Kerma Partners Quarterly 2007, Issue 2

GOVERNANCE in the Growing Partnership

NO GOVERNANCE STRUCTURE CAN ENTIRELY PREVENT PROBLEMS CAUSED BY WEAK AND INEFFECTUAL MANAGEMENT, OR THE GENERAL MUDDLE WHICH ACCOMPANIES MANAGEMENT VACUUMS, OR LONG TERM DISASTERS CAUSED BY PETTY TYRANTS.

However, a coherent and suit their particular balanced management structure circumstances. This article clearly helps. This is provides a framework for firms particularly true of a to consider when thinking governance structure which is about their governance. It aligned to the strategic and explains the transition points at business needs of the firm and or around which firms may by Nick Jarrett-Kerr which contains the appropriate need to consider changing their provisions for mature and structural model, and looks at UNDERSTANDING sensible accountability. There is some of the typical problem STRUCTURAL FAULT LINES of course no shrink-wrapped areas encountered as firms The problem is typically governance solution which will grow. The article also outlines a historical. In many cases the suit every firm at every stage in typical structure for management arrangements its development. It is, however, professional partnerships with which may have suited the important to understand both fifty to seventy five partners or partnership in the past, have the reasons for governance more and in excess of two just ceased to work as the firm difficulties and also the hundred professionals – what has moved on. As firms grow, it principles which can assist firms might be described as medium is no longer practicable to to discover sensible recipes to sized firms. involve every partner in every

7 The problem then is that firms, unless well ARTICLE SUMMARY advised, can often tend to lurch from a previously extreme consensus model of governance to an equally extreme autocratic model, spurred on by ¯ Governance structures in law firms are calls for ‘strong management’. In the extreme often outdated and ill-suited for version of the autocratic model, consultation and further growth. partner involvement disappear out of the window and partners find themselves bullied into meeting ¯ Transition points are critical as performance targets. Consensus freaks get properly constructed governance and replaced by control freaks. management can support the overall objectives of the firm. There is also no greater example of management muddle than the tangle in which many firms find ¯ Good governance structures strike a themselves over management elections. Typical balance with the firm’s strategy; examples of weird election provisions include: corporate models offer some ideas for alternatives to the classic ‘partnership • Partners in a department or practice area systems’. having the entrenched right to vote for their practice area head who then automatically has ¯ While every structural solution is a seat on the management board or executive unique, all partners need to adapt to committee; the new structures and back the required changes. • The partnership as a whole voting for board members who then divide up the jobs of decision. Equally, it becomes difficult for the managing partner and departmental heads managing partner in a fast growing firm to between them; consult with all partners or even connect with • In one firm, it is reported that the managing them in a meaningful way. At the same time, the partner is elected by a board of advisors. The firm has usually not yet developed a sensible board of advisors is appointed by the hierarchy of accountability. Combined with an managing partner; absence of role definition at the level of department or divisional head, this can lead • In another law firm, the partners in each general partners to feel disenfranchised and practice group elect the practice group uninvolved in major decision-making, and – leaders. If a partner is in more than one even worse – to become disengaged from the practice group, they get half a vote for each strategic planning and business direction of the group they are in (a partner in three groups firm. One example is the annual budget. Tablets gets 1 1/2 votes whereas a partner in one of stone delivered from a mountain top do not group gets one vote). The chairman of the seem to work well in partnerships. A budget corporate department is by definition which is prepared and delivered top down to chairman of the firm and the chairman of uninvolved partners does little to engage and the Litigation department is by definition the motivate partners to stretch for an uncomfortable managing partner. If the chairman or target. What then happens usually is that managing partner retires or resigns, an subversion and inertia take over. Partners simply election is called and all practice group ignore the loftily delivered edicts and the firm’s chairs stand for election. financial performance meanders or deteriorates.

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Such bizarre practices may be designed to act as a around the twenty partner point, however, check and balance on management, but tend to informality of management tends to stop working produce governance systems which are inflexible and needs to be replaced with something a bit and slow to change and in which partners gain more formal. Partners usually have a growing election success through politics rather than appreciation that not every decision can made in management competence. The structure should partners’ meetings and become ready to embrace support methods of selection which give the best a structure in which decision-making is filtered chance of appointing the best managers rather and refined provided that they continue to be than those who are most senior, the most popular consulted by someone they know and trust and or the most politically savvy. that consensus is somehow achieved on most decisions. In this phase, a simple management RECOGNISING THE TRANSITION POINTS structure is usually enough. Accordingly, many It is critical to recognise, as early as possible, the firms will simply have a management committee growing need for a change in governance presided over by the managing partner and structure, and to anticipate the transition points reporting to the partnership on a regular basis. at which the previous arrangements for managing The next stage of development is trickier. There and governing the affairs of the firm can become is a governance transition point when the small to ineffective. We have noticed some typical medium size firm becomes too large for transition points in the growth of many management by consensus. Although this point is partnerships. Just as milk can go sour seemingly reached by firms at varying sizes, this transition within minutes, the transition point from point often (but not always) occurs when the firm effectiveness to ineffectiveness can happen within reaches between fifty and seventy five partners and a very short time. more than two hundred professionals. But there One such transition point occurs when a firm are two problems. First, change in size of itself reaches about twenty partners. Until that point a may not always bring about the need for change large measure of informality can be seen in many and is not the only transition trigger. The need partnership arrangements including partnership for revisions to the governance structure can also reward systems. Often, of course, such smaller be brought about by mergers, significant change firms are heavily influenced or led by a strong or in the leadership group, sudden change in idiosyncratic founder – or set of founding profitability, the onset of a crisis of some sort, partners – and can falter quite markedly in the and even an increase in the number of offices or classic founders’ trap if the firm fails to jurisdictions. appreciate the need for change as it develops. At

TYPICAL TRANSITION TRIGGERS

•SIZE •MERGERS •SIGNIFICANT CHANGES IN LEADERSHIP GROUP •SUDDEN CHANGE IN PROFITABILITY •ONSET OF CRISIS •INCREASE IN NUMBER OF OFFICES

9 The second problem is that some firms continue and to be aware of what triggers those transition with their existing management structures long points. The team can then take steps to work out after changes ought to have been made. After all, what governance structure is needed and work on the development of appropriate governance the partnership to educate the partners and begin arrangements (particularly in medium sized to soften them up for the unpleasant reality that professional service firms) tends to lag way the firm needs to make changes which are likely to behind the development of the firm’s strategy and lead to the twin displeasures of decreased growth, and varies somewhat according to how autonomy on the one hand and increased democratic or autocratic the firm has previously accountability on the other. been. Many firms partners, accustomed to consultation and even control in the context of a THE PURPOSE OF GOVERNANCE small firm, are reluctant to cede their authority as Whether you are a partner, a client, a lender (or the firm changes. This means that many firms even an investor), there are certain things which carry on growing far beyond the normal all parties want to see in a vibrant and progressive transition point without any change in structure; professional services firm. They want to see a the growing pains become more acute as they well-coordinated firm rather than just a loose struggle to continue to accommodate extreme group of individuals. Clients in particular want to consensus (or indeed extreme autocracy). see partners working as a team with consistently Accordingly, the trick is for the leadership team applied and agreed methodologies and to look ahead for anticipated transition points approaches. Indeed, how the firm delivers its

THE PURPOSE OF GOVERNANCE — TEN PROPOSITIONS

1. STRATEGY CREATION FOR COMMITTED, COMPETITIVE AND PROFITABLE BUSINESSES 2. ALIGNMENT OF INTERNAL OPERATIONS WITH EXTERNAL SERVICE 3. COHESIVENESS AND COORDINATION 4. PROGRESSIVE AND CONSISTENT WORKING PRACTICES 5. FLEXIBLE AND EFFICIENT DECISION-MAKING 6. ARCHITECTURE OF BUSINESS UNITS 7. FORMULATION OF PLANS FOR BUSINESS UNITS TO MATCH OVERALL FIRM STRATEGY 8. CLARITY OF RULES AND ACCOUNTABILITIES 9. PROVISION OF RESOURCES 10. RISK MANAGEMENT AND SUCCESSION

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IT IS CLEAR THAT GETTING THE STRATEGIC CHOICES CORRECT FOR ANY FIRM IS NOT AN IVORY TOWER EXERCISE DURING WHICH THE MANAGING PARTNER AND A FEW OTHERS CLOSET THEMSELVES IN GREAT SECRECY BEFORE UNVEILING A NEW STRATEGY TO THEIR ADMIRING PARTNERS. RATHER IT IS OFTEN AN EMERGING AND EVOLVING EXERCISE WHICH REQUIRES INPUT AT ALL LEVELS.

services is of as much importance to clients as important issues over time and it is vital that they what the firm delivers. Above all, external parties should be kept as minimal as possible. We have, of all types want to see a ‘one-firm’ approach for example, seen in some partnership accompanied by well designed systems and agreements, provisions that prohibit the spending processes. of more than a fairly small amount of money without the partnership’s approval - and usually The governance structure can assist with all of that outdated financial limit has not changed for these desirable features. The ten propositions many years. At the end of the day, there are only highlight the areas where a properly constructed a few key decisions over which partners as governance and management structure can help shareholders should retain a vote. These are all in support the overall objectives of the firm. One the area of major changes – changes to the firm’s such aim of any governance structure is to achieve constitution or entity status, mergers and alignment with the formulation and acquisitions, major changes in policy or strategic implementation of strategy. This balance between direction and major changes in capital or debt strategy and structure takes two main forms. First, structure. In practice, whilst many partnerships it is critically important to ensure that the way the reserve the right to vote on new partners, the firm operates and managed itself internally admission of new partners can quickly becomes a matches the way the firm operates externally both nominal ratification process. currently and in the future. If the firm’s objectives include growth, for instance, the firm The second balancing act between strategy and needs to be sure that the governance structure will structure concerns the creation of the firm’s be fit for purpose as the firm grows. It is not ongoing strategy. It is clear that getting the always possible to get this adjustment right. The strategic choices correct for any firm is not an point however remains that partners meetings can ivory tower exercise during which the managing fairly quickly become too large for sensible partner and a few others closet themselves in great decision-making, and management committees secrecy before unveiling a new strategy to their can also become too big or too unrepresentative. admiring partners. Rather it is often an emerging The same is true of the issues which are often and evolving exercise which requires input at all described as ‘Reserved Matters’. These comprise levels. Nevertheless, there is a top level need for a areas of decision making which have to be put to selective group of partners to filter ideas, analyse the vote of the general partnership rather than situations and issues, and generally oversee the being delegated to the managing partner or some whole process of strategy formulation. The task board or committee with executive authority. here is to bench test the emerging plan for clarity These Reserved Matters usually shrink to a few

11 and reality and to ensure communication. In the partner was fairly recently described to me as smaller firms, partners can be highly involved in ‘never seen round the offices, managing by dictat this process, but as the firm grows, the business and email’. In another firm, the management needs to find the right formula and structure to committee was made up of the managing partner enable this overseer task to be done effectively. and senior professional managers in charge of the support function – with no representation at Another main aim of any governance structure is practice group level. to ensure overall coordination and firm cohesiveness. The brutal truth is that many firms THE TREND TOWARDS CORPORATE completely fail to achieve any sense of STRUCTURES assimilation. A multitude of firms remain loose In the face of these problems the increasing trend associations of solo practitioners even as they towards a more corporate style of governance grow. Some firms achieve cohesiveness at office seems inevitable. Indeed, the trend will speed up or practice area level but do not transfer that as the markets for professional services continue cohesiveness to the whole firm – and a silo to consolidate. The imperatives for this trend are culture is spawned. Other firms seem to enter a becoming clear. Firms need to drive business phase where the top level management becomes performance and the overriding priorities of the remote and aloof – uninvolved and disconnected management structures of the firm must be from the areas of fee generation. One managing

FIGURE 1

POSSIBLE GOVERNANCE MODEL FOR MEDIUM SIZED FIRMS (ORGANIGRAM)

THE PARTNERS (Owners)

REMUNERATION PARTNERSHIP OR COMPENSATION BOARD COMMITTEE

EXECUTIVE BOARD

DEPARTMENTS AND SENIOR MANAGEMENT PRACTICE AREAS OR LEADERSHIP TEAM

PRACTICE AREA 1 PRACTICE AREA 2 PRACTICE AREA 3 PRACTICE AREA 4

12 Kerma Partners Quarterly 2007, Issue 2 directed towards this imperative as well as strategy implementation. At the same time, the role of RELATED RESOURCES the managing partner or CEO is becoming much more ‘executive’ – with greater authority and less consensus-driven. The authority of the (all available on www.KermaPartners.com) management boards and bodies is also increasing. ¯ THE ROLE OF THE MANAGING The interests of partners as shareholders from the PARTNER; by Nick Jarrett-Kerr management and operational decisions of the organisation are steadily separating. In some ¯ THE BIG PARTNERSHIP TENT; by Ed Wesemann progressive firms, we are seeing the introduction of external non-executive directors at board level, ¯ FACING THE FUTURE; whilst line management is being strengthened by Nick Jarrett-Kerr with beefed up roles – and accountabilities – for ¯ MANAGING THE CONSENSUS-BASED group and divisional heads. LAW FIRM; by Ed Wesemann

ONE POSSIBLE STRUCTURE FOR MEDIUM SIZE FIRMS Clearly, there is no one-size-fits-all governance Compensation or Remuneration Committee, be structure for any firm. However, medium size responsible for partner remuneration and firms (of the sort of scale previously discussed) discipline. The Partnership Board or Council should consider making a clear distinction should also be responsible for the principles between the interests of partners as proprietors behind all the big decisions which are likely to on the one hand and those of the firm as a affect the partners in their capacity of owners. Its business on the other. There are many ways of responsibilities should include recommendations achieving this; one is by changing the structure to to the partners on all reserved matters – matters a three layered model. The three layers in this such as the opening and closing of offices, model would be the Partnership Board (mainly mergers, and partner promotions. One concern oriented towards the partners as owners), the of any partnership is that there should be some Executive Board (mainly oriented towards the checks and balances, hence some of the bizarre firm as a business) and the Divisions, Practice election processes referred to earlier. It would Areas or Groups (mainly oriented towards the therefore be a primary purpose of the Board or delivery of client services). Council to act as the firm’s moderating and monitoring control on the operations of the 1. The Partnership Board or Council Executive Board and the Leadership Team. This elected body would in effect act as the guardian or trustee for the partners. It would 2. The Executive Board consist of the Senior Partner or Chairman, the This Board would typically comprise the Managing Partner or CEO and a number of Managing Partner or CEO, and the senior directly elected members which might include management team (comprising the COO – if representation from fixed share or salaried there is one – and the heads of professional partners. Among its duties would be an overseer functions such as Finance, HR, and Marketing); role for the firm’s over-arching strategy, and in for many medium-sized firms these make up the most cases, strategy formulation would start in leadership team. Additionally, a small selection of this forum. It could, absent a separate partners (who would usually be the group or

13 IN ORDER TO ACHIEVE THE OBJECTIVES OF ANY NEW GOVERNANCE STRUCTURE, PARTNERS NEED TO RECOGNISE THAT THE CHANGES WILL NOT JUST BE THEORETICAL BUT THAT THE WHOLE MODE OF OPERATION WILL ALTER. WHILST THERE WILL OF COURSE BE CONSULTATION, THERE WILL NO LONGER BE CONSENSUS ON MANY AREAS OF DECISION-MAKING.

divisional heads) should be members of the 3. The Divisions, Practice Areas, and Departments board. The Executive Board’s responsibilities There are many operations within a professional would include the formulation and services firm that can only be done at a implementation of annual budgets and business practitioner level. These are familiar to most plans. This Board would have a big role in the firms and will not change much as the governance context of the development of strategy and the structure develops. The main responsibilities at detailed analysis which accompanies strategic this level include the apportionment of work planning. This work would be done in between partners and teams and the setting of conjunction with the Partnership Council or team/individual targets within the context of the under its overseeing eye. Strategy formulation overall budget and business plan. Consistent and strategic positioning for some firms may be services must be delivered and knowledge straightforward in concept terms but strategy management, workflows and precedents have to implementation is never easy – the Executive be developed. The division or practice area also Board has important executive duties here. Other needs to be accountable to the Managing Partner, responsibilities would include: and ultimately the partnership, for its performance, its quality of work and the • Driving and monitoring economic and development of expertise. business performance including the performance, both financial and Although such responsibilities may be familiar, operational, of each practice group and team, what is often missing on a day to day basis is and the improvement of profitability, and appropriate implementation. Governance structures can only supply a framework in which • The development and implementation of accountability can happen, follow up occur, and policies for the improvement of the firm’s the principles of active management can be Intellectual Capital including risk adhered to. management, quality, client care, human resources, IT and marketing. HOW DO PARTNERS ADAPT AS THE It may be controversial for some firms, but I GOVERNANCE STRUCTURE DEVELOPS? believe that the partners with principal executive In order to achieve the objectives of any new responsibility – those who will have a seat on the governance structure, partners need to recognise Executive Board – should be selected by the that the changes will not just be theoretical but Managing Partner who needs to be free to choose that the whole mode of operation will alter. and balance his or her management team. In Whilst there will of course be consultation, there many firms, there is a trend for the Managing will no longer be consensus on many areas of Partner to be selected by a selection committee decision-making. The leadership team must be rather than by a direct election.

14 Kerma Partners Quarterly 2007, Issue 2 allowed to get on with its job and at an emotional level within the make decisions which would partnership, bearing in mind then be reported to the the loss of influence which partnership. Additionally, those many partners will feel that a board members who are partners new structure will entail. will not just be representing their Third, they must work to build office or division but need to up trust and confidence understand that their role will be amongst partners. executive and decisive. They will be part This is why it is important for of a leadership team which is responsible for partners to discuss structural issues driving the firm forward. openly and maturely, recognising that if the firm We come across many firms where the partners is to progress, the implementation of strong but who are members of either of the main boards sensible management needs to be accompanied by continue to regard attendance as both optional responsible and accountable partner behaviour. and secondary to their client work. For any vibrant business, meetings just have to take CONCLUSION precedence over client work and should be run It is often correctly said that structure should on a tighter corporate type model with properly follow strategy, but in our view it should not lag prepared papers and focused discussion, and a far behind. As firms consolidate and grow, there minimum of ‘house-keeping’ and circular is a constant need to keep a watchful eye on the discussion. management and decision-making processes in any firm, and the likely transition points when Partners do not always respond well to such changes need to be made. The design of the changes in management structures. At times, they changed structure is critical – it needs to be fit will protest vocally, but often their protests are for current and future purposes – but how those seen silently in undermining, back-sliding, and modifications are proposed and steered through even subversion. Often partners will simply the partnership requires a deft touch. ignore edicts which they dislike and, if they get away with it once, will try the same trick again. At one firm, many major decisions of the board, Nick Jarrett-Kerr advises mainly law firms on leadership, until quite recently, were invariably reversed as a management and strategy. result of partner protests. Other decisions were frequently made by the board as a result of political pressure rather than business need.

Before making any changes, the firm leaders need to achieve three things. First, they must communicate a compelling view of the horizon which they visualise for the firm, and the structure which needs to be in place to enable the firm to move successfully towards that vision. Second, they need to anticipate the likely obstacles to sensible and disciplined governance

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