Summary:
- Law firms accepting stock in lieu of fees must navigate complex ABA ethics rules including Model Rule 1.8(a), requiring written disclosure, client consent, and fair transaction terms before acquiring any ownership interest in a client
- Firms should establish clear partnership agreements addressing whether equity distributions follow immediate allocation or vesting schedules, with most successful firms opting for hybrid models that balance individual contribution recognition with firm-wide risk sharing
- Modern tracking technology and transparent policies are essential for managing equity compensation—firms that implement clear written guidelines reduce internal conflicts while positioning themselves to benefit from the startup economy’s growth
Picture this: A promising startup walks through your door seeking help with their Series A financing. They’re cash-strapped but equity-rich, and they make you an offer—take stock in lieu of some or all of your fees. Your corporate team is excited. Then someone asks the question that can turn opportunity into chaos: “If this company goes public, who exactly gets that payout?”
If you don’t have a clear answer, you’re not alone. While law firms have been accepting equity from clients since at least the Silicon Valley boom of the 1990s, many mid-sized firms still lack formal policies for distributing that equity among partners. The result? Potential windfalls that become partnership-destroying disputes.
The practice of equity billing—accepting stock or other ownership interests as compensation for legal services—has evolved from a Silicon Valley curiosity into a mainstream alternative fee arrangement. According to recent data, 84% of law firms now offer some form of alternative fee arrangement, and equity compensation is increasingly part of that mix, particularly for firms serving emerging companies and startups.
But here’s what keeps managing partners up at night: when that equity eventually becomes liquid, how do you divide it fairly among partners who may have contributed in vastly different ways and at different times?
Why Firms Accept Client Equity (And Why It’s Getting More Common)
The economics of equity billing are compelling. Cash-strapped startups need sophisticated legal help but can’t afford premium hourly rates. Law firms, meanwhile, can potentially earn returns that dwarf their standard fees if they pick winners. The ABA’s Formal Opinion 00-418 confirms that accepting stock is not per se unethical, opening the door for firms willing to navigate the regulatory requirements.
The startup ecosystem continues to attract massive investment. Legal tech alone has seen record funding levels, with companies like Harvey reaching valuations of $3 billion and beyond. When law firms serve these high-growth companies and accept equity as part of their compensation, even small ownership stakes can become significant assets.
But opportunity comes with complexity. Unlike a fee paid in cash, equity creates ongoing financial relationships that can span years—from the initial grant through vesting, liquidity events, and eventual distribution. Your partner compensation model needs to account for all of it.
The Ethics Framework: What You Must Do Before Taking Stock
Before diving into distribution strategies, let’s address the threshold question: Can your firm ethically accept equity from clients? The answer is yes, but only if you follow the rules carefully.
Model Rule 1.8(a) Requirements
ABA Model Rule 1.8(a) governs business transactions between lawyers and clients, including equity arrangements. The rule requires three things:
Fair and reasonable terms. The transaction must be objectively fair to the client. This means valuing the equity at the time of the transaction and ensuring the client isn’t being overcharged. The ABA recommends that lawyers “establish a reasonable fee for services based on the factors enumerated under Rule 1.5(a) and then accept stock that at the time of the transaction is worth the reasonable fee.”
Written disclosure and advice. You must disclose the terms of the transaction in writing, in language the client can understand. You must also advise the client in writing to seek independent legal counsel and give them a reasonable opportunity to do so.
Informed written consent. The client must sign a document consenting to the essential terms of the transaction and your role in it.
Additional Ethical Considerations
Beyond Rule 1.8(a), firms must watch for conflicts under Rule 1.7. When you own stock in a client, your personal financial interests become intertwined with theirs. This can create problems—for example, when you need to advise a client to disclose adverse information that might tank the stock price you’re counting on.
Many firms minimize conflicts by limiting investment in any single client to a nonmaterial sum and keeping their equity stake to an insubstantial percentage of the client’s total equity shares. Some firms cap total equity investments across all clients to prevent any single attorney’s financial interests from becoming too concentrated.
Insurance matters too. Many professional liability policies exclude coverage for claims arising from a lawyer’s ownership interest in a client, particularly when that interest exceeds a certain threshold (usually 10-25%). Review your coverage before accepting equity and consider supplemental policies if needed.
Understanding Vesting vs. Immediate Distribution
Now for the question that actually brings you here: When your firm receives equity from a client, do you distribute it to partners immediately, or does it vest over time?
How Vesting Works
Vesting is the process of earning ownership rights incrementally over time or upon achieving certain milestones. The standard structure in the startup world is “4 years with a 1-year cliff,” meaning nothing vests for the first year, then 25% vests at the one-year mark, with the remainder vesting monthly over the next three years.
Applied to law firm equity compensation, vesting could mean that a partner who brings in an equity-paying client doesn’t receive full credit for that equity immediately. Instead, they earn their share over time—incentivizing them to maintain the client relationship and continue contributing to the firm.
How Immediate Distribution Works
The alternative is immediate allocation, where equity is credited to partners’ accounts as soon as it’s received. The equity might still be illiquid—meaning partners can’t actually cash it out until a liquidity event—but it’s “theirs” from day one for purposes of the firm’s books.
The Trade-offs
Each approach has advantages and drawbacks:
Vesting protects the firm from partner departures. If a partner lands a big equity client and immediately leaves for another firm, the remaining partners may be stuck managing that client relationship without the partner who earned the credit. Vesting ensures partners who leave early forfeit unvested equity that returns to the firm pool.
Immediate distribution rewards rainmaking. In competitive markets where business development drives compensation, partners expect prompt credit for client relationships they originate. Holding equity in escrow can feel like the firm doesn’t trust its partners—a culture killer in eat-what-you-kill environments.
Vesting creates administrative complexity. Tracking vesting schedules for dozens of equity positions across multiple partners requires sophisticated systems. Without proper technology, vesting becomes an accounting nightmare.
Immediate distribution simplifies taxes. When equity vests over time, the tax treatment can be complicated. Partners may need to file 83(b) elections within 30 days to lock in favorable tax treatment, adding another layer of administrative burden.
Building Your Equity Distribution Policy
The best approach for most mid-sized firms is a hybrid model that balances multiple considerations. Here’s how to structure it:
Step 1: Define Who Gets Credit
Before any equity comes in the door, your partnership agreement should specify how credit is allocated. Consider these categories:
Origination credit goes to the partner who brought in the client. This is typically the largest share, reflecting the business development effort. In traditional fee arrangements, origination credit often ranges from 10-33% of revenue; for equity compensation, it might be higher given the added risk.
Relationship credit goes to the partner who maintains the ongoing client relationship. This might be the same person as the originator or someone different. If a partner hands off a client to a colleague after the initial engagement, who manages the equity relationship going forward?
Working credit goes to partners who actually perform the legal work. If a junior partner bills 500 hours on a matter that generates equity, should they receive a share even if they didn’t originate or manage the relationship?
Firm credit is a portion retained by the firm for overhead and shared expenses. Just as firms retain a percentage of hourly fees for overhead, some portion of equity might go to the firm itself rather than any individual partner.
Step 2: Choose Your Vesting Structure
If you implement vesting, consider these options:
Time-based vesting with a cliff. A partner earns their equity allocation over a period (typically 3-4 years) with nothing vesting for the first year. This mirrors standard startup equity practices and protects against early departures.
Service-based vesting. Vesting is tied to continued service to the specific client rather than just tenure at the firm. If a partner stops actively working on the client’s matters, their unvested equity stops vesting.
Hybrid vesting. Split the allocation—perhaps 50% vests immediately as origination credit, with the remaining 50% vesting over time based on ongoing relationship management.
No vesting (immediate allocation). All equity is credited immediately to the appropriate partners’ capital accounts. This approach works best for firms with high trust levels and robust non-compete provisions.
Step 3: Address Liquidity Events
Your policy must specify what happens when equity becomes liquid—through an IPO, acquisition, or other exit:
Distribution timing. Do you distribute proceeds immediately upon a liquidity event, or does the firm retain them for a period? Some firms hold proceeds in escrow to address potential clawbacks or indemnification obligations.
Tax handling. Specify whether the firm or individual partners are responsible for tax planning and payments. Make clear whether partners receive gross proceeds or net-of-tax distributions.
Departing partner treatment. If a partner leaves the firm before a liquidity event but after their equity has vested, what are they entitled to? Most firms allow vested equity to remain with the departed partner, but require ongoing cooperation with tax and administrative matters.
Step 4: Handle the Failures
Most startups fail. Your policy needs to address worthless equity:
Write-off procedures. Establish clear criteria for when equity is written off (bankruptcy, extended inactivity, etc.). Partners shouldn’t carry phantom assets on the books indefinitely.
Tax loss treatment. Partners may be entitled to tax deductions for worthless securities. Coordinate with the firm’s tax advisors to maximize these benefits.
Psychological considerations. Partners who took reduced cash compensation in exchange for equity that became worthless will be frustrated. Clear up-front communication about risk can prevent later resentment.
Technology and Tracking Requirements
Managing equity compensation without proper technology is asking for trouble. Your systems need to track:
Equity grants by client. What equity has the firm received, from whom, and under what terms? Include vesting schedules, liquidity provisions, and any transfer restrictions.
Partner allocations. How is each equity position allocated among partners? Track origination credit, working credit, and any other allocation categories your policy specifies.
Vesting status. For each partner’s allocation of each equity position, what percentage has vested? What remains unvested? What cliff dates or milestones remain?
Valuation history. Track valuations over time for financial reporting, partner buyout calculations, and tax purposes. Document the methodology used for each valuation.
Liquidity events. When equity becomes liquid, track proceeds, distributions, tax withholdings, and any holdbacks or escrows.
Modern legal billing software that integrates with your accounting systems can handle much of this tracking automatically, reducing administrative burden and minimizing errors.
Case Studies: How Firms Structure Equity Distribution
The Silicon Valley Model
Pioneered by firms like Wilson Sonsini and Cooley during the dot-com boom, this approach requires lawyers responsible for bringing in equity-paying clients to personally invest in a portion of the ownership interest. The remaining partners invest in the balance on a pro-rata basis.
This model accomplishes several goals: it ensures the originating partner has skin in the game, it spreads risk across the partnership, and it creates a review mechanism (since other partners must approve the investment).
The Rainmaker Model
Some firms allocate 100% of equity credit to the originating partner, treating it like any other origination credit. This maximizes business development incentives but concentrates risk and can create partnership tension when windfalls occur.
The Collective Model
At the opposite extreme, some firms pool all equity and distribute proceeds based on standard profit-sharing formulas—the same as they would for any firm revenue. This reduces individual incentives but promotes firm cohesion and simplifies administration.
The Hybrid Model
Most successful firms land somewhere in the middle: significant credit to the originator (perhaps 40-60%), meaningful credit to the working attorneys (20-30%), and a firm share (20-30%) that either goes to overhead or is distributed based on standard profit-sharing. Vesting provisions ensure ongoing contribution, while immediate allocation of some portion rewards the initial business development.
Common Pitfalls and How to Avoid Them
Pitfall 1: No Written Policy
The most common mistake is simply not having a policy. When equity is occasional and small, firms often handle distributions ad hoc. Then a position becomes valuable, and suddenly everyone has different recollections about what was agreed.
Solution: Establish a written policy before you need it. Include it in your partnership agreement and review it annually.
Pitfall 2: Ignoring the Ethics Rules
Some firms accept equity casually without going through the Rule 1.8(a) requirements. This creates risk that the arrangement could be voided entirely—leaving the firm with neither fees nor equity.
Solution: Create a standard intake procedure for equity matters that includes all required disclosures and consents. Train partners on compliance requirements.
Pitfall 3: Overconcentrating Risk
A partner whose compensation depends heavily on a single client’s equity is conflicted in ways that harm both the firm and the client.
Solution: Cap the percentage of any partner’s compensation that can come from equity in any single client. Require diversification.
Pitfall 4: Forgetting About Departed Partners
When partners leave, unclear policies create disputes. Does the departed partner keep their vested equity? Must they sell it back to the firm? At what price?
Solution: Address departed partner treatment explicitly in your policy. Consider mandatory buyout provisions that give the firm predictability while treating departing partners fairly.
Pitfall 5: Tax Surprises
Partners may not understand the tax implications of equity compensation until a large, unexpected tax bill arrives.
Solution: Provide tax education when equity is allocated. Consider requiring partners to make estimated tax payments or set aside reserves.
Implementation Roadmap
Ready to formalize your equity distribution policy? Here’s a practical timeline:
Month 1: Assessment
- Audit existing equity positions and how they were handled
- Survey partners about preferences and concerns
- Review current partnership agreement provisions
Month 2: Design
- Draft proposed policy with input from compensation committee
- Model impacts on current and hypothetical equity positions
- Engage outside counsel to review ethics compliance
Month 3: Approval
- Present policy to partnership for feedback
- Revise based on input
- Obtain formal approval and amend partnership agreement
Month 4: Implementation
- Update tracking systems and accounting procedures
- Train partners on new policy and procedures
- Create standard forms for client disclosure and consent
Ongoing: Monitor and Refine
- Review policy annually for needed updates
- Track equity positions and distributions
- Adjust based on experience and market changes
The Bottom Line
Accepting equity from clients can be a powerful tool for mid-sized firms—it helps you compete for emerging company clients, aligns your interests with theirs, and offers upside that traditional billing can’t match. But without clear policies for distributing that equity among partners, you’re planting seeds for future disputes.
The best time to establish your equity distribution policy is before you receive your first equity grant. The second-best time is now.
Whether you opt for immediate distribution, vesting, or a hybrid approach, the key is clarity. Document your policy, communicate it to partners, implement systems to track it, and revisit it regularly. With the right framework in place, you can capture the benefits of equity compensation while avoiding the partnership pitfalls that have derailed other firms.
Because when that startup client finally IPOs—and your 0.5% stake is suddenly worth seven figures—you want to be celebrating, not litigating.
Frequently Asked Questions
Q: Can our firm accept equity from any client, or are there limitations?
A: While ABA ethics rules don’t prohibit equity billing outright, you must comply with Rule 1.8(a) requirements for any equity arrangement. Additionally, some firms establish internal policies limiting equity relationships to certain client types (typically startups and emerging companies) or matter types. Check your state’s specific ethics rules, as some jurisdictions have additional requirements or restrictions.
Q: How should we value equity when we receive it?
A: Value equity at the time of the transaction based on the most recent financing round, fair market value appraisals, or other reasonable methodologies. Document your valuation approach carefully—you may need to defend it later to partners, the IRS, or (in worst cases) ethics regulators. The ABA recommends accepting “stock that at the time of the transaction is worth the reasonable fee.”
Q: What happens to a partner’s unvested equity if they die or become disabled?
A: This should be addressed explicitly in your policy. Many firms accelerate vesting upon death or disability, similar to how startups often handle employee equity. Others distribute unvested equity to the firm pool. Whatever you decide, document it clearly to avoid disputes with estates or family members.
Q: Should we treat equity differently in lockstep vs. eat-what-you-kill compensation systems?
A: Yes, your equity policy should align with your broader compensation philosophy. In lockstep systems, equity might be pooled and distributed according to standard formulas. In eat-what-you-kill environments, originating partners typically expect to keep most of the equity credit. Hybrid approaches are common for hybrid compensation models.
Q: How do we handle situations where multiple partners claim origination credit for an equity client?
A: The same way you handle origination disputes for fee-paying clients—through clear policies and, when necessary, management decisions. Establish criteria for determining origination credit before disputes arise. Some firms split credit when multiple partners contributed meaningfully to landing the client; others use “first in time” rules.
Q: What’s the tax treatment of equity received as compensation?
A: Equity received as compensation is generally taxable income at the time it’s received (or when it vests, if subject to substantial risk of forfeiture). Partners may be able to file an 83(b) election to accelerate taxation to the grant date, which can be advantageous if the equity appreciates. Consult tax advisors for specific guidance—this area is complex and fact-specific.
Q: Should non-equity partners or associates participate in equity distributions?
A: This depends on your firm culture and the specific arrangement. Some firms limit equity participation to equity partners; others allow non-equity partners to participate in working credit distributions. For associates, consider whether equity participation creates retention incentives or problematic conflicts. Document whatever you decide in your policy.
Q: How long should we hold equity before writing it off as worthless?
A: There’s no universal rule, but most firms establish criteria based on: the company ceasing operations, bankruptcy filing, extended periods without financing activity (often 5+ years), or formal dissolution. Work with your accountants to establish write-off criteria that are both practically reasonable and tax-compliant.
Sources
- American Bar Association, Formal Opinion 00-418 (July 7, 2000)
- ABA Model Rules of Professional Conduct, Rules 1.5, 1.7, and 1.8
- Georgetown Journal of Legal Ethics, “The Ethical Implications and Practical Concerns of Equity Billing”
- California Lawyers Association, “Put Your Money Where Your Mouth Is: Ethical Guidelines for Lawyers Investing in Clients”
- Colorado Bar Association, Ethics Opinion 109: Acquiring an Ownership Interest in a Client
- New Hampshire Bar Association, “Taking Stock In Your Client As Legal Fees Or An Investment”
- Major, Lindsey & Africa 2024 Partner Compensation Survey
- Law360 Pulse 2024 Compensation Report
- Carta, “Vesting Explained: Schedules, Cliffs, Acceleration, and Types”
- The Holloway Guide to Equity Compensation
