Question:
I and another partner are the owners of a seven lawyer family law practice in Chicago suburbs. We started the firm twenty years ago after leaving behind a partnership in another firm. Of the other five attorneys there are three non-equity partners and the rest are associates. I am sixty three years old and my other partner is sixty. Both of us are beginning to think about retirement and how we are going to transition out of the practice. Two of the non-equity partners are well seasoned attorneys, have major case responsibility, and bring in client business. We have discussed equity partnership vaguely with two non-equity partners but they have been non-committal. I would appreciate your thoughts and advice on what our next steps should be.
Response:
I believe that you have been two vague in your discussions. Your non-equity partners need to know what the deal is, what financial investment will be required, and what their expected return will be based upon the historical financial performance of the firm. It is hard for non-equity partners or associates to commit to equity and taking on the risk of ownership when they don’t know what the deal is. This is a scary proposition for them and they need detailed information so they can evaluate and make an informed decision. A vague discussion doesn’t cut it. I suggest that you put together an equity partnership proposal that includes:
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am the sole owner of a twelve-lawyer defense litigation practice in Chicago. We represent automobile manufactures and have approximately ten major clients. I am the only equity partner in the firm and all of the other lawyers in the firm are associates. Two associates are seasoned lawyers with substantial experience and have been with the firm for many years and the other nine have less than five years experience. The two seasoned associates are in their mid-sixties. I am sixty-eight. I just realized that the firm’s office lease expires in eight months and I have decided that this is a good time to retire. I will not sign another lease and I would like to be completely retired in the next six months. My wife has some health issues and I need to devote my total time time to her. I have talked with the two senior associates and they plan on retiring as well. Therefore, I will have to either close the firm or find another firm interested in taking over the firm. Have I waited too long?
Response:
Possibly so. Eight months is a very short timeline to locate another law firm that might be interested in acquiring or merging with your firm. However, this is not always the case. I have had situations where interested parties were located in a month or two through cold approaches, discussions held, details worked out, and the transaction concluded within six months. If you have a few firms in mind that you could approach the process could go much quicker than if cold approaches have to be used. So your timeline is not impossible but you need to get started yesterday. Keep in mind that client transition is paramount in the success of such arrangements and usually the acquiring firm wants a transition period, often of a year or so in which you work at the firm in a consultant capacity to assist with client relationship management and transition. Therefore, you might have to stick around in an Of Counsel role for a year or two.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am one of three founding partners in a fourteen lawyer firm in Cleveland, Ohio. We are an insurance defense firm with three founding partners, five non-equity partners, and six associates. We have three primary insurance companies that refer a majority of cases to the firm. All three of us founding partners are in our early to mid sixties and contemplating our retirement and departure from the firm in the next five to eight years. Our lease runs out in eight years and none of us want to sign another lease. Three of our non-equity partners are in their mid to late fifties and two are in their forties. All of our associates have less than five years experience. When and how should we begin planning for our retirements and exits from the firm?
Response:
I suggest that you start now, especially if you are planning on an internal succession strategy. I believe that an internal succession should be your first step if you have the right people in place. When a firm has institutional clients such as you do with many different relationships within each client organization it can take time to transition relationships to the next generation of attorneys in the firm to ensure that clients stay with the firm when you retire. Transition to the next generation of attorneys usually involves legal skill development, management skill development, and client transition. We often recommend five years.
If you are looking for a buy-in for new equity partners you need sufficient time so new equity partners can pay for their initial ownership interests over time and acquire additional interests as they can afford to acquire more. Waiting too long can also create a situation where non-equity partners in the firm feel they can simply wait your out and inherit the clients without paying anything, or very little, for their ownership interests or buy-in/buyouts. Consider making a few folks minority equity partners as soon as you can.
This assume that any of your non-equity partners even want to be equity partners in the firm which is often the case these days. Three of your non-equity partners may also be close to retirement themselves and have no interest in stepping up to equity. If this is the case you will have to focus on the other two non-equity partners. I would begin a dialog with all of your non-equity partners to determine their interest level. At some point you will not really know until you present them will a proposal and appropriate financial information – initial buy-in if there is to be one and founding buy-outs if there is to be such.
If it looks like the interest or commitment level is not there in your non-equity partners you may have to consider an external option such as a merger. The timeline often can be much shorter in such situations.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm is an eight lawyer litigation firm in Portland, Oregon. We have three founding equity partners in their early sixties and late fifties, three non-equity partners, and two associates. Recently the equity partners began succession planning discussions among ourselves. Our preference would be an internal succession and transition to the younger non-equity partners in the firm. In our discussions we were discussing buy-in, buyouts, and valuation and one of my partners suggested obtaining a formal valuation. What are your thoughts regarding hiring a business appraisal firm to provide us with a formal appraisal/valuation of our firm?
Response:
While I don’t wish to downplay a formal valuation, they can be expensive and I find often not really used in the final outcome, especially when it involves selling partnership interests to others within the firm.
Most law and other professional practices sell (to outside parties) for a multiple of annual gross fee income. Often this is discounted (sweat equity discount) when assets or shares are sold to other attorneys within the firm. Generally, this rule-of-thumb method of valuing a law practice is used to value the practice. However, the eventual value of a law practice comes down to what an interested party is willing to pay. In the final analysis the value of the practice is what an outside buyer or an attorney working for the firm will pay for (or invest) the practice. The valuation process is simply a tool to use to help you begin discussions and get to this point.
Many law firms with multiple partners view the law firm simply as a compensation vehicle designed to put as much income as possible in the pockets of the partners. They do not see the firm as an investment vehicle nor do the partners expect unfunded buyouts when they retire or otherwise leave the firm. These firms try to fund retirements with 401k and other retirement vehicles so there is no unfunded buyout upon retirement. The goal of these firms is to be in a position to acquire and retain top lawyer talent. Often these firms simply require an initial capital contribution and return cash-based capital accounts and earnings to date upon withdrawal or retirement. Sometimes a founder benefit is provided for the original founder(s) of the firm as a reward for their sweat equity establishing the make and making the initial investments. Such founder benefits are often a percentage based on an average of a founder’s compensation over the past three years.
Value in a law practice is largely personal to the lawyer and that individual’s ability to attract and retain clients. The lawyer has knowledge, experience, skill, judgment, and reputation—all elements of professional goodwill – not institutional or firm goodwill. As long as clients primarily hire lawyers, as opposed to firms, this will remain a guiding principle in valuing law practices. This is not to say that some firms have not created a “brand identity” that is separate and distinct to the institution. And in larger practices, the servicing team (including other partners and other practice specialties) influence the client’s selection decisions. Those firms are rare.
Often when selling partnership interests to others in the firm affordability and terms plays a larger role than valuation.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm is a twelve-attorney insurance defense firm based in Indianapolis, Indiana. The firm was founded thirty years ago by myself and two other partners. We represent approximately twenty-five insurance companies. Our lawyer headcount consists of three equity partners, four non-equity partners, and five associate attorneys. My partners and I are in our early sixties and just beginning to think about retirement. Two equity partners will retire in the next five years and the third is not sure of his timeline. We would really like to see an internal succession as opposed to a merger with another firm. We have yet to have any discussions with our non-equity partners and their interest in equity ownership. Frankly, we have never promoted any non-equity partners to equity partnership because none of them bring in any business and we have always thought this should be a prerequisite to equity partnership. Your advise and thoughts are most welcomed.
Response:
I believe that for an internal succession strategy to be successful you have to start the transition early and the best way to accomplish this is to begin admitting others to equity partnership sooner than later, especially if you are expecting a founder benefit or buyout. While I believe that business development should be a major consideration when admitting equity partners this may not apply in your situation. If your non-equity partners are good minders, have solid relationships with your insurance company clients, and can hold the clients after the three of you retire this may be more than adequate for a successful succession strategy. I have worked with numerous insurance defense firms that are in their second generation totally serving clients that were originated by the original founders. Keep in mind that you are looking for an exit strategy.
By starting early and admitting them sooner than later you can implement a client and management transition strategy and determine if they are willing to buy-in and purchase an initial minority interest as well commit to purchasing your remaining ownership interests or paying your founder benefits.
The three of you should be giving some thought as to your financial expectations keeping in mind that valuation of the firm must be balanced with affordability and future equity partners ability to financially handle the buy-ins and buyouts.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am the sole owner of a litigation firm in San Antonio, Texas. In addition to myself I have two associates and three staff members. Both associates have been with the firm over five years. I am 66 and am just starting to think about my exit plan down the road. While I am not in a hurry to retire or work less I believe that I should at least be thinking about my options. I would appreciate your thoughts.
Response:
I agree that you should begin planning for your eventual retirement and exit from the practice. Anytime a sole owner has associates on board I believe that an internal transition of the practice to those associates should be the first option explored. It can benefit your associates, your staff, and your clients. External practice sales, merger, and Of Counsel arrangements with another firm can be explored after you have explored the feasibility of transitioning your practice to your associates. This assumes that they even have an interest in owning a law firm. Often we find that they don’t.
You should begin exploring whether your associates have such an interest and you may want to consider selling them each a minority interest now so they don’t become dissatisfied and leave the firm and you empty handed. I don’t think I would wait until you are ready to exit the practice to offer them a partnership interest. Partnership is an important career marker for associates and many will move on if they feel their careers are stagnated and they are not advancing.
If you decide to offer them a partnership interest and they accept begin injecting them into client relationships and firm management. This will help ensure a smooth transition when you retire and exit the practice.
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John W. Olmstead, MBA, Ph.D, CMC
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:
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
Question:
I am a member of the executive committee of a fourteen attorney firm in Houston, Texas. We have ten partners and four associates in the firm. Seven of our partners are in their sixties and we have done nothing to prepare for the succession and transition of our senior partners and have concerns whether we will be able to continue as a firm. Where and how do we start?
Response:
You need to begin to have some serious discussions with your senior partners as to their retirement goals and timelines and determine how close together their exits will be. Can the remaining three partners hold and serve the clients? How experienced and senior are your associates? I suspect that you will have a large talent gap and you will need to either bring in some experienced lateral talent or consider merging with another firm. This could take a considerable amount of partner time and needs to be managed like you would manage a project, otherwise you will not have the focus and momentum to keep a things on track.
A key question will be how your partners will manage the work of the succession/transition/project while continuing to practice, serve clients, and managing the firm? How will they balance billable client production with the non-billable time that a succession/transition/project will require? Otherwise, the project will drift, will not be prioritized, and will fail to receive the proper attention to keep it moving forward. Newspaper reporters are taught to ask the following question when working on a story:
To succeed at managing a succession/transition/project you will need to ask and answer and address many of the same questions.
WHO
Who will lead, direct, and manage the project? In a solo or solo owner firm, this may be the owner, or an outside consulting firm retained to lead, direct, and manage the process. In a larger law firm, this may be the management or executive committee, a managing partner, or a transition committee formed for such purposes. Larger firms may also retain a consulting firm as well. Other outside advisors such as certified public accountants, financial planners, and insurance professionals may also be involved as well. Specific roles, expectations, and accountability should be developed for everyone, inside and outside the firm that will be working on the project.
WHAT
What is the specific nature of the project? The law firm should define the succession/transition project specifically. Will the project involve looking into all possible transition/succession/ options or will it be limited to a single specific option, such as sale of the practice to another law firm, admission of a non-equity partner or associate to equity ownership, or merger with another firm? Define the specific scope of the project and put it in writing in the form of a succession/transition/ project charter or project plan. Define desired outcomes.
WHERE
If the firm has multiple offices what office location, is the primary focus? In the case of a practice sale or merger, what geographical areas should the candidates be presently located? Will the project team have to be located in the same area as the law firm? Can the law firm and team members be located in different locations? Will the law firm require face-to-face team meetings? Will the meetings be able to be held remotely?
WHY
Why is the succession/transition/ project necessary? Why the project being considered? What are the consequences for failing to start and successfully complete the project – loss of key clients – loss of retirement payout and or sweat equity from the practice? Why is important to start the project now – rather than later?
WHEN
When should the succession/transition/ project start? When should the project be completed? What are the key milestone dates, specific tasks, and specific task start and completion dates? Examples of two milestone dates in a larger firm that has a transition/phase-down plan might be;
HOW
The HOW involves the how of managing the project. In other words, some of the basic project management tools used to keep the project:
The HOW also involves deciding upon and implementing the succession/transition/strategy that achieves the goals of the solo, sole owner, or equity owners in a larger law firm. Usually the project planning HOW leads to the specific strategy and implementation HOW. The strategy and implementation HOW might involve selling the practice, admitting a non-equity partner or associate to equity ownership, or merger with another law firm. In the case of a larger law firm, it may involve the specific transition and phase-down activities.
If you put in place a solid project plan your partners will be able to balance priorities and transition the firm in a timely and effective manner.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am a sole owner of four attorney, including myself, boutique litigation law firm in Chicago. I am fifty-two and looking for a long-term succession strategy for my firm. I have been approached by a large Chicago national firm involving merging my practice with their firm. We have had several meetings and they have provided me with an initial proposal. I have spent many years building my law firm, and, by merging with a large law firm it seems that I am not really receiving any value for goodwill. What are your thoughts?
Response:
It is normal to exchange equity in your firm for equity in a large firm and not receive any cash consideration in those situations where equity partnership is being offered. Some large firms have a goodwill factor which is included in the value of each capital share or unit. The payment of the goodwill factor is usually waived in a merger. However, if you are considering merging with a large law firm and you will not be receiving any cash consideration for your practice, you should give serious consideration to why you are merging. In other words, why work for 20 years and receive nothing for the goodwill or for the value of the client list and the development of excellent personnel? Perhaps you could be included in the firm’s retirement plan, which could be considered a payment for goodwill. Another approach might be for you to receive a certain percentage from your clients and referral source fee collections for say three years after you retire. Receiving cash consideration for goodwill in a merger occurs more often in mergers with smaller firms.
Bear in mind that in many mergers where small firms merger with large firms equity partnership is not being offered and non-equity partnership is being offered instead.
With all of this said there could be other considerations that could result from a merger with a large national law firm such as greater compensation, professional recognition, peer mentoring, size and type of cases, staff and other resources, etc. that could outweigh a cash consideration for goodwill.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am the owner of a general practice firm in the Southwest Suburbs of Chicago with four associates and four staff members. I am 66 and was planning on beginning to work on my retirement plan this year and approach two of my senior associates regarding acquiring my practice. I was hoping to retire and exit the practice two years from now. Now with the Covid-19 situation I am not sure what I should do. Is this a good time to even think about approaching my associates? While business is slow we are doing fairly well working remotely. I still want to retire and be done in two years. I would appreciate your thoughts.
Response:
One thing is for certain, you will continue to age regardless of the virus and unless you needed higher income in your last year or two, your retirement goal and timeline has not changed. While I would not suggest approaching your associates for the next few months I believe you could begin some of the preparatory work. When I work with law firms on succession planning projects there is a sequence of work steps that take place that take time and often the process can take several months. For example:
So as you can see there is a lot of pre-work that needs to be done before you even approach your associates. Slow times are a good time to work on non-billable administrative and management projects and unless you have changed your mind on your retirement and exit goals this might be a very good time to begin working on your succession and exit planning.
Since legal skill, client, and management transition takes times you don’t want to wait too long otherwise you may have to move your retirement timeout out further.
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John W. Olmstead, MBA, Ph.D, CMC