Law Practice Management Asked and Answered Blog

Category: Practice Sale

Sep 30, 2020


Law Firm Sole Owner Looking to Retire Next Year Looking for Options

Question: 

I am a solo practitioner in Southern Indiana. I have been practicing law for 43 years and I want to retire next year. My practice is a general practice firm although approximately 80% of my work is estate planning and estate administration. I am the only attorney in the firm and I am assisted by one paralegal that has been with the firm for twenty years. She plans on working for another ten years or so and will need a future home. I am not sure whether there is any practice value, whether I should just close the practice, or whether another attorney or law firm might be interested in my practice. Your advise would be greatly appreciated.

Response: 

A practice review would be required to determine the potential value and marketability of your practice. If your firm has generated adequate revenues, net earnings, and a diversified base of clients and or referral sources your practice should have an appeal to another attorney or law firm. The key question as to whether there is a goodwill value is whether future cash flows will continue from your clients and referral sources after you exit the practice. It has often been said that clients hire the lawyer – not the law firm. However, a well planned client transition with the new acquiring attorney or law firm can increased the odds of success.

I would only consider closing the doors and shutting down your practice as a last resort option. You will not receive any value for the sweat equity that you have invested in the firm or a home for your clients/referral sources and your paralegal. Before considering this last resort option I would begin a search for other candidate attorneys that you might be able to sell your practice or law firms that you might be able to merge with or join up with in an Of Counsel arrangement. An Of Counsel arrangement is often a solution in your situation. In essence you winddown your practice operation, bill out your work in process and collect your receivables, and take your clients and employee over to the other firm. After joining the other firm you work as long as agreed to and you:

  1. Transition your clients
  2. Integrate your practice
  3. Transition your employee
  4. Work until you are ready to retire
  5. Retire

Typically you will be paid under an eat-what-you-kill system based upon your fees collected based upon, working and originating attorney, while working at the firm and sometimes receive a goodwill value based upon a percentage of your client origination fees collected (past and future clients) after your retirement for three to five years.

Joining another firm would be a better option than shutting down if you can find the right fit.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Jul 01, 2020


Law Firm Acquisitions – Acquiring a Senior Attorney’s Practice

Question: 

I am a partner in a small law firm in Northern Virginia. We are a four attorney firm with two equity partners and two associates. We are interested in acquiring a solo practitioner’s practice that is 60 years old and ready to retire. What are the issues that we should be concerned with before we spend a great deal of time on this matter?

Response: 

I understand your concern and reason for asking for my thoughts. You must immediately determine the nature of the clientele that you would be acquiring and whether the seller is interested in remaining with the firm for a period of at least one year so your firm can become acclimated to the new clients. If the firm’s clientele are older, what would be the reaction if they were represented by younger attorneys? People chemistry is very important. It has often been said that clients hire the lawyer and not the firm. While this is not totally true – there is some truth in this statement. A successful client transition and retention is crucial.

If the sole practitioner is interested in selling out and leaving the area, then you may consider proceeding with the transaction with payments which would be based upon subsequent collections during a period of years after the acquisition. In other words, the more the seller participates during the first year to retain certain clients, the more the set we would receive.

The worst scenario is if the seller dies unexpectedly after signing the agreement. This recently happened one of our clients, and they had to spend a great deal of time and effort trying to retain clients that they had never had contact with.

You must also review the financial records to determine the profitability of the practice. Many sole practitioners do not keep adequate time records, don’t have automated practice management systems, and are not paperless. What is the shape of their client files and how well are they organized? Certain data is stored in their heads. In many cases, the hourly rates are low and could be raised during the first year to make the practice more profitable. However, this increase must be one that will be accepted by the client. The next question would be whether family members are involved in the practice, if they are, there may be problems in the future. The clients know the family, and if there are any remaining family members working in the firm, they may leave the your firm empty-handed. For example, if a paralegal who is a family member leaves the firm after the merger is consummated, several clients could follow the paralegal to their new place of employment. In such situations I have had client law firms that have had such persons execute non-compete agreements. In one situation the deal was aborted by the acquiring firm due to the paralegal not willing to sign a non-compete agreement. This was a situation where the paralegal in the firm actually had the client contact relationship. The owner’s contact with the client was limited. The paralegal had the relationship.

Finally, there should be other safety valves for the purchaser in acquisition of this nature. On a positive note, the situation could present a fine opportunity for growth. Just ensure that the  buy sell and other legal agreements provide the appropriate safeguards.

The above issues such as non-compete and practice sale agreements should be addressed with your business attorney.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Nov 08, 2018


Selling an Owner’s Law Practice to an Associate Gradually

Question: 

I am the owner of an elder law firm in Phoenix, Arizona. I have one full time associate, one part-time associate, and three staff members. I am earning around $300,000 a year from the practice and my full time associate’s salary is $100,000 a year. I am sixty and would like to retire and be out of the practice in five years. I would like to begin phasing down and working part time in the next year or two. My full time associate has been with the firm for ten years and she is an excellent attorney and has an excellent relationship with our clients and referral sources. While she has not brought in many clients through her own referral sources she has done an excellent job signing up new clients from the firm’s referral sources, website, and seminars that she has conducted. I have talked with her in general terms about her buying my practice when I retire and she has expressed an interest.

I feel that I should be entitled to some sweat equity from the practice in the form of retirement compensation or buy-out. With this said I would prefer that my practice “stay in the family” and be sold to my associate rather than selling my practice to an outside buyer. I would appreciate your suggestions.

Response: 

One of the issues today with many associates is they have large student loan debt and have little in the way of capital and little or no borrowing capacity. As a result many firm owners in your situation have to get much of their payout from future earnings after their retirement if they wait too long. Your best bet is to start selling shares as soon as you can based upon a valuation method that you determine. You have five years remaining – ten years would have been better. In essence you determine the value of the firm, determine the price per share, determine how many shares that associate will acquire, and then calculate the price for the number of shares being acquired. For example, let say you practice is valued at $600,000. Divide by 100 = $6,000 per share or percentage point. For an initial twenty percent interest or twenty shares the buy-in price would be $60,000. Then over the next five years gradually sell the associate additional shares. Upon your retirement you would have sold all of your shares.

Typically the problem is the associate does not have any cash or ability to borrow on their own. You may be able to help the associate borrow the money from your bank. If you can – this would be the preferred approach. If the associate cannot raise the capital they you will have to finance the buyout. For a $600,000 buyout a five-year timeline will be impossible for you to have all your cash by retirement. How you structure your compensation as you begin working part time and your associate’s compensation as a partner will have a bearing on capital that your associate will have available. Be careful that you are not funding your own buyout. You will more than likely have to get a large portion of your payout after retirement via a secured promissory note with the associate for the balance.

The sooner you start the better your chances for a successful outcome.

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John W. Olmstead, MBA, Ph.D, CMC

Sep 05, 2018


Law Firm Valuation – Factors that Effect Firm Value

Question: 

I am the owner of a small estate planning firm in Kansas City, Missouri. I have two associates and four staff members. I am considering acquiring a small (solo) practice in a nearby community. I have read some of your articles as well as your book on succession planning and valuation, and the multiple of gross revenue used to establish a goodwill value for a law firm. What are some of the factors that can impact whether the multiple is higher or lower – a firm’s potential value?

Response: 

While multiples of gross revenue is a common approach, a key ingredient should be the profitability picture before distribution to owners. In other words, what is the quality of earnings? A firm that nets fifty percent of gross revenue would generally command a higher price that a firm that nets twenty-five percent. Factors that should be considered in determining a firm’s potential value are:

  1. Quality of Partner Earnings
  2. Quality of Personnel
  3. Strategic Location
  4. Nature of Clientele
  5. Practice Areas
  6. Fee Structure
  7. Hours Managed by Partner
  8. Investment in Office Facilities
  9. Investment in Technology
  10. Quality of Services per Client Satisfaction Reviews
  11. Firm Stability

The average partner or owner earnings figure is the critical component. If the average partner/owner’s income is low, normally the practice is not worth much. A good business person will not pay for a business and pay a premium when it cannot be justified.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Jul 11, 2018


Law Firm Goodwill and Valuation

Question: 

I am the owner of a six-attorney litigation firm in San Francisco Bay area. I am sixty and starting to give though to gradually transferring my interest to associates in the firm. I have heard other attorneys mention that I should get some goodwill out of my practice. I would appreciate your thoughts.

Response: 

Many law firm owners prefer to leave a legacy and keep the firm “within the family” and transition the firm to non-equity partners or associates in the firm at a discounted value and buy-in as an incentive to stay on with the firm and a reward for their years of dedication to the firm.

Some law firms – typically second generation or later firms – allow non-equity partners or associates to become equity owners with no buy-in whatsoever. The thought being that the real assets of the firm are its talent – its people and the firm’s priority is to retain and keep the best talent that it can. These firms also do not have hefty buy-outs for partners or shareholders leaving the firm other than possibly the initial founders of the firm. Over the years, such firms fund retirement through 401ks, profit sharing plans, and other mechanisms. When partners or shareholders leave the firm, they get their cash-based capital account, or share of retained earnings and their share of current year earnings.

A “founders benefit” is sometimes put in place for firm founders in which they may be paid a share of the accrual-based capital or retained earnings – WIP and A/R. They may also be paid a goodwill value as well either in the form of a multiple of earnings or a specific sum based upon a multiple of gross revenue.

The problem in many firms is that associates are still paying off student loan debts and they don’t have cash available to purchase the owners interests. As a result, if you don’t start early, the cash often has to come from future cash flows that are available after the owner leaves the firm from the compensation that the owner is no longer receiving.

You need to start early, get people committed and start selling affordable minority shares years before you retire so you can get at least half of your ownership interest paid for before you leave the firm and the other half paid out over a five-year time period.

Wait too long and your associates may feel they can just wait you out and inherit your clients without having to pay you anything.

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John W. Olmstead, MBA, Ph.D, CMC

Mar 21, 2018


Law Practice Acquisition Proposal

Question:

I am a partner in a three partner six attorney in Chicago. We have been having discussions with another law firm in the city regarding us acquiring their practice. The owner is seventy years old and wanting to retire and exit his practice. My partners and I have looked over the numbers and believe this would be an excellent opportunity for us to expand our client base. The practice handles the same type of work that we do. We are unsure what our next step should be? Do you have any suggestions?

Response: 

I would start by asking for all the due diligence information that your can get your hands on. For example:

  1. Profit and loss statements and balance sheets for the past five years
  2. Income tax returns for the past five years
  3. Copy of office lease
  4. Copy of all equipment leases
  5. Copy of most recent malpractice application
  6. Equipment and furniture inventory list
  7. Personnel list with current compensation and benefits paid, length of time with the firm, current job duties, etc.
  8. Information pertaining to benefits offered employees.
  9. Copies of marketing and business plans.
  10. Reports showing billable hours, fees collections by timekeeper, etc. for past five years.
  11. Reports showing fees collections by clients and practice areas for past five years.
  12. Current work in process and accounts receivable report.

Insure that you have done a thorough conflict of interest check and insure that you review the Illinois rules of professional conduct concerning sale of law practice. Give consideration to the value of the firm and what you are willing to pay for it and how? What assets do want to purchase – just the goodwill or will fixed assets be included? What about work in process and accounts receivable? Is there a building involved and if so do you want to purchase the building and real estate? Do you want to take on any of the employees? Do the numbers work for you? What terms would be acceptable to you?

The next step is to prepare and present a proposal. Some of the following elements would be included in a proposal:

Once you have prepared the proposal present it to the owner of the firm and go from there.

Click here for our blog on succession

Click here for out articles on various management topics

John W. Olmstead, MBA, Ph.D, CMC

 

 

 

 

 

 

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