Law Practice Management Asked and Answered Blog
Category: Mergers
« Earlier | Later »Oct 10, 2018
Law Firm Merger as an Exit Strategy for Sole Owners
Question:
I am the owner of a small general practice firm in Novato, California. I have three associates working in the firm, three legal assistants, and one office manager/bookkeeper. I started my practice thirty-five years ago right out of law school. I am sixty years old and wanting to retire within the next five years. None of my associates have the ability or the desire to take over the firm. I believe that my best option is to sell my practice to another practitioner or join another firm through merger or other arrangement. I would appreciate your ideas regarding merging with another firm and how I would be compensated and receive payment for the goodwill value of my firm.
Response:
Merger or an of counsel arrangement are approaches that many sole owner firms are taking when there is no one on board that is capable or willing to buyout your interest. Often merger or of counsel arrangements look very similar in how they are structured. Typically, the owner joining another firm:
- Winds-down the firm and transitions clients to new firm.
- Retains the firm’s cash accounts.
- Collects accounts receivable and unbilled work in process on the books before the transition date through the old firm.
- Sells fixed assets to the other firm if the firm is interested in purchasing.
- Retains responsibility for any liabilities on the books before the transition date.
- Transfers trust accounts to other firm for clients that agree to have their matters transferred to the new firm.
Employees that the new firm has accepted would join the new firm and receive compensation and benefits spelled out in the merger or Of Counsel agreement.
How the arrangement will be structured and how compensation/buy-out will be structured will depend upon the size of the other firm. I assume that you will be looking at a firm similar to your size or a little larger (1-20 attorneys). If this is the case and if the arrangement is structured as a merger you would more than likely be classified as a non-equity partner and not an equity partner. While the other firm could pay you in the same manner that other non-equity partners are paid, often a special compensation arrangement is developed where you are paid a percentage of your collections and if you are lucky a referral fee arrangement for your client origination’s for two or three years after your retirement – typically twenty percent. In many cases if will be difficult to get a goodwill value payment and impossible in mergers or Of Counsel arrangements with large firms.
Another option would be an outright sale to another sole owner or small firm for a fixed price for the goodwill value of your firm and any assets the firm desires to acquire. More than likely this would be with an initial down payment and payments over a three to five-year period. Typically, practice sale agreements have provisions whereby the purchase price can be reduced if revenues fall below a certain level.
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John W. Olmstead, MBA, Ph.D, CMC
Aug 01, 2018
Law Firm Merger or Of Counsel Arrangement and Due Diligence Information from Larger Firm
Question:
I am a solo practitioner in upstate New York and I hope to retire three years from now and move to Florida and spend my retirement years there with my family. I have been talking with a larger firm, twenty-attorneys, in Albany that has an interest in me either merger my practice with their firm or joining as Of Counsel. My plan would be to work three more years, gradually phase back, and transition clients and referral sources.
I have had several meetings with the partners in the firm and they are now asking me for detailed due diligence information – tax returns, financial statements, etc. I have no problem providing these documents however I was wondering if I should be asking them for information. What do you think?
Response:
I believe that you are entitled to similar due diligence information from the other firm. You need to see what you are getting into.
Usually the smaller firm gets less – but they should share some information with you as you have with them.
I would ask for the following from them (or discuss with them):
- Five years profit and loss statements, balance sheets and tax returns.
- Lawyer and staff headcount for each of those five years.
- Current hourly billing rates.
- Description of practice area mix of clients by dollars collected – practice type and office location.
- Description of how the firm bills (hourly, flat rate, contingency)
- Copy of all leases (office space, equipment)
- Copy of malpractice insurance policy and last application.
- Salaries and benefits for equity and non-equity partners.
- Any governance plan or agreements.
- Copies of all partnership agreements or operating agreements for all business entities.
- Any documents pertaining to the retirement of partners including information as to obligations for partners who have already retired and those nearing retirement.
- Compensation data for equity and non-equity partners.
- Copy of the written compensation plan for equity partners if one exists or if not a discussion of how the compensation system works.
- Information on the line of credit and copies of all debt agreements.
- Copies of third party vendor agreements (equipment leases, subscriptions)
- Copy of the firm’s present malpractice insurance policy and most recent application.
- List of benefits provided.
I presume that you all have discussed any potential client conflicts of interest, etc.
You need to zero in whether the arrangement is going to be a merger or Of Counsel arrangement. If the arrangement is to be an Of Counsel arrangement the firm will be less likely to be willing to share all the information on the list and you will have less need as well. However, I believe you should at least have the basic financial and compensation information.
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John W. Olmstead, MBA, Ph.D, CMC
Apr 17, 2018
Subjective Law Firm Partner Compensation Systems
Question:
I am a partner in a twelve attorney commercial litigation law firm in Palm Beach, Florida. There are five partners in the firm. We are contemplating merging with another firm in the area of similar size. We have done our due diligence and have come across a possible non-starter – the compensation system. Our compensation system is totally objective – formula-based very close to an eat-what-you-kill system. The other firm has operated under a subjective system and they are pushing for the firm to operate under this type of system. We would appreciate your thoughts and enlightenment concerning subjective-based systems.
Response:
Subjective-based systems are the most commonly used approach to setting partner compensation, especially in larger firms. More and more firms your size and larger are moving to subjective systems as a result of the failure of other systems to account for the full range of contributions that partners make to the law firm. Subjective systems can take on a variety of forms but the central theme of such systems is that they rely on a subjective assessment of partner performance, without reference to specific weighting of factors or a set formula. This is not to say that subjective systems lack structure or predictability, or that they don’t consider objective financial data. Successful subjective compensation systems include these elements and more.
Subjective compensation systems vary widely. Here are some of the most common elements found in subjective systems:
- Prospective vs Retrospective System. Systems can take the approach that sets compensation at the beginning of the year by assigning relative shares of the profits and applying allocations as the profits are earned or await the end of year results before making major allocations of profits. Prospective approaches are more common than retrospective approaches. However, most prospective approaches reserve some funds for year-end allocation.
- Who Makes Compensation Decisions. Since the system is not a simple plug and play using a formula, either a person or a group must be empowered with deciding how profits will be allocated among the partners – how they will be compensated. In most firms these decisions fall upon the executive or compensation committee. Often the success or failure of the compensation system hinges on getting the right people that are trusted by all of the partners on such committees.
- Factors – What Does the Firm Reward. Most subjective systems have defined factors that the system is designed to reward. Some compensation committees have these outlined very specifically in writing and others simply communicate the factors or consideration criteria verbally prior to annual performance reviews or through general discussions of goals.
- Data Review. The better subjective systems review financial performance data for each partner and subjective data for each partner often in the form of performance evaluation or peer review.
- Client Origination. Some firms consider client origination as a direct factor, others simply track client origination, and yet others do not track it all all.
- Point Structure. May firms use a point structure in which partners are moved up or down depending up their performance.
- Bonus Pool. Bonus pools are often used in such systems to reward exceptional performance.
In additional to subjective compensation systems some firms used hybrid systems that employs objective (formula) and subjective components.
Subjective systems are not for all firms. They will fail with out strong, trusted, leadership. In very small firms it is difficult to structure a compensation decision making body.
It sounds like your firm and the firm you are thinking of merging with may come from two very different cultures. Subjective systems work well for firms that are “firm first” firms but not for lone ranger firms that often operate under eat-what-you-kill systems. If you firm is not a long ranger firm and your are in fact a “firm first” firm or aspire to be such you may be able to adapt to a subjective system. However, you may need a post-merger phase-in period. Another comprise approach might be a hybrid system.
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John W. Olmstead, MBA, Ph.D, CMC
Nov 22, 2017
Law Firm Growth – Partnership/Merger
Question:
I am the sole owner of a six attorney energy law practice in Houston. I have had my practice for twenty years and have enjoyed the independence of being the boss but I am tired of being solely accountable for the success of the practice, having to do all the management, and having all the worry and stress. I believe I have reached the point where I am ready for a partner or partners and I believe that the practice can be positioned for growth if I bring in a lateral partner, make a couple of my associates partners, or merge with another firm. I welcome any suggestions that you may have.
Response:
Whether you bring in a lateral partner, elevate your associates to partnership, or merge this will be a major step for you and you will need to do some serious soul searching. Here are some general thoughts:
Partnership is like a marriage. You must marry the right person or persons. Most partnerships that fail do so as a result of partnering up with the wrong partners. Compatibility is critical. Consider:
- Long term goals of both parties
- Work ethic computability
- Common interests
- Money and compensation
Thinking of merging? Research indicates that 1/3 to 1/2 of all mergers fail to meet expectations due to cultural misalignment and personnel problems. Don’t try to use a merger or acquisition as a life raft, for the wrong reasons and as your sole strategy. Successful mergers are based upon a sound integrated business strategy that creates synergy and a combined firm that produces greater client value than either firm can produced alone. Right reasons for merging might include:
- Improve the firm’s competitive position. Increase specialization – obtain additional expertise.
- Expand into other geographic regions.
- Add new practice areas.
- Increase or decrease client base.
- Improve and/or solidify client relationships.
Reasons for wanting to merge and your objectives. Ask yourself the following questions?
- Do you want to practice in a large firm? If not, what is the largest firm that you would want to practice in?
- What is driving the desire to merge?
- If the desire to merge is being driven by a desire to retreat from internal problems – what have you done to address these issues internally?
- Is your name being part of the firm name important to you?
- What are your expectations and objectives for a merger?
- What are you looking from a merger partner?
- Make sure that you look for a complimentary fit. If you are weak in firm leadership, management and administration – look for a partner that is strong in these areas. Strong leadership, management, and administration may be hard to find in a firm under 25 attorneys.
Partnering up with others can be a great move for you if you make the right people partners for the right reasons or merge with the right people for the right reasons. Due your due diligence and your homework.
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John W. Olmstead, MBA, Ph.D, CMC
Oct 18, 2017
Law Firm Merger – Pitfalls to Avoid
Question:
I am a partner in a twelve attorney firm in Rockville, Maryland. We are a corporate transactional and litigation firm. We are a first generation firm. The firm was founded by the present four equity partners twelve years ago. We have been very successful over the years and this is borne out by out by our excellent financial performance. While we have done well in our core practice areas we have been considering diversifying our practice into government sector work due to our proximity to Washington D.C. and we have been considering merging with a six attorney (three partner) firm in D.C. that is totally focused on such work. Can you share with us any pitfalls that we should look out for.
Response:
It sounds like this might be an opportunity if the cultures and people are compatible, the practice area makes sense for your firm, there are no conflicts, the billing rates, and other factors are in line. Start getting to know the firm and its people. Then move to conflicts checks and ask for five year’s of financial statements and tax returns, internal financial reports, attorney and staff compensation data, partnership agreement and other partnership documents, schedule of billing rates, client lists, copy of building and equipment leases, and malpractice applications. Assess the stability of the revenue stream, repetitive ongoing clients, client dependency, etc. Make sure there are no pending malpractice claims or other liability issues.
Obviously you will want to do all the due diligence that you can. Initially examine and make the following calculations:
- Headcount by the number of equity partners, non-equity partners, associates, Of Counsel and other attorneys, paralegals, secretaries/assistants, and admin staff.
- Fee Revenue
- Total Revenue
- Total Expenses
- Net income available to equity partners. (Add back guaranteed payments and other income that equity partners received)
- Profit Margin
- Fee Revenue per Lawyer
- Fee Revenue per Equity Partner
- Expense per Lawyer
- Net Income Per Lawyer
- Net Income Per Equity Partner
- Schedule of billing rates (current only)
- Compensation ranges by Equity Partner, Non Equity Partner, Associates – past five years
- Current malpractice insurance coverages and with whom.
- Current Lease obligations – office space and equipment
Examine the balance sheet items such as bank debt, large tapped out credit lines, equipment leases and other liabilities. Take a look at the partner capital accounts. Then examine the items that are not recorded on the balance sheet – namely unfunded partner retirement buyouts and long term real estate leases. What are the ages of the partners in the candidate firm and are there partners close to retirement? What are their provisions for retirement of these partners? These are often major deal breakers in mergers and scare away potential merger partners.
Keep in mind that the financials are only part of the equation – the other part your gut feel. Does the potential deal make sense? Will one plus one equal three – will a synergy result? Do you feel comfortable with the people (partners) in the other firm? Do you share common vision and philosophies and will you make good partners?
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John W. Olmstead, MBA, Ph.D, CMC
Aug 30, 2017
Law Firm Practice Acquisition – Acquiring a Personal Injury Practice
Question:
I am a non-equity partner in a four attorney personal injury plaintiff law firm in Newport Beach, California consisting of the firm owner, two associates, and myself. The owner is planning on retiring and has provided me with a proposal to sell me his practice. How do I determine whether this is an opportunity or a potential curse? You advise is appreciated.
Response:
I would start by asking yourself if you have the desire, inclination, and ability to manage a business – a law firm? Do you have the self discipline required? Do you have the needed capital or access to appropriate level of credit line? A personal injury firm will have to fund client advances as well as operations until cases are brought to conclusion and this will require capital or a credit line. I would check with the firm’s bank and other banks to see if you will be able to obtain the same credit line that the firm has enjoyed in the past.
Ask the owner for the following documents:
- Income tax returns for the past five years.
- Profit and loss statements for the past five years.
- Balance sheets for the past five years.
- Headcount expressed as full-time equivalents for the past five years by year for attorneys, paralegals, legal assistants, staff.
- Firm lease if the firm leases office space.
- A spreadsheet listing of all open cases providing the name of the case, the date opened, type of case, expected value of the case, expected referral fees due others, expected fee due firm, client advances invested in the case, and date the case is expected to conclude and fees will be received.
I would then prepare a firm financial profile spreadsheet spreading the revenue, total expenses, net income, owner earnings, and balance sheet summary over the five year period. Using the headcount data calculate fee per lawyer, expense per lawyer, and net income per lawyer and compare to general benchmarks. Hopefully fee revenue is in neighborhood of $400,000 or more per lawyer. Examine what the owner’s earnings have been over the five year period as well as the assets and liabilities on the balance sheet. Keep in mind that accounts payable and the firm lease are not usually reflected on a case-basis balance sheet. Consider the information that you have gathered and ask yourself the following questions:
- Has the firm been successful and well managed?
- Are revenues in line with what a four attorney personal injury firm should be generating?
- Is the firm’s overhead in line?
- How much additional income can I expect over the next five years?
- What is my “payback” period – in other words if I pay X for the practice how many years of extra income as an owner will it take me to pay for the practice?
- Considering what I have to pay for the practice, could I do better by starting my own practice?
- Where are the firm’s cases coming from and what is the quality of the existing cases in process?
- What level of case flow can I realistically expect when the owner is no longer here?
- Using the open case listing, what do the future cash flow projections look like?
- When the owner leaves will you have to hire another attorney? What level?
- How much debt does the firm have?
- What is the remaining lease obligation – term and amount?
This review will give you a good idea of whether this is a deal that makes sense for you.
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John W. Olmstead, MBA, Ph.D, CMC
Jul 04, 2017
Law Firm Merger Agreement
Question:
Our firm, a fourteen-attorney litigation firm in Sacramento, California, is planning on merging/acquiring a three-attorney firm in the area. We have completed our due diligence and both firms have agreed on the terms of the merger. What type of agreement and legal documents do we need to effect and implement the merger?
Response:
If business law is not your forte you may want to consult with a business attorney to determine the appropriate legal agreements that should be used to effect the merger. The agreement may be as simple as a Letter of Intent signed by the two law firms, a Memorandum of Understanding, or as formal as a merger agreement covering the major details and terms of the merger which have been approved by required vote of the partners of both firms including:
- Merged firm name
- Effective date of the merger
- Method of integration, assets and liabilities contributed by each firm, and whether accounts receivable and work in process will be pooled and contributed
- Management and governance structure and names of partners from each firm that will hold key management roles/positions
- Compensation system for partners, non-equity partners, associates, and staff
- How employee benefits will be handled and integrated
- Capital contributions
- Employees and their respective roles in the merged firm
Typical exhibits to agreements often include:
- Employee Benefits Summary
- Asset/Equipment Purchase Agreement
- Employee Roster and Wage Rates
- Proforma Balance Sheet
- Proforma Income Statement
- Partner Compensation Plan
- Non-Equity Partner Compensation Plan
- Associate Attorney Compensation Plan
- Staff Compensation Plan
- Attorney Career Advancement Plan
- Office Lease
- Partnership Agreement
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John W. Olmstead, MBA, Ph.D, CMC
Mar 10, 2017
Law Firm Merger – Are We a Suitable Candidate
Question:
Our firm is a two partner firm in Columbus, Ohio. We have two staff members. There are no other attorneys in the firm. We have been in practice together for seventeen years. I am sixty two and my partner is in his fifties. My practice is limited to intellectual property and my partner’s practice is limited to medical malpractice defense. Recently, as a result of lack of coverage, our unwillingness to hire associate attorneys, and our frustrations with dealing with management issues we have decided that we would like to merge with a larger firm. However, we are concerned that our numbers may not be satisfactory. Our five year averages are as follows:
- Gross Revenue – $500,000
- Expenses – $240,000
- Net Income – $260,000
Since we split the pot evenly we each made $130,000 on average.
With these numbers are we a suitable candidate or are we just whistling in the wind? We would appreciate your thoughts.
Response:
Obviously these are not great numbers. Depending on firm size and type of practice – most firms (small firms) are looking for revenue per lawyer in the range of $360,000 and up. Many firms are looking for books of business that will keep the candidate and an associate busy – $750,000 plus.
However, law firms are also looking for new sources of business (clients) and lawyer talent. There are firms out there that have the work and need help with the work and might be interested in your talent and skills as well as the clients that you could bring in. You may not be able to join the firm as an equity partner but may be able to join as a non-equity partner. (Depends on firm size) Due to the very different practice areas that each of you have you may not find opportunities in the same firm.
I encourage you to look around, start your search, and see what happens.
I have seen many situations similar to yours that have resulted in successful mergers and lateral or Of Counsel positions.
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John W. Olmstead, MBA, Ph.D, CMC
Aug 31, 2016
Law Firm Lateral Growth Strategy – One Plus One Equals Three
Question:
Our firm is a sixteen lawyer firm – eight partners and eight associates located in Memphis. We handle business transactional work and litigation for small to mid-size companies. However, for the past forty years our mainstay has been small community banks. With recent bank mergers and new banking regulations our banking business has dropped off significantly. We have reached a desperate stage and we must replace this business quickly or consider possible dissolution. We have talked with a possible lateral partner that has a $300,000 book of debtor bankruptcy business. Is adding a lateral partner a good strategy for us?
Response:
Lateral partner acquisition is a growth strategy being used by many firms today. However, many lateral hires are not successful as a growth strategy. In a recent survey conducted by Lexis-Nexis and ALM Legal Intelligence only 28 percent of the respondent law firms found lateral partner acquisition a "very effective" strategy for growth.
I suggest you start with the following two questions:
- Does the lateral candidate's book of business fit within your strategic plan? If you do not have a strategic plan develop one. A strategic plan can be a useful guide in keeping the firm focused on the right opportunities. It can help the firm clarify the type of work that it does not do.
- Does One Plus One Equal Three. This question should be asked when considering any lateral or merger candidate. In other words is there is business case? How will the addition of the lateral result in more business than either the firm or the lateral currently has separately? Does the lateral have enough business to keep himself or herself busy plus a couple of associates?
I would question whether debtor bankruptcy fits within the firm's overall business strategy. I also don't believe a $300,000 book of business satisfied the one plus one equals three rule.
A lateral strategy may be a good strategy for the firm. However, I believe you need to expand your search and it may be difficult to attract candidates given your present financial situation.
Aug 24, 2016
Law Firm Acquisition – Acquiring Another Practice
Question:
Our firm is a twelve lawyer firm in Austin, Texas. We have been approached by the owner of a three attorney firm in an adjacent city who has a complimentary practice consisting of institutional business clients. He is looking to retire within the next thirty days and he would like us to acquire his clients. We have reviewed his practice and we would be willing to take over his clients but not his personnel or other fixed assets. He has no interest in a merger or an lengthy relationship with us. It could add $800,000 per year to our practice. We would appreciate your thoughts.
Response:
It sounds like a great opportunity if there are no conflicts, the clients actually transition, and the billing rates are in line. Start with conflicts checks. Then ask for five year's of financial statements and tax returns, internal financial reports, schedule of billing rates, client lists, copy of building and equipment leases, and malpractice applications. Assess the stability of the revenue stream, repetitive ongoing clients, client dependency, etc. Prepare a letter of intent with terms for acquiring the practice. I would lead with a down payment of say $25,000 and then a percentage of collected revenue for say five years at 20% and see how he responds. He will want more certainty and a fixed price. If you have to go with a fixed price to seal the deal structure it with an initial down payment, payments over three to five years with provisions for reduction in the purchase price if the clients and revenues don't materialize. Make sure there are no pending malpractice claims or other liability issues.
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John W. Olmstead, MBA, Ph.D, CMC
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