How do law firms distribute profits?

Jan 12, 2023

Written By Claudia Chan

A profit is an amount of money earned by a business when its total revenue exceeds its total expenses. At the end of the day, law firms are businesses, thus, knowing how law firms distribute profit is one way to improve commercial awareness. This article will first define the metrics used to determine profitability, then explain how profits are distributed in law firms.

Key terms

Revenue per lawyer: this is the gross revenue divided by the number of lawyers or staff.

Total profit: the financial gain of a company. This is calculated by taking the law firm’s revenue minus their expenses.

Profit margin: this is a measure of a business’ profitability expressed as a percentage. It is calculated by dividing the company’s net sales or revenue from the company’s net income.

Profits per equity partner (abbreviated as ‘PEP’, ‘PPP’ or ‘PPE’): this is the overall profits divided by the number of equity partner

How are profits distributed?

1. Increased compensation

Generally, hard work and good performance is both recognised and rewarded by law firms through increased compensation, or ‘bonus’ to employees. These bonuses can be awarded to both entry-level associates to senior-level partners. Bonuses are complementary to their existing base pay, or salary.

The purpose of bonuses are twofold. They can be used to incentivise and entice students and practicing lawyers to apply to their firm, but they can also be given to current employers to reward performance and encourage employee retention.

2. Increased partner profits

Law firms also distribute profits to their partners. These are typically paid out to partners on a quarterly basis. They are based on estimates for future firm profits, and thus are subject to market fluctuations.

For example, in 2020, at the beginning of the COVID-19 destruction, several firms considered a reduction or delay to the distribution of profits.

Yet by 2021, law firm profits generally soared due to the increased M&A deals. According to the Law Society Law Management Section’s annual Financial Benchmarking survey, the median net profit per equity partner increased by 39%, from £146,417 in 2020 to £203,199.

3.Growing the law firm

When profits are not going to associates or partners in the form of bonuses, they are often used to reinvest in the firm to promote growth. Profits may be used to promote three main aspects.

First, they can be invested in current employees. Profits can be used to improve current facilities to improve the overall law firm environment. For example, law firms can improve diversity and inclusion within the firm by working with diversity and inclusion groups and educating the firm on recognising discrimination.

Secondly, firms can invest in future employees by improving their graduate recruitment team and marketing team. More funds can be allocated to improve employer branding and articulate the firm’s vision. Being able to provide better resources to market the firm and their opportunities are likely to attract the best graduates.

Thirdly, profits may be used to invest in legal technology. Technology is developing at a breakneck pace and disrupting industries around the world. In order to avoid being a relic of the past, law firms are increasingly investing in legal technology to support their firm. These include: smart contracts, e-discovery and legal research platforms.

These investments in the firm have the ability to improve morale, improve retention and maintain skin in the game in the hyper-competitive world of law.

Law Firm Structure