Law Practice Management Asked and Answered Blog

Category: Succession/Exit Strategies

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May 05, 2021


Law Firm Succession Planning – How Important is a Formal Appraisal Valuation of the Firm?

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

Apr 07, 2021


Law Firm Internal Succession – Non-Equity Partners and Business Development Ability

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

 

Nov 12, 2020


Law Firm Owner Succession/Exit Strategy – Admitting Associates to Partnership

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

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

 

 

Aug 19, 2020


Law Firm Succession Planning – Managing the Project

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;

  1. Start phase-down – January 1, 2020
  2. Retire – December 31, 2020

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

 

Jul 22, 2020


Merging a Small Law Firm with a Large National Firm

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

Apr 08, 2020


Law Firm Succession and Exit Planning in the Era of Covid-19

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:

  1. Initial call with owner or partners.
  2. Document request to law firm.
  3. Law firm collecting and gathering documents (financial and other) and sending to us.
  4. Financial and document reviews.
  5. Telephone with owner or partners.
  6. Telephone interviews with associate candidates that you are thinking of transitioning the practice.
  7. Preparation of opinion letter (valuation, approach, etc.)
  8. Telephone call with owner or partners re discussion of opinion letter and next steps.
  9. Preparation of proposal to be presented to associate candidates.
  10. Conferences calls.
  11. Presentation of proposal to associates.
  12. Execution of legal documents.

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

 

Mar 04, 2020


Law Firm Short-Term Succession Planning

Question: 

I am the owner of a six lawyer business transnational law firm in South Florida. I have been practicing law for twelve years and I started my present practice nine years ago. I am 42 years old.  The five attorneys that work for me are all associates of which two are very experienced seasoned lawyers and three have less than five years experience. Since I am still a young attorney I am not concerned about retirement or long-term succession planning, maybe I should be, but I am concerned about the short-term. What would the firm do if I got hit by a bus?

Response: 

Your concern is the concern of many solo practitioners and sole owners of firms that have several associates but no equity partners. In fact many state bar associations are beginning to require attorneys in private practice to have written succession plans or in the very least a designated representative authorized to act on a limited and short term basis to protect the rights and interests of lawyers and lawyers’ clients in the event of an attorney’s death, disability, disappearance, practice abandonment, or any other similar event.

At the personal level a concern would be your personal income. If you are a major producer of revenue in the firm, which I assume you are, there would be a major impact on revenue and your personal income as well. Covering firm overhead would be an issue as well. Part of this can and should be covered with insurance. You might want to consider:

The second level of concern will be at the firm level, particularly if you were to become disabled either for an extended period or permanently or die. In this situation a key question would be whether or how the firm would sustain itself or even continue. Will the work continue to come in and who would do the work? If you have a firm administrator he or she would be there to manage the business-administrative side of the house but who (lawyer) would manage the client/project side (client service side) of the firm? This would generally fall to the other partners, but until such time as you have partners another attorney in the firm needs to be identified and groomed for such a role. If you decide that a non-equity partner tier is appropriate for your firm this role might fall to a non-equity partner until such time in the future that you have, if you have, other equity partners.

You would want a succession plan or what I call a practice continuation arrangement. A practice continuation arrangement is an arrangement – typically in the form of an agreement or contract -made between you and an attorney or attorneys in the firm or outside lawyer or law firm. The arrangement would describe a course of action to manage and cover and possibly transfer your practice and sets payment for its value. In the event of temporary or permanent disability, or death, a practice continuation arrangement protects the practice, the your business interests or your clients and your and your family’s financial interests.

Your plan should include records pertaining to client identity and financial records as well a list of passwords and other security protocols necessary to access the attorney’s electronic business files, calendar, and other law office related records in a location known and accessible by the attorney’s designated representative or office personnel.

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

 

 

Nov 27, 2019


Law Firm Contingency/Practice Continuation Succession Plan for a Solo Attorney

Question: 

I am an attorney in solo practice in the Southwest Missouri. I am forty five years old and I have two paralegals working for me in the firm. The practice is a general practice firm that I started ten years ago. I have been advise that I should have a succession plan. What exactly do I need to be putting in place? Any thoughts that you have would be appreciated.

Response: 

Due to the number of baby boomers approaching retirement much of my writing has been on succession and exit planning for this group. Based upon your age I think you are talking about contingency or practice continuation planning which is succession planning for the short-term. Since you are a solo you have no backup within the firm if something were to happen to you today. So you should form a relationship with another attorney or law firm to provide coverage if and when needed.

Generally a contingency plan or practice continuation plan is an arrangement with another law firm or attorney to step in if you become sick, disabled, or die. A basic contingency or practice continuation plan involves having written instructions designating another competent lawyer to temporarily assume the responsibilities of your practice and notify clients in the event that you become disabled or die. To prevent neglect of client matters in such situations, the ethical duty of diligence  requires in many status that each sole practitioner prepare a plan, in conformity with applicable rules, that designates another competent lawyer to review client files, notify each client of the lawyer’s death or disability, determine whether there is a need for immediate protective action, have a receiver appointed in some cases. Many states are making such plans mandatory.

A contingency or practice continuation agreement with another attorney or law firm should include:

Here is an article on practice continuation plans.

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

Sep 25, 2019


Succession-Exit Options for Law Firm Solos

Question: 

I am a solo real estate practitioner in Long Beach, California. I have one paralegal that works in the firm. I am 70 years old a would like to retire in the next couple of years. What are my options?

Response:

Solo practitioners have the greatest challenge since they have no associates or anyone in place to transition the practice. Therefore, the practitioner must both hire and groom an associate that could buy the firm or become a partner and buyout the owner’s interests, sell the firm to another firm, or merge with another firm. Other options would be to become Of Counsel with another firm or simply close down the practice. This takes time.

Hiring and Grooming an Associate

Hiring and grooming an associate can be problematic for the solo. If he does not have sufficient business and the associate does not originate business, the associate will be an expense and the owner’s net earnings will suffer. Other issues include:

Sell the Firm to another Lawyer or Law Firm

The owner can sell the firm to another lawyer or law firm. This option works best when the practitioner is actually ready to retire and quit practicing. Often this is not the case and the restrictions on sale of law practice levied by a state’s rules of professional conduct, in particular Rule 1.17, may make this option undesirable. Locating desirable candidates will take time and a well-planned search process may have to initiated. Our experience has been that this can take a year or longer.

Solo practices are often very personal practices with little annual repeat business. Clients of law firms advise us that they hire the lawyer and not the law firm. This makes buyers very cautious due to their concern that the clients and referral sources will not stay and the revenues will not materialize after the owner sells the practice. Therefore, many buyers are not willing to pay cash for a law practice. Our experience has been that most of these practices are sold with payouts over time based upon a percentage of revenues collected over a certain number of years. Usually, the seller stays on in a consulting capacity for a year to help insure that clients and referral sources stay with the new owner.

Merger with another Firm

Merger with another lawyer or law firm is another option. This is often a better option for solos that want to gradually phasedown yet continue to practice for a few more years. In essence, they join another firm as either an equity or non-equity partner, member, or shareholder and subsequently retire from that firm under pre-agreed to terms for the payout. The odds are improved for clients and referral sources staying with the merged firm and the merged firm is more committed that a buyer might be under a payout arrangement based upon collected revenues. The solo practitioner has more flexibility with regard to the ability to continue to practice longer, reduced stress, additional support and resources, and gradual phasedown to retirement.

Of Counsel with another Firm

Forming an Of Counsel relationship with another firm is an option that many solos are taking. Sometimes it is a final arrangement where a solo winds down his or her practice and then joins another firm as an employee or independent contractor. He or she is paid a percentage of collected revenue under a compensation agreement with different percentages depending upon whether the practitioner brings in the business, services work that he or she brings in, or services work that the firm refers to the practitioner. In other situations, an Of Counsel relationship is used as a practice continuation mechanism that provides the solo with additional resources and support if needed. An Of Counsel relationship can also be used to “pilot test” a relationship prior to merging with another firm. We have had several law firm clients that has taken a phased approach to merger with Phase I being an Of Counsel “pilot test” exploratory arrangement and Phase II being the actual merger.

One option is not necessarily better than the other – much depends upon “fit” and individual circumstances as well as a little luck.

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

 

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