Stop confusing yourself with the law firm you own. Your law firm is a business entity that exists to create customers and turn a profit. But when you practice law, send out invoices, create marketing material, and otherwise run your law firm, you are acting as an employee for your law firm, not as an alter-ego of the business entity. And that means your law firm needs to pay you a fair wage.
Determining Your Wage
Determining your salary is not a difficult task. The internet is full of websites that will give you quality data in a few minutes, including Payscale and the National Compensation Survey from the Bureau of Labor Statistics.
Remember that you are wearing many hats. If you are practicing law full time and then handling marketing and CEO duties in the early morning hours, then you should be the highest paid employee in your firm. Your salary should reflect your duties.
Pay yourself on a regular payroll cycle, along with the rest of your team. While you are at it, set aside personal taxes just like your employer would if you were working for someone else.
Assigning yourself a fair wage will bring clarity to your dual roles as an owner and employee. It will also help you keep accurate data for your accountant when preparing financial reports.
Failing to Pay Yourself a Fair Wage Leaves Your Accounting Reports Meaningless
Ideally, your accountant will provide you with monthly financial reports that include a profit and loss and cash flow statement. You do not learn to read these reports in law school. You have to work with your accountant to understand what the numbers mean. And more importantly, how to use this information to make smart decisions for your business.
But your financial reports are only as good as the data you provide your accountant. If you are not being paid a competitive wage, then your data is wrong. Your reports are meaningless.
As a service firm, the most important data to track is the cost of your labor and the revenue your labor generates. In most cases, the money your firm spends on employees should be the largest expense. If you do not pay yourself a fair wage, you will not be able to see if your employees are making your firm money. Even worse, you will think your firm is generating a profit when it is really losing money.
Taking a “Dividend” Instead of a Wage Is Irresponsible
Your firm needs to protect itself against slow cycles. It needs to have reserves for taxes at the end of the year. At certain points, it will need to retain profits to invest in marketing, equipment, or real estate. Only after assuring the health of the firm should you consider taking dividends.
You need to eat too. But you should be eating from your salary that is properly accounted for in the financial reports. Taking dividends based on your inflated “net profit” number is irresponsible. In some cases, business owners “take dividends” in an effort to minimize payroll taxes. Underpaying yourself in salary and collecting only distributions puts you at risk for an unreasonable wage audit with the IRS. No thanks. It takes too much time and energy to play games. You are better off focusing on getting quality financial reports you can use to guide your decision making.
If You Cannot Afford Yourself, Cut Labor or Go Work Somewhere Else
If you do not think your business can afford to pay you a fair wage, that is a problem you need to fix.
Few law firms are generating substantial revenue on their first day of business. There is almost always a lag period before your revenue grows enough to cover the cost of you. Tech and office sharing have helped law firm start up costs plummet. But if your firm has been operating more than 18–24 months and it still cannot pay you a market-based wage, then something is wrong.
It is possible that your firm’s problem is insufficient revenue. This is possible if your firm is new. In this case, your legal work should be light, leaving you plenty of time to market yourself.
More likely, you are spending too much on staff. That means you need to fire somebody. Of course, nobody likes the thought of having to fire an employee. Some small firm owners dislike firing so much they would rather cut their own pay than their employees.
Do not do this.
As a business owner, you need to make sure your firm stays healthy so it can provide you a return every year. This requires accurate data so that you can make the right decisions when reinvesting profits or taking the money out. You can’t stand for anything less. As an employee, you need to demand an honest fair wage for the work you do. You are the lead attorney, head of marketing, and CEO of your firm. Your business may need to cut support staff to meet your payroll. And if your business can’t make those tough decisions and pay you what your worth, then maybe you need to go work somewhere else. As a shareholder, you are allowing your firm to perform sub-optimally — increasing the chance it will fail. You are also not getting a return on your investment. Ask yourself: would you be better off liquidating your business assets and putting the money into treasury bills?
Your small law firm is a business. You are both a partner and an owner of your firm. Make the smart decision to start acting like a business and pay yourself like you would any other employee.
Originally published 2015-10-12. Republished 2016-10-21.