£24.3m) 6. Despite their revenue rankings, these firms must have large profit margins in order to accommodate large PEP values.

An article written by The Lawyer published in July, also presents evidence for PEP outgrowing revenue. For instance, so far this year [2014] Nabarro’s revenue has remained relatively flat (up by 0.3%), yet it’s PEP has increased by 10.5%. In fact, the PEP growth exceeds the revenue growth of 12 out of the 13 firms who have already published their data 1.

On the other hand, firms such as Clyde & Co and Allen & Overy seem to believe in conservative PEP growth. For example, despite Allen & Overy’s 24% increase in net profit since 2010, PEP has for the most part remained flat since 2010 1. In fact, within 2012/13 Allen & Overy’s PEP was an exact reflection of it’s revenue achieving rank 5 in both the UK Top 100 – PEP and the UK 200 – turnover 6.

At the other end of the scale some firms are increasing their PEP to match their high revenues. Within the year 2012/13, Osborne Clark was ranked 53rd in The Lawyers UK Top 100 – PEP (£350k) but 30th in the UK 200 – turnover (£112.8m) 6. This year, Osborne Clarke has mirrored it’s massive 25.9% growth in turnover by rocketing it’s PEP figure by 46.6% from £350,000 to £513,000. Similarly, Berwin Leighton Paisner grew it’s PEP by 35.2% (from a UK 100 – PEP rank 47 with a PEP of £401k) as it’s revenue increased by 5.6% (from a UK 200 – turnover rank 17 with a turnover of £233m) 1.

Viv Williams of the 360 legal group attributes the strong increase in PEP this year to firms making a concerted effort to become more efficient, whilst Alasdair Douglas of the city of London Law Society agrees and adds that firms are also trying to take advantage of the positive turn in the UK and international economy as revenues increase 7.

Overall, it cannot be said that PEP is a direct reflection of a firms profitability, but it can be one of the key components in assessing a firms profitability as one assumes, the larger the PEP value the larger the profit margin that can be distributed amongst the equity partners. It also acts as a window into how much profit key individuals earn within a firm, assuming the value as an average has not been manipulated.

Is it an outcome and not an objective?

Charlie Geffen (partner at Ashurst) warns of PEP becoming an objective rather than an outcome of successful practice. In theory, PEP should enhance a transparent and positive business culture, however law firms can become fixated on the value and manipulate it to their advantage 5.

As legitimate businesses, law firms should define clear objectives. They need to establish their identity within the market and structure their goals according to the services, sectors and clients they want to provide for, creating a united vision amongst their partners for them to strive for 5.

However Charlie Geffen is concerned with the distractions that can obstruct such a positive culture. A major one being the compensation system that a firm employs. This often concerns the range between top and bottom of the equity and the criteria a partner is expected to meet in appraisals in order to be classified as a partner who is performing to the standard of that law firm. Ultimately, it is not personal chemistry but factors such as these which affect the culture of a law firm the most 5.

As soon as increasing the PEP value becomes the primary objective of a firm, their strategy becomes very short-term and the decisions they make deter from any long-term strategy they have in place. Additionally, more of a certain type of partner is attracted to the firm, partners who will use the increased inter-office competition as an excuse to throw professionalism aside and cause other partners to feel insecure. This will affect the firms performance, the relationship they have with their clients, and the atmosphere at the firm as a whole 5.

The American Lawyer acknowledged that it’s PEP survey may encourage such behaviour, however the founder states that the few who do act in that manner clearly don’t understand that professionalism and good business must be synonymous in order to satisfy today’s sophisticated client base 2.

Charlie Geffen believes that ultimately, it is the firms who have positive cultures, an ethical partnership, the ones who don’t objectify PEP, but who do have a clear long term strategy that will be the true winners, achieving higher profits as an outcome 5.

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References

1. Katy Dowell. 07/07/2014. All rise, as PEP growth outstrips revenue. The Lawyer. http://ow.ly/AjY6e

2. Kim Kleman. 11/06/2014. In Defence of PPP. The American Lawyer. http://ow.ly/AjXXZ

3. Kate Beioley. 12/06/2014. Dentons escalates PEP row: ‘no two firms are the same, so cannot be compared.’ The Lawyer. http://ow.ly/AjYnd

4. Catrin Griffiths. 13/06/2014. Dentons, The American Lawyer row, and why PEP is not “meaningless.” The Lawyer. http://ow.ly/AjYDw

5. Charlie Geffen. 21/07/2014. Charlie Geffen: PEP should be an outcome not an objective. The Lawyer http://ow.ly/AjYNX

6. The Lawyer UK 200 Annual Report 2013, in association with KPMG. 21/10/2013. UK Top 100 – PEP. Page 56. The Lawyer.

7. Kathleen Hall. 14/07/2014. Top-40 PEP growth into double figures. Page 4. The Law Society Gazette.