Law Practice Management Asked and Answered Blog

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Apr 09, 2013

Law Firm Margin/Profitability Ratio – Net Income to Gross Revenue

Question:

I am the owner of an elder law firm in Boston. I recently closed out the 2012 books for tax preparation, I'm reviewing my annual numbers from what was my 4th year in solo practice and wondering how I'm doing.  Is there some kind of benchmark/goal or can you share any advice about an ideal ratio between gross income and overhead costs?

Response:

I usually say 35-45% margin (net income divided by total fee revenue) which is supported by most of the survey data. (Expenses used in the determination of net income defined as total expenses less owner/partner compensation). However, I have some law firm clients that have 20% margins were the partners/owner are taking home $1,000,000 per year. So margin is sometimes tells only part of the story. Depends upon the area of practice and practice/leverage structure. Solos operating virtually with no staff may have a margin of 80% but only taking home $40,000. ($40,000 net income divided by $50,000 fee revenue – only $10,000 in expenses.)

Be careful of using the term overhead as this often refers to expenses less all producer compensation. (partners, owners, associates, and paralegals) I assume that by the term overhead you are referring to total expenses less your compensation or draw.

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

 

Apr 02, 2013

Law Firm Merger – Where to Start When Merging/Acquiring a Smaller Firm

Question:

Our firm is a 26 attorney firm in Louisville, Kentucky. We are considering merging/acquiring a 12 attorney firm in the local area. This is virgin territory for us as we have not done this before. We would be interested in your thoughts as to where we should start and the process we should use to minimize the risk of making a mistake.

Response:

While mergers can be a valid option making them work is often another matter. Research indicates that one third to one half of all mergers fail to meet expectations due to cultural misalignment and personnel problems. Don’t try to use a merger or acquisition as a life raft, for the wrong reasons and as your sole strategy. Successful mergers are based upon a sound integrated business strategy that creates synergy and a combined firm that produces greater client value than either firm can produced alone.

There can be a whole list of reasons for failure including poor financial performance, attorney defections, loss of key clients, and leadership and management issues. However, it has been our experience that most failures have been the result of poor cultural fit. The merging firms – after they have moved past conflict checks and excitement about new client potential – jump immediately to an examination of practice economics and the financials. They fail to perform proper due diligence on the people. It is critical that firms insure that cultural due diligence is a key component of the merger assessment process. Philosophies, personalities, and life styles should be generally compatible. The partners should like each other and the deal should make sense.

The question is not the what (merge) but the who (people)

You should do all the due diligence that you can – start with the people – then move through the rest of the process.

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

Mar 26, 2013

Sale of Law Practice – Proper Timing

Question:

I am a sole owner of a 4 attorney law firm located in Washington, D.C. Our practice concentrates on estate planning and administration. We have 6 support staff members. I just turned 60 the first of the month and am beginning to think about what I will eventually do with the practice. None of the associate attorneys are interested in partnership or in purchasing the practice – they just want jobs – they are not interested in owning a law practice. When is the best time for me to sell my practice?

Response:

You really have to give some thought to your timeline – how long do you want to work? Do you plan on pursuing another career? Have you put enough money away so you can simply retire without concern about the need to generate additional income?

If you need revenue for an additional ten years – a way to earn it – and if you enjoy what you are doing – then it will not be in your interest to sell the practice too early. Let's say you could sell your practice for one million dollars – this might equate to two years of earnings. If you worked another ten years – you could have earned five million dollars.

To a large extent owning a law firm is in essence a job where you work for a living where you have provided employment for yourself. It might be hard to find a job that pays as well as your firm. So if you need revenue for another ten years and your enjoy your work – you should probably plan on working another ten years. Build you timetable to sell your practice around your future work timeline. Things change – you may find that your associates change their mind or down the road you may end up with new hires that will have an interest in partnership.

Start with planning out how long you want or need to work and go from there.

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

 

Mar 19, 2013

Law Firm Lateral Partner: Size of Book of Business

Question:

I am a partner in a mid-size firm in Memphis. We have 250 attorneys in the firm and I am considering making a move to a smaller firm. While I have a client base I am not sure how much business would go with me. I am currently making $600k in compensation. With my experience – 25 years plus – how important is a book of business initially? How big of a book will firms be looking for?

Response:

A portable book of business is critical – especially if you are looking to earn what you have been earning. A rule of thumb for many of the lateral moves that we have seen for compensation is 1/3 of book. You will need a book of $1.5 to $2.0 million to generate interest from major players.

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

Mar 12, 2013

Partner Compensation – Two Attorney Start-up Firm

Question:

I am a solo practitioner in Chicago. I've been offered by another solo to join him as a partner, and was wondering if you could suggest any articles or books I could look at to think about how to structure the partnership.  We bill about the same number of hours, but his rate is 50% higher than mine (300 v 200) and he has 20 years on me in age and experience.

Response:

I am a believer in true partnerships as they seem to work best and the compensation system that seems to work the best is where the partners share and share alike the profits based upon their ownership percentage. Initially a percentage is agreed upon based upon the revenue/profit
history and experience that each brings to the firm. If the level of contribution changes over time you talk about it and the percentages are adjusted. You may want to start by looking at your fees and profits over the last five years and compare them to his and use this as a starting point. Consideration should also be given to his experience. Hours don t matter as much as dollars. Then determine that ratio. Often in an arrangement such as this, depending on the ratio, it might be a 60%/40% split. If this is what you agree to then establish your capital accounts in accordance with that ratio (initial firm investment in the form of cash or other assets) and then split profits according to this split. Over the years adjust as needed. If you have a healthy partnership you will be comfortable discussing this subject.

Other approach if you want to be lone rangers would be a formula eat-what-you kill approach.

Here are my blogs on this topics generally:

https://www.olmsteadassoc.com/blog/category/compensation/ 

Here are a couple specific blogs:

 https://www.olmsteadassoc.com/blog/2009/05/  

https://www.olmsteadassoc.com/blog/law-firm-eat-what-you-kill-partner-compensation-systems

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

 

Mar 05, 2013

Law Firm Partner Conflict: Ideas for Resolution

Question:

We are based in Kansas City, Missouri. We have two partners, two associates, 5 staff members, and have been together for 6 years. The firm is the result of a merger of each of the two partner's practices a few years ago. The integration has not gone well. We are quite polarized. Each partner operates as a separate island, does his own thing without regard for the other partner, and staff follow suit. Each partner has very different practice values, approaches to practice, and goals. Conflict has escalated to the point when productivity and profitability has suffered and everyone is miserable. Would you share your thoughts?

Response:

Conflict is not always bad – sometimes conflict can actually be productive if it can be effectively managed. Destructive conflict on the other hand can destroy a small law firm. I often try to look at conflict from both a micro and macro point of view.

From a micro perspective I would look at the individuals themselves. Are their personalities compatible? Do each of the partners have the same vision for the firm and share similar core values, propensity for risk taking, need for control and tolerance for ambiguity?

From a macro perspective I would look at some of the organization and structural characteristics of the firm. This might include internal communications systems, interdependence of work tasks, clarity of job roles and responsibilities in the firm, decision-making, resource sharing, etc. Often people are stepping over each other and if we change some of the structural elements we can resolve the source of the conflict.

It is easier to fix and resolve macro level conflict than micro – individual – personality caused conflict. Your situation sounds like micro – individual – personality caused conflict and general incompatibility. Unless your firm wants to operate as a "long ranger" firm operating essentially as independent practices you may want think long and hard if it makes sense to continue the partnership.

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

Feb 24, 2013

Mentoring Law Firm Associates: Getting the Basics Right

Question:

I am the chair of our three member executive committee. We are a 20 attorney firm in Atlanta. We have 5 partners and 15 associates. We have done a terrible job of mentoring our associates and we need to do better. Do you have any ideas?

Response:

A law firm's greatest asset is its people and your associates are your firm's future. Lack of mentoring is one of the biggest complaints that we hear from associates in on-site interviews.While you may be too small for a comprehensive formal mentoring program you should at least explore an informal program. Start with baby steps and go from there. 

The keys to successful mentoring relationships involve the mentor and mentee deciding on the logistics up front. Many potential mentoring pairs fail to form because the parties did not agree
on the little things up front. Below are tips designed to help both participants in formal and informal programs:

1. Meeting schedule:  Decide on an approximate meeting schedule. Suggest that meetings be scheduled at least once a month.

2. Means to schedule meetings: Share the best way to get on each other’s calendar.

3. Scheduled meetings: Don’t wait until the end of one meeting to schedule the next. Always have the next two or three meetings on the calendar.

4. Length of program/partnership: For formal programs; the firm may suggest a length of time to meet (usually a year). For informal mentoring, suggest having a date on the calendar to review goals and examine the relationship.

5. Confidentiality: Mentors and Mentees need to discuss what confidentiality means to them. It is the foundation of trust, which is the basic currency of mentoring.

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

Feb 20, 2013

Selling a Law Practice – How do I Value My Practice

Question:

I am the founder and owner of a law firm in downtown Cincinnati, Ohio. I have three other attorneys and 4 staff members. We represent primarily business and civic organizations. Our fee revenues are around $735,000 per year and I take home $175,000 to $200,000 from the practice. I am looking to sell the practice to either the associates in the firm or another law firm. Do you have any idea what my firm might be worth?

Response:

There is no one “right answer” when valuing a law practice. There are different types of valuations performed by different advisors for different reasons. Valuations can be extensive or ballpark estimates. 
 
While law firm owners and partners would like a simple “plug and play” approach to establishing a value for their firms, such an approach does not exist in the real world. There are too many variables that come into play. At the end of the day it comes down to what someone will pay you for your practice and the terms. Often the terms are as important as the price or value.

What a potential buyer is really the future cash flow (earnings from the practice) I suggest that you use the rule-of-thumb approach to get started. Multiply one year’s gross revenue by a factor of x. The result will be the stream of income’s value.

We usually suggest that you average the firm’s gross fee revenue over the past five years to even out any peculiar ups or downs in the revenue stream. Then multiply this average year’s gross fee revenue by a given factor. The factor varies with the industry and even with geographic location. Accounting firms, for example, are valued at 1.0 to 1.5 times (100 to 150 percent) annual gross fee receipts. A well established standard is still in its infancy in law firms. Some argue that the multiplier for the rule-of-thumb method for law practices should be between 0.5 to 3.0. However, based upon what we have seen in recent sales of law practices, the multiplier for the rule-of-thumb method for law practices is ranging between 0.6 to 1.0 (60%-100%) of annual year’s gross fee revenue. Another way to look at it would be 1.2 to 2.0 (120% to 200%) times net income. (Based upon partnership method of accounting and not including owner’s compensation as an expense) Whether the multiplier is in the lower or higher level of the range depends on the following:

  1. Quality of owner earnings
  2. Quality of personnel
  3. Location
  4. Practice area and types of services
  5. Financial performance
  6. Nature of clients
  7. Fee Structure (hourly rates charged)
  8. Repeat or one-time clients
  9. Referral sources.

Start with a multiple of one and adjust for the above factors.

Based upon the figures you provided I would think you would have a difficult time getting a multiple of one for your practice due to the low margin of 24%. Peer practices average 35-45% margins. You might ask for around $700,000 but due to the low earnings, etc. $350,000 – $400,000 might be the best that you can hope for and that may be subject to a five year earn-out. The key is often to find the right person to buy the practice. Finding the right person could take a lot of work and time – so start early.

Click here for our blog on succession/exit strategies

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

Feb 12, 2013

Mitigating Law Firm Case Portfolio Risk With a Firm Contingency Fee Case Selection System

Question:

Our firm – St. Louis, Missouri – handles personal injury cases on a contingency fee basis. All 6 attorneys practice in this area and we do no work on any other type of fee or billing arrangement. During the last couple of years cash flow has been tough, we have lost some cases, and we are looking for ideas on what we should be doing differently. We would appreciate any ideas that you may have.

Response:

A balanced case portfolio is critical for contingency fee firms. You must carefully select your cases. Here are some ideas for an effective case selection system:

1. Develop an evaluation/case rating tool to be used to determine risk and feasibility of taking on contingency fee cases. The tool could be a form with an brief write-up and synopsis of the case, potential fee (high and low), probability of success or failure expressed as a probability percentage, specific risks, how long case might be in progress, hours that it may take to staff the case, client cost investments, and other resources that may be required.

2. Determine criteria that must be met to accept or reject a case.

3. Require more than one head or set of eyes on a case before committing to accept a new case. You might want to require all contingency fee cases to be reviewed and discussed at a weekly team meeting before a case can be accepted by anyone – including. This will help keep any  one attorney from getting too emotional and close to a case and base acceptance upon business and economic considerations rather than emotional considerations.  This is routinely done in lot of my PI firms to help access and mitigate case risk.

4. Write-up and document the case selection system.

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

Feb 06, 2013

Law Firm Expansion – Expanding Your Geographical Reach

Question:

Our firm is a 14 attorney firm in central Iowa. We have one office in Des Moines and have been considering opening an office in another city. We represent business organizations and very few individual clients. I would appreciate your thoughts and suggestions.

Response:

I hope this is part of an overall strategic planning process and not a random act. If it is then the first consideration should be the needs of your most important existing clients. The first questions you should address are:

  1. Where are your present clients located and how do they communicate with the firm?
  2. To what extent have the needs and demands of these clients changed due to advances in technology?
  3. Are your client relationships based upon direct contact and communication? To what extent are interpersonal relationships crucial to the maintenance of these clients?
  4. Are any of these key existing clients expanding into new geographical areas?

After giving some thought to the above questions determine whether the firm can meet the needs of key clients from existing geographical locations, or whether it must consider new venues. Then consider the following:

  1. It is necessary for the firm to be physically present where the client is located or is the firm better served utilizing existing resources to expand practically, while not physically?
  2. Is a physical presence required to practice in the new location?
  3. Would the firm be better served by utilizing technological resources instead of physical location expansion?
  4. Are there marketing disadvantages by not having a physical presence even if the firm can service the legal needs of the client with a local presence? Could the firm lose out of opportunities by being out of site out of mind?

A geographical strategy must carefully consider and weigh the importance of personal contact.

Think through the process strategically and as a part of your planning process – run the numbers on a few scenarios – and weight the pros and cons of moving into other areas.

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

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