Law Practice Management Asked and Answered Blog

Category: Succession/Exit Strategies

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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.

Click here for our blog on practice sale

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

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:

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.

Click here for our blog on succession/exit strategies

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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.

Click here for our blog on practice sale

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Click here for out articles on various management topics

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):

  1. Five years profit and loss statements, balance sheets and tax returns.
  2. Lawyer and staff headcount for each of those five years.
  3. Current hourly billing rates.
  4. Description of practice area mix of clients by dollars collected – practice type and office location.
  5. Description of how the firm bills (hourly, flat rate, contingency)
  6. Copy of all leases (office space, equipment)
  7. Copy of malpractice insurance policy and last application.
  8. Salaries and benefits for equity and non-equity partners.
  9. Any governance plan or agreements.
  10. Copies of all partnership agreements or operating agreements for all business entities.
  11. Any documents pertaining to the retirement of partners including information as to obligations for partners who have already retired and those nearing retirement.
  12. Compensation data for equity and non-equity partners.
  13. Copy of the written compensation plan for equity partners if one exists or if not a discussion of how the compensation system works.
  14. Information on the line of credit and copies of all debt agreements.
  15. Copies of third party vendor agreements (equipment leases, subscriptions)
  16. Copy of the firm’s present malpractice insurance policy and most recent application.
  17. 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.

Click here for our blog on mergers

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

 

Jul 24, 2018

Law Firm Succession Planning – Getting Partners to Discuss their Future Plans

Question: 

I am the firm administrator for a twenty-five attorney firm in Baltimore, Maryland. We have fourteen partners and nine are in their sixties. We have no succession or transition plans in place for senior partners. Every time I bring up the topic there is a resistance to even discuss the topic. I would appreciate any help that you can provide.

Response: 

A decade ago, only the more proactive, well-managed law firms had in place programs and provisions for senior partner succession and transition. A majority of firms simply had not addressed or even given serious thought to the eventual retirement and exit of their senior partners. However, in the last five years, I have seen a lot of interest in succession, transition, and exit planning. The avalanche of baby boomers reaching retirement age has fueled this interest. Firms from the largest to the smallest are getting proactive and actively addressing succession and transition of senior partners. Some are putting in place formal programs, while others are at least addressing succession and transition informally using ad hoc approaches.

A recent Altman Weil Transition Survey gives us a glimpse of what other law firms are doing. Here are a few highlights from their survey concerning responding law firms.

Many other law firms are finding it a major challenge to get senior attorneys to talk and share their plans concerning retirement. In many cases the families of senior attorneys are having the same challenges. Coming to terms with aging is a difficult topic. In the case of law firms, often senior attorneys simply don’t know their future plans themselves, need the income, fear that others shareholders/partners will steal their clients, or the firm simply does not have a mechanism in place that mandates transition planning. Some firms are implementing mandatory retirement and others are putting in place financial incentives to motivate early transition of clients. Client loss is the most significant concern.

Keep at it and don’t give up but it may take a series of baby steps. Educate your partners on the risks of “doing nothing”. Provide them with articles and other resources and keep the topic on the agenda.

Click here for our blog on succession

Click here for out articles on various management topics

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.

Click here for our blog on succession

Click here for out articles on various management topics

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

Jun 06, 2018

Law Firm Succession Planning – Getting the Conversation Started

Question: 

Our firm is a seventeen attorney business law firm in Chicago. Our clients consists of mid-size companies and a few Fortune 500 companies. There are eight partners and nine associates in the firm. Four of the eight partners are in their early sixties and the other four partners are in their forties and fifties. The four senior partners are the founders of the firm. Consequently, we have not had to deal with succession of partners until now. While we realize that we need to be thinking about succession planning we have not made much headway. The senior partners are reluctant to discuss their retirement plans and timelines. We would appreciate your thoughts and suggestions.

Response:

Client transition, management transition, and talent replacement are the major succession planning issues for law firms. Such transitions take time, especially with clients such as yours, and law firms can not wait until a senior partner comes forward, announces his intentions, and gives his required notice. Law firms should begin having conversations with senior attorneys and begin transition planning five years prior to a partner’s actual retirement. Having these conversations can be difficult. Senior attorneys may not know their plans themselves and may not have even discussed this topic even with their family. In some cases there can be trust issues at the firm and in other situations the firm’s compensation system may be a barrier. Law firm management must force the issue by institutionalizing a transition program and requiring conversation and discussion at a certain age. Some firms have mandatory retirement and others have a five year phase-down requirement with a formal client and management, for those partners that have management roles, transition program. Personally, I prefer the phase-down requirement with an individual tailored transition plan over the phase-down period. I suggest that transition plans be tailored for each retiring partner and reflect partner, firm, and client perspectives. Use compensation to reward successful client transitions.

Click here for our blog on succession

Click here for out articles on various management topics

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

May 08, 2018

Of Counsel Arrangement as a Law Firm Exit Strategy

Question: 

I am the owner of a solo real estate practice in Merced, California. I have two staff members that work for me. I am the only attorney in the firm. I am sixty years old. While I am concerned about the long term exit from the practice I am also concerned about office coverage in case something would happen to me in the short term. I appreciate any recommendations that you may have.

Response: 

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.

Click here for our blog on succession

Click here for out articles on various management topics

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

 

 

 

 

 

 

Feb 28, 2018

Selling My Law Practice to My Associate

Question: 

I am the owner of a general practice firm in Chicago’s west suburbs. I have three associate attorneys in the firm and three staff members. I am sixty-four and contemplating my retirement and exit from the practice. I would like to start phasing back over the next three years and be out of the practice by December 31, 2021. There is one associate in the firm to whom I would like to sell the practice and he has expressed an interest as well. What are your thoughts as to how I approach this?

Response: 

Client, referral source, and management transition will be major concerns and will impact the value you can receive for your firm. You will need to use the next couple of years to effect a successful client, referral source, and management transition to your associate. Clients and referral sources will need to have a relationship with your associate and perceive him as a partner.

I have seen law firm owners approach this in the following ways:

  1. The associate is elevated and given the title of partner (non-equity) with the execution of practice sale agreement for the sale of the practice to occur in the future with a non-refundable deposit. The practice sale agreement outlines the sale price (which includes a goodwill value) and specific terms for the sale of the practice. Upon purchase of the practice  the associate would setup a new practice entity. This approach is often taken by firm’s that don’t want to “play partner.”
  2. A value is determine for the practice and price per share. Often this includes a goodwill value. The associate buys in and initially becomes a minority partner – say twenty to twenty-five percent. Over the next several years the minority partner buys additional shares based upon the valuation formula and the price per share determined at that future time. When the owner retires his or her remaining shares are acquired with the payment for these shares often paid over a period of three to five years.
  3. An associate becomes a minority partner and makes a capital contribution (usually based on cash-based-capital) that has no relationship to the value that the owner is seeking to receive from the practice. The partnership agreement has a “founder benefit” provision that provides that the founder receives a multiple (1.5 to 2) of the average of his or her last three year’s earnings upon retirement. For example, if the founders average annual earnings for the past three years was $350,000 – $525,000 (multiple 1.5) would be his founder benefit. Typically this would be paid out over three to five years. This would be in addition to a return of the founder’s capital account.

In each of the above scenarios it will be critical that you put in place an action plan with dates, timelines, and activities to ensure that activities that have to occur for a successful client, referral source, and management transition get accomplished. Your biggest challenge will be client and referral source transition. Both of you will need to ensure that clients and referral sources stay with the firm as that will effect the value of the arrangement for both of you.

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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