Creating a Sustainable Group Bonus Structure for Your Law Firm

I'm Melissa Shanahan, and this is The Law Firm Owner Podcast Episode #306. 

Welcome to The Law Firm Owner Podcast, powered by Velocity Work, for owners who want to grow a firm that gives them the life they want. Get crystal clear on where you're going, take planning seriously, and honor your plan like a pro. This is the work that creates Velocity.

Hey everyone. Welcome to this week's episode. All right, so the previous two episodes that we have done have covered some incentive conversation about how to think about incentives, about a healthy way to consider structuring your incentives. This is just as a guide to help you learn how to think about it. It's not meant to suggest that this is the incentive plan or plans that I cover that you should put into place. By no means am I saying that. I would never say that unless I really understood underneath the hood of your business and could evaluate things fully. Then I would be able to decide what probably made the most sense for your firm. And so you should be thinking of this in the same way.

If there's data that you don't feel like you are able to get in order to make an informed decision when it comes to something like this, then you need to figure that out. As the owner, it's your job to know this, and to be a good steward of this business, and to keep it healthy. And the only way you can do that is if you really have a deep understanding of the current state of the firm. Facts, not feelings. Numbers, not hunches.

So if you need help with this, come and get involved at Velocity Work. You can go to velocitywork.com. There is a simple form to fill out to work with us that gives me some insight into you and your business. And then there's an opportunity to chat with me so I can help figure out, number one, are we a good fit for you and for your needs right now? And number two, which of the programs that we have probably makes the most sense for where you are. So head on over if you need help with this stuff.

Now, we're going to build on the last two episodes because the last episode was so long. I knew there was something else I wanted to cover, but it was already an hour in last time. So I'm going to just touch on today a little bit more about group incentives or group bonus structures, and give you some things to consider if you are thinking about putting a group bonus structure into place. If you have a group bonus structure incentive plan in place, hopefully the nuggets I'm going to share here will be helpful and useful to you when you are thinking through your current setup, determining if it's really the healthiest setup for the firm.

There's a couple different ways you could set up a group incentive. Typically what you will see is people do this on revenue. And if you're going to do it on revenue, no matter what you do it on, I really do believe that the finding the true average and calculating a baseline is the way to go, which I've talked about in the previous two episodes. But and if I already repeated that, since I started this, please forgive me. I started the podcast and I had to stop and walk away and come back. And so I don't remember if I said that out loud or not yet, but you will find that information in the previous two episodes on how to calculate the baseline.

But anything above the baseline can be incentivized. And there are many practices that do this on revenue. The problem with revenue is that you have to make sure, you have to watch your expenses closely, or that, you know, the profit margins closely, because it's very easy to end up in the red if you are basing this incentive on revenue. Because maybe you have a month where for some reason, there was a lot more expenses involved, but you had a decent revenue month. So everybody's getting incentivized on the revenue, but you had to pay a ton out that month. That creates issues. It creates animosity between the owner and the team and resentment. And it's all in how it was set up.

So you told them what to focus on, they focused on it, and it's time for a payout, and you're dying over here because you can't figure out how to pay them because there's not any money really there. So it can be tricky with revenue. You just need to be very careful if you're going to put that into place. You have to watch your expenses like a hawk. You have to make sure and forecast out what's coming in terms of expenses so that you can set aside cash so that on those high expenses months, if your team does really well and should be incentivized, you've got the cash for it. It's a lot to keep up with doing it this way.

I'm not saying you can't do it this way, but you have to be cognizant of what you're getting yourself into. That deal is the deal. No matter if you got the cash or if you don't have the cash, that deal is the deal. So be thoughtful around that. My suggestion is to incentivize, if you're going to do a group incentive, based on a percentage of profit that will go to the team. We'll talk about there's a couple different ways to do that. And the other thing you have to think about with groups is, is it going to be distributed evenly amongst the group or is it going to be given weight to different team members based on their position, their role, their responsibilities, their impact, etcetera.

Now, I'm going to go one step further and make a suggestion that it's not just all profit, that you have some conditions set up so that you can make sure that you're not taking too much of a percentage, that the business really is taken care of, and that you as the owner are taken care of in a really healthy way before you start divvying out incentives.

So what I mean by that, one example of what this might look like, is it's the profit that's left over after owner distributions and taxes have been set aside. Now, I know that distributions, the amount is discretionary. So you need to know that there's a certain amount of take-home that you need to have every month. And once that starts happening, incentives are then on the table.

So, for example, if you know that you want to take home $25,000 a month, and you know what your W2 is, and let's just say that that's $8k. Well, then you have $17,000 in distributions every month that you'd like to take. So you would calculate the bonus would be the profit minus $17,000, that allows that to go to owner distribution, minus the taxes that should be set aside in terms of estimated taxes. And then what's left over after that gets divvied up, or a percentage of what's left over after that could get divvied up amongst your team.

Before I go into a math example for this, I thought I'd just take a minute to address how you can talk about this with your team. You know, the truth is, setting up the incentive structure this way after owner distribution, after taxes are set aside, is a very healthy way to set up an incentive structure. As long as it's set, like this is a set amount of distribution and then what's left over, not I think every month it being discretionary when you have a plan like this in place is kind of tough.

It doesn't mean you can't take more distribution. It just means that after, in this, you know, the example we were using previously, after the $17,000 is distributed, then what's left over, there is a percentage that goes to the team, and it's not the entirety of what's left over. So you could still take more after that. It's more of just a measure of making sure that the owner is taken care of in the ways that they need to be taken care of before giving out money to the rest of the company.

I see all too often owners who are struggling, and their team is winning more than the owner themselves. And it's very easy to justify that move for those of you listening who are in that position or have been in that position before. It's very easy to take the stance that, well, yep, this is the risk that comes with owning a business. I need to make sure my team is taken care of. My time will come. Listen, yes and no. If the funds are there, you have to take care of yourself. You have to make sure that your needs are being met because resentment builds and frustration, and burnout when you're not taking care of yourself first, but your team is being taken care of, that dynamic is just rocked. It's not healthy. So you have to make sure that you're taken care of.

So whatever standard you have set for yourself in terms of what it takes to be okay, to be comfortable. Yeah, there's just no reason for everybody else to win when you're not even at your standard yet. It's super tight for you on the personal level, then, no, we're not going to start giving out incentives. So I just want to, hopefully, that serves as a wake-up call for some of you who do think or feel like you need to do that. Some of you are in positions where you are doing that just because of the high salaries that you're offering, and you are not able to take what you should be taking because of it.

Now, if this is strategic and you saw that like, there are three months where you might take a dip, and then it's going to pick up and it's all good. Like that's an investment that you're making. That's fine. But if you're making a decision that feels like you're not sure when it's going to end, you don't really have an expectation about when things will balance back out in the way that makes it okay for you, that's a no. You cannot do that. You have to enter into this clear-eyed and with expectations around timing.

Okay, I'm starting to get on a tangent. But I do think that's a point worth making. And the reason I decided to make that point up front is because the way that you explain this to your team matters. The way that it's received matters. Now, you can't control entirely the way it's received, but you absolutely have control over how you present this so that it is received as easily as possible.

My recommendation, based on the fact that it is true that you need to be taken care of, and you should not be shelling out cash until you are in a space where your standard is met, then and only then should you put this into place. And considering that, I think that your approach to presenting this to the team is to talk about how you or we, if it's an executive team, you've designed this bonus structure to reward the team when the firm is thriving. And here's what that means.

Before any incentive is paid, the firm must meet its essential financial responsibilities, covering all operating expenses, setting aside reserves for taxes, ensuring we've reached a healthy baseline profit. And that baseline reflects what it takes to keep the business strong, sustainable, and positioned for continued growth. I think if they really understand that that's the truth, then they can get behind how this incentive structure is set up.

So when profit exceeds that baseline, which we'll talk about that math in a minute, when profit exceeds that baseline, a portion of the excess is shared with the team. And that's where the bonus opportunity lives. The reason that it matters is because it protects firm stability. It allows for you as a team and as a firm to plan responsibly. It ensures that you can celebrate true success together. And this approach will help you grow in a way that rewards great work without compromising the long-term health of the business.

This is very easy for someone to understand and for someone to get on board with. Now, what may not be as easy is if you say this incentive structure is after owner distribution and taxes are set aside. The only thing people are going to hear, and some team members are mature enough in a business sense to not think in the way that I'm going to share with you, but most are not. They're not equipped with their experience and their understanding about how all of this works to be able to handle this in a mature way.

So when you say that to them, all they think is, oh, so after the owner gets rich, then we get a cut. That's the sentiment. And though that's not true, it doesn't mean that you should say it so explicitly that it lets their minds wander into some untrue territory. So that's why I really suggest centering the conversation with the team more about that this is for when the firm is thriving. That's when we get to take part in an incentive like this is when the firm is thriving.

Again, I just want to reiterate, I really do believe, I'm sure there's exceptions to this. Again, you've got to get under the hood and see what makes most sense for the business that we're talking about. But generally speaking, I really do believe that these group incentives set up in this way, set up to protect the business, they're best suited for small, tight teams that collaborate really heavily together.

And if you have a larger company and there's departments, every firm technically has departments, but there's departments to where people don't interact with each other a whole lot because they are so specific with the role set that they have and there isn't a lot of cross communication and collaboration. Everybody, of course, in every business, everybody contributes to the top and the bottom line. But this is meant for teams who there's a lot of cross-functioning happening and pulling together. And so smaller, tighter teams are better suited for something like this, generally speaking, than larger firms.

By the way, just because your revenue may be higher than someone else, to me that doesn't necessarily mean larger teams. I have worked with teams that are doing three, three and a half million in annual revenue a year and their team is still really tight and they're super organized, but they all really gel together to make that business run well and they're tight knit. It's worked for them. So I think some of you who might be thinking, well, I'm like, you know, at a million and a half or two million, maybe I'm getting too big for it. Not necessarily, but it depends on the dynamic and the culture in your firm.

Let's walk through some math on this just to give you an idea of how you can think about setting this up for yourself if this sounds like something you'd like to do. Okay, so let's start with first looking back when you're trying to figure out the true average, you're going to figure out your true profit average. So your average profit before distributions, before taxes. Now, when you look back to get the true average for that, so you'll do the last 12 months, the last six months, and the last three months average, and you're going to add those all up and divide by three to get the quote unquote “true average.”

So let's say for the last 12 months, every month was $30,000 in profit. And I'm kind of running this on a generic example of $150,000 average for revenue and a 20% profit on average. And so that's where I'm coming up with these numbers. So look back to see what's true for you with these numbers, but I'm just going on 20% profit margin and looking back to calculate monthly what the averages are.

So for the last 12 months, the average profit before distribution and before taxes was $30,000. And the last six months, it was $32,000. And in the last three months, it was $34,000. So when you add all of those up, and then you divide by three, you get the true average. And the true average is $32,000 a month in profit before owner distribution and before taxes.

Now that we have the true average, then we're going to add on 10%. So $32,000 times 1.10. So, to add on 10%, is $35,200. That's the baseline for that pre-tax, pre-owner distribution profit number needs to be at $35,200. If that is hit, there can be eligibility for a bonus pool, an incentive pool. But after you take out the obligations for the business. So this is where you would subtract out the owner distribution, the monthly owner distribution that you have slated, and said this is what you need. And also, the taxes are set aside. Then what's left over is the pool that you could pull from, give a percentage of to distribute amongst the team.

So let's say that that result is created in your firm. Together, you guys were able to hit that $35,200. And so, okay, now we are eligible for an incentive after the obligations are taken care of. So this is where, from the $35,200, you will subtract out the owner distribution that needs to happen. And then you're going to subtract out the taxes that need to happen. So let's say the owner distribution is $17,000. So you subtract that off of the $35,200. And then you're going to subtract off, in this example, I'll just use 25% of the net profit number, 25% of the $35,200. That is going to be set aside for taxes. What you're left with is $9400.

Now, a percentage of this is what can be shared. When you're trying to decide what percentage of that shareable portion of the profit, what percentage should we divvy up? 25% is typically safe, because you have to think about the owner's taken care of, the taxes are taken care of. You've already hit a higher net profit level, and that's what made them eligible for this bonus, right? So the business is protected.

So, keeping 75% for the business, for growth and considerations, and 25% of that goes to the team, could be a really safe and rewarding structure to use. So that would mean that if we're taking 25% of the $9400, that's $2,350 that could be divvied up amongst your team. There are a couple different ways that you can weight this, or you can just distribute it evenly. I'll talk more about that in a moment.

But the last thing that I want to say here is that you could set into place that these are paid out quarterly. They're calculated monthly, but there's a quarterly incentive that they receive. So that check is typically a little bit bigger, and so that's why some people like to do this.

I mean, if you have four team members plus yourself, and you leave yourself out of these incentives, so you would divide this by four. So the $2350 divided by 4 is $588. So that would be the incentive that month to each person if you were giving it out evenly. But sometimes a quarterly check can feel more impactful. So, you know, you can imagine if they did this for three months in a row, that is over $1700, it's almost $1800. So that would be the check that each of them get at the end of the quarter versus a monthly check of $588. So that's up to you. You can do that any way you want. I'm just throwing it out there because I do see this and people get excited by bigger checks. It's all psychology, right? So do it how you please.

Let's talk about how you split these up. So you can, like I said, you can distribute it evenly. I do find that most people prefer to weight the positions in the firm that are in this pool. And, you know, if you already have an individual incentive for your producers, maybe you don't weight it, and maybe it does just get distributed evenly. But if this is your main thing, I would suggest considering having a weight to certain team members who are in the pool. So one way that I love, it just seems totally fair. I've seen this done a few times in firms. And then I actually plugged this into Chat GPT and said, what do you think about this? Poke holes in it. And it didn't have much negative to say. It felt pretty fair, which I thought was cool. So I'm going to share this with you here.

Basically, if you want to weight this, you could do it on a point system. So let's say there's the higher number of points, the more impact that role has on the bottom line, top and bottom line. So, for instance, maybe you have attorneys, and so there's three points for each attorney. And paralegals are two points. And administrative staff is one point. Well, when you assign each team member a point, let's say you have two admins, you have one paralegal, and you have one attorney that works for you. So then each admin gets one point. So you have two points total there. The paralegal gets two points, and there's only one of them, so there's two points there. And the attorney gets three points. So there's three points because you have one attorney. And you add up the points that exist in the firm. So in this case, we have two points plus two points plus three points. That's seven points.

So what you can do then is take the pool that is going to be distributed. And in this case, for this month, it was $2350. And $2350 divided by 7, seven points is 335.7. So each point in this pool, in this bonus pool is $335.70. Now, because the attorney has three points, you take that times three to figure out their payout. And that is $1,000, a little over that, actually, if you do the math, it's like $1,007. And then we have the paralegal who has two points. So 335.7 times 2. So her payout is $671. And then the assistants, they each have one point. So each of them get 335.7 that month. So that's one way you can think about doing this so that it's not split up just, you don't just divide by four. You actually have a way to weight it that makes sense. Everybody wins. It's relative to their impact.

So that's one idea. That's my favorite idea of how I've seen this broken up. And if you have a spreadsheet, this is simple. It makes it all simple for you. You have to set this up once, and then you can just run it month over month, over month, over month, over month. In this case, you may not decide to weight for quarterly because it's a little more shifted to what might make sense for each role. I think paying this out monthly in this way is really great.

Okay, I hope this helped. I hope this helped you think through what you need to do. And I hope even though I mentioned it at the top of the hour about you can incentivize in a group way off of revenue, I hope you steer clear from that. It's just not a good sustainable incentive structure. I don't know that you would ever have someone who had a ton of business acumen walk in, and they had to put an incentive program together, and they would do it on revenue. It just doesn't make sense. Unless you have so much control over your expenses and they're so low that it's fine to just use revenue. But that is few and far between businesses. That's not normal. So I wouldn't bank on that.

I really want to encourage you to think about doing this profit after distribution and after taxes. But of course, the profit number that you're using, that net profit number before you pay distribution and taxes, it needs to be bumped. It can't just be your standard and what you've done, average prior. It needs to be average plus 10%. Then you subtract out the obligations that the business has to its owner and to the government. And then what's left is a percentage of that is divvied up. That is a healthy, safe way to go. It's a win-win, and the business is protected.

All right, everybody. I'll see you here next Tuesday.

Hey, you may not know this, but there's a free guide for a process I teach called Monday Map Friday Wrap. If you go to velocitywork.com, it's all yours. It's about how to plan your time and honor your plans so that week over week, more work that moves the needle is getting done in less time. Go to velocitywork.com to get your free copy.

Thank you for listening to The Law Firm Owner Podcast. If you're ready to get clearer on your vision, data, and mindset, then head over to VelocityWork.com where you can plug in to quarterly Strategic Planning, with accountability and coaching in between. This is the work that creates Velocity.