What's the problem with PEP?

I had an interesting conversation yesterday. I was talking with a lawyer friend of mine (who will remain nameless) and was continuing on my recent theme of measurement within law firms and, specifically, the problems with PEP (profit per equity partner). I won't repeat my issues with PEP here - just have a look at my last post if you'd like to see what I think.

My lawyer friend is not a partner (yet). He suggested that, since he was going to be a partner, and since PEP was published for almost every firm, this measurement gave him a fine way to compare firms. Our conversation went something like:

"PEP is great - I can see which firm is best", he said.

"No - you can see which firm might give you the most money when you are an equity partner. PEP isn't a measurement of which is best"

"Well it's the same thing, really..."

I countered with a story about a mutual friend who is a corporate finance manager in a large company. He had recently moved firms and during the process had gone through the books of prospective firms in great detail, examining profit flows, balance sheet health, forward strategies and client surveys. Yes of course he was concerned about the amount he would be paid - but he was as concerned that the company he was about to join was healthy.

PEP gives no idea about the health of the firm. Look at the results from Shoosmiths (as published by Roll on Friday). They have published an increase in PEP of 70% despite a decrease in revenues of 9% - and have issued a statement that this has been possible because of "...developing existing clients and ...winning new ones". Just to repeat - they have managed to take more money out of the firm, even though less came in. Not only that - but they justify this by saying that they have "developed clients". What does this tell us about the health of the firm. On the face of it, nothing at all. In fact, however, it suggests that Shoosmiths either have no idea about forward planning and building reserves, and so are content to pump money out of the firm at the very time that it needs it - or that they are content to paint a rosy picture to prospective employees and partners. Neither is very good at all. I am not suggesting that Shoosmiths are any worse than any other law firm. The majority of the larger firms (by revenue) have posted similar increases in PEP and decreases in revenues - while suggesting that this is good.

I suggest that prospective partners look well beyond revenue and PEP before moving from one firm to another. At the very least I suggest that they:

• Look at five years worth of balance sheets to see
• the ration of liabilities to assets
• the amount of band debt written off
• reserves
• Look at the strategy of the firm and whether it has actually been implemented
• Look at the marketing strategy of the firm to see if it actively supports the firm strategy and whether pervious measures of success have been achieved
• Look at staff and partner satisfaction surveys
• Look at client satisfaction surveys
• See evidence of business training for partners - after all, you will probably be asked to take some sort of role in the management of the firm.

If a firm is unable to supply any of the above - if, for example, they have no firm measurements of success for marketing or do not take satisfaction surveys - I'd be a little worried. It might not be a deal-breaker, but it's a large red flag that suggests that the firm you are looking at may not be amongst the "best" after all - no matter how much money they might give you.