Our firm is an insurance defense firm based in Denver, Colorado. The firm was founded in 2015 by two founding partners and we have grown to a firm of twelve attorneys – two founding equity partners, three non-equity partners and seven associates. Non-equity partners are included in firm management and the non-equity partners serve as members on the management committee. Non-equity members are compensated in the same manner as are equity partners – salary and bonuses determined by three year moving average ratios of weighted working attorney and originating attorney collections. Partner ownership interest does not factor into equity partner compensation. The firm does not have a partnership agreement. The firm is currently considering admitting qualified non-equity partners as equity partners. We are considering having a requirement that new equity partners purchase their shares via a buy-in tied to a firm valuation that includes a goodwill value. Our initial discussion with the equity partner candidates that we are considering has not been positive. They feel there should be no buy-in and they don’t see any benefit to being an equity partner. We would like you thoughts and opinions on this matter.
I can see where there is little distinction in your firm between equity and non-equity partners. I encourage firms when creating a non-equity tier to resist the temptation of giving away the farm and not retaining some incentives for non-equity partners to want to become equity partners. Typically, I suggest that there be a different compensation structure for equity partners than non-equity partners so that there is a compensation component for bearing the risk of ownership for equity partners. Often I suggest that non-equity partners come under a different compensation structure than associates, be given a few additional perks, and be included in partner meetings to a degree but not having a vote.
Approaches to buy-ins and buy-outs are all over the place in law firms. Here are a few of the common approaches:
The spectrum of law firm valuation and withdrawal entitlement theory can be characterized by two polar positions. The first considers the firm as a means to generate income (i.e., compensation), with modest, if any, value beyond the cash basis capital account. This is the dominant view currently in the profession and has resulted in the vast majority of firms valuing only the cash basis balance sheet for internal withdrawal rights. The second considers the firm as an investment, much like most other commercial endeavors.
I have many firm clients that are in their firm generation with original founders that have been in practice for twenty years and these firms have substantial institutional goodwill. Some of these firms sell shares to equity partner candidates based upon a firm valuation including a goodwill value. Other such firms take one of the other approaches. Often the problem with this approach is affordability.
Personally, I believe there should be some skin in the game for a non-equity partner to become an equity partner or shareholder. In your situation you are a young firm and acquiring and retaining lawyer talent should be your primary objective. Therefore, rather than selling shares I believe that you might want to consider approach number two – naked in – naked out with a cash-based capital contribution that is affordable. If cash is a problem for the candidate have them pay what they can with the remainder payable on a capital (promissory) note paid over a one to three year period. Then have the partnership agreement provide for a founder benefit for the two founders as discussed above (say 1.5 multiple) upon retirement.
Do all that you can to fund partner retirements through 401k plans and other vehicles.
John W. Olmstead, MBA, Ph.D, CMC
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.
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.
John W. Olmstead, MBA, Ph.D, CMC
I am the firm administrator of a sixteen attorney firm in Kansas City, Missouri. We, like many other firms, have done our best to face up to the challenges presented by COVID-19. For several months attorneys and staff worked remotely from home office using the internet, telephone, and video conferencing as the primary means of communications with clients and the office. To our surprise it worked fairly well but most of the attorneys were glad when they were able to return to the office. We have been having discussions as to the long-term impact of COVID-19 both in the short-term while we continue our fight against COVID-19 and in the long-term after COVID-19 has been defeated. I would be interested in your thoughts.
For years law firms have held the attitude that employees – attorney and staff alike must been seen, observed, and on premises in order to be productive. Law firms that have had and continue to have their attorneys and staff working remotely during COVID-19 have disproved this premise. They have found that not only have their attorneys and staff been able to remain productive but in many cases even more productive then when they worked face to face in the office. However, communications has been a challenge for many firms.
Below is what I refer to as the scale of communication media and richness of each:
1. Face to face
2. Video Conferencing
4. Email and text
Face to face is the richest form of communication and should be used for sensitive communications such as performance reviews and other such discussions concerning performance, praise, training and mentoring, etc. It should still be used when ever possible in these situations.
Video conferencing using platforms such as Zoom, GoToMeeting, Team, etc. in the second richest form of communication and should be used when face to face would normally be used but is not possible.
Telephone is the third richest form of communications and should be used for less sensitive communications or for face to face situations discussed above when a face to face meeting is physically not possible.
Email, text, and other written communications should be used for routine communications such as assignment of projects and tasks, work instructions, etc.
Sensitive and difficult communications should be communicated through a rich medium such as face-to-face meetings or video conferencing and routine communications through a lean medium such as a memo.
Media richness is determined by the speed the media provides, the variety of communications channels on which it works, the extent of personal interactions allowed, and the richness of language it accommodates. As tasks become more ambiguous, you should increase the richness of the
media that you use.
Our law firm clients have advised us that after awhile they missed the face to face interaction and found that the major problem with working remotely was that the communication with other members of their work team took much longer than walking over to the next office or desk and was frustrating. While I don’t believe that traditional offices will completely disappear, I believe that law firms have learned lessons from COVID-19 and we may see the following changes in the future:
John W. Olmstead, MBA, Ph.D, CMC
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.
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.
John W. Olmstead, MBA, Ph.D, CMC
I am a partner and a member of a three member management committee in a eighteen attorney firm in Chicago. During the past year we have discussed conducting an offsite long range planning retreat in the fall that would include the partners and other attorneys in the firm. We have never done this before so this would have been a new experience for us. However, with the COVID-19 crisis we have cancelled our site reservations and are wondering whether we can still conduct our retreat remotely? Any thoughts you have would be appreciated.
Sure you can. I suggest that you consider a virtual retreat using Zoom or some other communication platform. Organizations are holding virtual conferences, churches are conducting virtual services, and law firms are conducting virtual retreats and planning meetings. Last week I attended a two-day video conference and the process went extremely well. There were even small group breakout sessions that focused on specific topics. While a in-person format is preferable, you can get the job done with a virtual retreat. During the current crisis a retreat and long range planning is more important than ever. So, I suggest that you try a virtual retreat.
Here are some suggestions regarding planning your first retreat:
A retreat differs from the typical firm meeting in that it is a specific structured program with an agenda of topics and procedures agreed to in advance. The purpose of the retreat is to help facilitate change. For example:
Setting up a retreat involves all of the following steps:
The first step involves key members getting together to discuss their initial thoughts about the firm, its structure, and its organizational problems to brainstorm for possible topics. Partners and other members of the firm can also provide written suggestions for the agenda. Tentative retreat objectives can be formulated at this time.
A preliminary program is formulated. An appointed retreat coordinator or team develops the preliminary program including tentative:
The coordinator works on further defining goals and objectives of the retreat, how it is to be coordinated, and who will be responsible for various functions and activities. Coordination checklists and timetables are developed.
The preliminary program is circulated for comments and suggestions. Changes are accommodated and the finishing touches are put on the program. The partners agree on all details of the agenda and program and the program is finalized.
The brainstorming process will require background data. Internal data such as firm financial reports, client lists, lawyer productivity reports, etc. and external information such as demographic and census data, information on competitors, business trends, etc. should be compiled and organized into appropriate presentation formats such as PowerPoint presentations, whiteboards, flip charts, and handouts.
A moderator should be assigned to the retreat. The moderator can be a member of the firm if the firm has a member who can be objective and has the skills to properly facilitate a retreat or the moderator can be an objective outsider who has the requisite skills. The moderator serves as the “tour guide” and keeps the retreat on track, in focus, and provides resource information when required. The moderator should be given the authority to control the retreat and enforce the ground rules.
A retreat will not be successful unless an implementation plan is formulated during the actual retreat and made a part of the proceeding. Specific assignments and completion dates must be agreed upon during the retreat itself and schedules for reporting on progress must be determined.
At the conclusion of the retreat the outcome of the retreat and the implementation plan should be summarized.
Within two weeks after the conclusion of the retreat a retreat report should be written and distributed to all firm members in attendance. Completion dates should be placed on the firm’s docket control system. A retreat follow-up item should be on each and every firm meeting. A post retreat evaluation should be conducted six months after the conclusion of the retreat.
John W. Olmstead, MBA, Ph.D, CMC
I am the owner of a six-lawyer law firm in San Diego, California. Our firm is a business litigation boutique firm. I founded and formed the firm nineteen years ago. The other attorneys are all associates of which one has been with me for over ten years, one over five years, and the other three less than two years. I am 56 and still plan on working another ten to fifteen years. However, I don’t want to lose my senior associates and I want them to be around in ten to fifteen years to take over the firm, I also believe that they should be partners. The firm is presently a sole proprietorship. I would like to extend an offer to the senior associate now and possibly to the other senior associate in a a couple of years. How do I get started? What are some of the issues that I should be thinking about?
If you have never had a partner in this firm or another firm in the past this will be a new experience for you. Law partnerships are like marriages and choosing the right partner is essential. Not only should the lawyer be an exceptional lawyer as far as legal skills, client satisfaction, fee production, and client origination, he or she should have similar values and goals for the firm that you do. Will you mesh well? At least the associate is somewhat of a known quantity since you know the associate and have worked with the associate for several years. However, the experience will be different. Being a partner with someone is different than a boss-employee relationship.
Here are a few ideas you might consider:
I suggest you think about your succession and eventual exit from the firm and what, if anything, you are looking to receive (goodwill value) in monetary terms when you leave the practice. Rather than having a large buyout upon your retirement/exit from the firm tie this to the value per share or unit of ownership interest and establish this is the purchase price as ownership shares are acquired.
Since you are a proprietorship you will need to change the structure of the firm to a multi-owner structure such as PC, APLC, or LLP. (LLC’s are not permitted in California for law firms).
John W. Olmstead, MBA, Ph.D, CMC
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?
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 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 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.
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 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 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;
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.
John W. Olmstead, MBA, Ph.D, CMC
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?
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.
John W. Olmstead, MBA, Ph.D, CMC
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?
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.
John W. Olmstead, MBA, Ph.D, CMC
I am a member of a three member management committee in a sixteen lawyer boutique litigation firm in downtown Chicago. The firm has been in business for over forty years. We have sixteen lawyers in the firm of which ten are equity partners and six are associates. The original founders are retired and we are in second generation.
Until five years ago all partners were involved in all aspects of firm management. At that time we made the decision to put in place a three-member management committee that was charged to handle certain aspects of firm management with the full partnership only participating in major decisions. We hired a firm administrator to handle the day to day administrative responsibilities. Our administrator reports to the management committee. This structure has worked very well for us. We are currently paying our administrator a base salary and a discretionary bonus. After five years of salary increases our administrator is making more than our associates. Is our present approach to compensating our administrator the best approach or should we be looking at a different method of compensation?
Base salary with discretionary bonus is the most common approach that I find being used to compensate firm administrators. The problem with discretionary bonuses is that many law firms don’t tie these bonuses to measurable performance and as a result they become expected and end up being an entitlement. However, I have worked with many firms where we have put in place alternative bonus systems that have either replaced or supplemented discretionary bonuses. This has allowed firms to put more emphasis on performance as opposed to continuing large salary increases for just showing up. While administrators still receive salary increases they are at a lower rate of increase, performance bonuses take on a larger role, a larger percentage of the compensation is variable rather than fixed, and administrator performance is aligned with firm goals.
A few approaches that firms have taken:
These approaches are just a few examples. The key is to align your administrator’s performance with firm goals and pay for performance.
John W. Olmstead, MBA, Ph.D, CMC