Article 5/6: Choosing an Internal Equity Transfer Model: Goodwill Firm or Lockstep Firm?
When a law firm chooses internal succession, it must decide how ownership will move from one generation to the next. The model matters because it affects affordability, retirement outcomes, partner behaviour, financing, control, and the firm’s ability to attract future equity partners. Two common approaches are the goodwill firm and the lockstep firm. Each can work, but each creates different incentives and risks.
In a goodwill firm, the departing partner’s equity has a value that is bought by incoming or continuing owners. This model is commercially familiar: value the firm, agree the outgoing interest, decide whether the transfer is staged or immediate, and settle payment terms. For the exiting partner, this can provide a clear capital realisation event. For the incoming partner, however, the challenge is funding. They may need to borrow, rely on vendor finance, accept staged acquisition, or use a structure within an incorporated practice that separates salary and dividend rights.
The entry mechanics need to be carefully designed. Will the incoming partner acquire the same percentage as the exiting partner, or a smaller initial share? Do existing shareholders have first rights? Are other owners comfortable with the dilution or change in control? How will the purchase be financed, and what happens if the new partner leaves early? These questions should be answered before emotions and expectations harden.
Exit mechanics are just as important. A staged exit may allow the outgoing partner to reduce working days while retaining some equity for a period. Salary can be apportioned to working days, while equity rights continue or taper according to the agreement. This may support client transition, but only if the commercial terms encourage the outgoing partner to transfer relationships rather than preserve dependence.
A lockstep firm takes a different approach. Instead of requiring incoming partners to buy a large goodwill interest upfront, partners move through a points system over time. A full parity partner may hold a set number of points, while an entry partner starts with fewer points and receives incremental increases each year. Profit is then distributed by reference to points. This can make entry more affordable and may help the firm attract talented younger partners who are not willing or able to pay a large goodwill price on day one.
Lockstep can also simplify exit if the system is already embedded. A retiring partner’s points can reduce over time, and profit share can fall accordingly. The firm may require a contribution to working capital, and it may decide whether outgoing partners receive repayment of working capital on exit. Performance gates can also be used so that progression through the lockstep is not automatic where contribution, capability, or conduct falls short.
However, lockstep does not eliminate difficult questions. If existing equity partners have built up goodwill value, they may expect to realise it. The firm then needs to decide whether current partners are paid goodwill now, whether the value is quarantined, whether the firm borrows to fund the payment, and who ultimately services the debt. These decisions can affect future profitability and may be sensitive between generations.
The right model depends on the firm’s history, profitability, culture, cash flow, partner age profile, appetite for debt, and ability to attract successors. A goodwill model may suit firms where ownership value is clear and incoming partners can fund acquisition. A lockstep model may suit firms that want a more gradual, accessible pathway to equality and an easier long-term entry and exit mechanism.
Whichever model is chosen, the key is transparency. Partners need to understand how value is calculated, how entry works, how exit works, how salaries and dividends are treated, and what happens when performance or timing changes. Internal succession succeeds when the financial architecture supports the human transition rather than undermining it.
Sam Coupland
Director, FMRC
E enquiries@fmrc.com.au