Asked and Answered

By John W. Olmstead, MBA, Ph.D, CMC

Q. I am an attorney in New Orleans who has been in practice for ten years. I practiced with a small firm for eight years as an associate and then opened my own firm two years ago. I primarily work from home supplemented with a virtual pay-as-you-go office. I do not have any staff employees. I have been approached by a 14-attorney firm that would like me to join their firm as a partner. Their offer includes a salary that I feel is low and a bonus based upon a percentage after covering my salary, other direct costs, and indirect firm overhead. The overhead allocations seem extremely high to me. In my practice, I am bringing in around $100,000 in gross fees and my overhead averages $10,000-$15,000 per year. My profit margin is around 90 percent. I feel like I am better off building up my practice rather than accepting their offer. What are typical overhead and profit margins for law firms?

A. We must be careful how we define overhead. Overhead is generally to be considered all law firm expenses less attorney salaries and sometimes less paralegal salaries. The overhead ratio would then be the overhead divided by firm revenues. Profit margin is expressed in terms of owner (partner, shareholder, etc.) earnings. In other words what is going into the owner’s pockets in terms of salary, share of profit, etc. Owner earnings is firm revenue less all firm expenses including associate and paralegal salaries but not including owner salary or compensation. The profit margin is total expenses (excluding owner compensation) divided by firm revenues.

A desirable profit margin range for law firms is thirty-five to forty-five percent.  Some firms can attain fifty percent. Profit margins depend upon the type of law practice, leverage ratios (associates to partners), how well the firm is managed, etc. I have some very successful firms with profit margins as low as twenty percent but the partner earnings are very high.

Your current overhead and profit margin is not sustainable in the long-term. While you have low overhead and a high profit margin you also have low earnings. You are only earning $85,000. You will soon reach a point where in order to increase your revenues you will have to hire people, acquire office space, and buy phone systems and other equipment. When this occurs, you will be in a similar situation as to the law firm you are talking with.

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John W. Olmstead, MBA, Ph.D, CMC, (www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics and author of The Lawyers Guide to Succession Planning published by the ABA. For more information on law office management please direct questions to the ISBA listserver, which John and other committee members review, or view archived copies of The Bottom Line Newsletters. Contact John at jolmstead@olmsteadassoc.com.