Law Practice Management Asked and Answered Blog

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Dec 01, 2015

Law Firm Partner Compensation – Arrangement When Buying a Senior Partner’s Interest

Question:

I am the owner of a solo practice family law firm in Jackson, Mississippi. I  have been in practice four years. I have been approached by a senior solo attorney that has a well established family law practice that generates $800,000 annually and is looking to sell his practice. We envision a merger where I would make an initial payment upon merging my firm with his and then buyout his interest over a five year period. We have agreed on a fixed price for his ownership interest. However, we are not sure how to handle compensation. He wants to continue to work for another five to seven years. We would appreciate your thoughts.

Response:

Your approach will depend upon how you are going to structure your initial ownership percentages and whether the other attorney plans on continuing to work fulltime or whether he plans on scaling back. Are you going in with a minority interest and then acquiring additional interest as you make the agreed payments?

Here are a few ideas:

1. Base compensation totally on ownership interests. As you acquire additional interest your compensation would increase.
2. Agree to a base salary for each of you and then allocate excess firm profits after your salaries based on ownership interest percentages.
3. Create two profit pools. One pool would be 70% of total profit called performance profit pool and the other pool would be 30% of total profit. The 70% pool would be allocated to each partner based upon individual performance as determined by a weighted average of each partner's origination/working attorney collected fee receipts. The 30% pool would be allocated to each partner in accordance with ownership interest percentages.
4. Create two profit centers (one for each partner) and allocate income and expenses to each profit center. Each partner's compensation would be based upon their individual profit center.

Sep 22, 2015

Law Firm Budgeting – Is a Budget Necessary

Question:

I am the managing partner of our six attorney firm in Fresno, California. I recently went to a management seminar that stressed the importance of creating a budget for the firm. We currently do not have one. The budgeting process looks like a lot of work. Is it really worth the effort?

Response:

I believe that a revenue goal budget is the most important aspect of the budget and it does not take that much time to develop. It establishes revenue accountabilities for the revenue producers (attorneys). Insufficient revenue is the most common financial challenge that most law firms face.

While expenses are important and should be managed as well – the bulk of a law firm's expenses are office rent, employee cost, and in some firms marketing expenses. Most of these costs are fixed and once set in motion can't be managed.

Unless you have an office administrator that you want to hold accountable for managing the operations of the firm and the expense side of the ledger – you could start by just budgeting the revenue and see how that works for you. If you have an administrator a revenue and expense budget is important so that you can delegate and allow the administrator to manage operations without having to second guess each and every operational decision that they need to make. The budget provides the accountability tool.

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

Aug 18, 2015

Law Firm Financial Management – Concern With Income Statement Showing Operating at a Loss

Question:

I am a new partner in our law firm of 6 attorneys. I was an associate for seven years and was just made an equity partner and just received a copy of this month's income statement. The income statement shows the firm operating at a loss. I was startled and took a look at past years' statements as well. All are showing a small loss. Am I looking at these correctly? How can a firm operate at a loss for seven years in a row and still be in business. I would appreciate your comments.

Response:

My guess is that the firm is running all or a portion of equity partner compensation though as expense on the income statement. Other personal items may also be run through the firm as well. Check with the firm's bookkeeper or outside accountant to see if this is the case. If this is the case add the total paid to equity partners back to the net income or loss on the income statement. This will give a better picture of the actual "pie" .

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

Jul 07, 2015

Law Firm Ownership – Acquiring a Founding Partner’s Interest – Question from a Reader

Question:

I have a quick question on a recent column of yours that appeared on last week's blog and Illinois State Bar Association (in an ISBA email).

You refer to the following:

“One to one and a half times the owner's average earnings for the past five years is typical. "Does this mean the total firm revenues or the amount the owner attorney received as income? I thought I have seen that multiplier to be on total firm revenue.

Thank you!

Response:

I was speaking in terms of net profit or earnings – not gross fee income.

It is true that we often speak in terms of a multiple of gross fee income when trying to value a firm. Typically a best case is a multiple of 1.0 – often less – .60 – .75 or even less. Downward adjustments are made to the multiple based upon practice risk, how high the overhead is, likelihood of clients or referral sources remaining etc. 

For example:

Law Firm A – has $1,000,000 in gross income and the net earnings of the owner is $600,00

 vs.

Law Firm B – is a collections practice – very high overhead intensive practice- has $1,000,000 in gross income and the net earnings is $150,000.

Using a multiple x gross has to be discounted substantially for law firm B due to risk, overhead, etc.

It is sometimes simpler to think in terms of net profit – with the typical ranges between 1.5 – 2.0.

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

Jul 01, 2015

Law Firm Ownership – Acquiring a Founding Partner’s Interest

Question:

I am a senior associate in a eight attorney elder law firm in Miami. There is one owner (founder) and seven associates including myself. The owner has approached me with a proposal to over time buy out his interests. I am the only senior associate in the firm and the only associate that he has approached concerning selling his interests. Specifically his proposal is as follows:

1. Pay him $825.00 for the practice over five years.
2. After five years I will own 100% of the shares.
3. My compensation arrangement will remain the same (salary plus formula percentage incentive bonus based upon my responsible attorney collections) until I have acquired 100 percent interest of the firm.
4. The owner wants to work in the firm indefinitely after his interest are acquired as an employee or Of Counsel.

I don't know how to respond to this proposal and would appreciate your thoughts? Is it fair? Does it make sense?

Response:

It makes sense for him. Seriously, you are going to need much more information that this proposal. To get started you need to ask for and review the following:

1. Profit and Loss statements and Balance Sheets for the past five years.
2. Tax returns or Schedule C for the past five years.
3. A report showing the current accrual based assets – mainly unbilled work in process and accounts receivable. There are often the largest assets that a firm has and it is not on a typical cash-based profit and loss statement.
4. A list showing any off-balance sheet liabilities.
5. Copies of the office lease and other leases to determine lease liabilities.

From these documents you can get a feel for the cash-based net equity, the accrual-based net equity after considering work in process and accounts receivable and unrecorded liabilities.

Two numbers that may be even more important is the average fee revenue generated over the past five years and the average compensation (net profit plus compensation – W2 and K1 earnings) that the owner has been earning over the past five years.

Here are a few thoughts:

1. One to one and a half times the owner's average earnings for the past five years is typical. So from this guideline you can evaluate the appropriateness of the $825,000.
2. What assets are included? Will he exclude any assets?
3. Will you be able to acquire minority interests over the five years as you pay towards the payout? I will insist on such.
4. If you do acquire minority interests as you go will there be a profit pie for you to share in or will the owner increase his compensation, personal perks he passes through the firm, cut down on his working time, etc.? You should get a handle on compensation as well.
5. I would not have the owner's employment open ended after you acquire 100% interest. Have some protection in case he fails to produce or has physical or mental problems that affects his performance. Suggest an Of Counsel agreement that gets reviewed and renewed annually.
6. Consider whether there is a transition that insures that the clients and referral sources stay with you after he retires. If he has not groomed you, involved you in relationships with clients and referral sources, had you giving seminars, and plugged you into referral sources future business could drop off dramatically. This should be factored into the value.
7. Weigh the cost-benefit of starting your practice v.s. purchasing his practice. 

Good luck!

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

Jun 16, 2015

Law Firm FInancial Management – Metrics for a Small Firm

Question:

I am a partner in a three attorney litigation firm in Boston. Two of us are partners. We are in our fourth year in practice after leaving a very large firm. We are concerned that we could be doing better financially. We are haphazard in our record keeping, have no goals, and are even sure what number matter. What are your thoughts are to the key number (metrics) for a small firm like ours?

Response:

Goals should be established for each attorney with monthly reporting showing performance against goals. Key metrics should include:

1. Fees collected – working attorney 
2. Fees collected – originating attorney 
3. Fees collected – responsible attorney
4. Billable hours – working attorney 
5. Non-billable hours – working attorney
6. Billing, collection, and overall realization – working attorney 
7. Other goals – financial and non-financial 
8. Summary dashboard report should be developed. 
9. Attorneys should consider keeping timesheets for all worked time – billable and non-billable with specific goals for non-billable activities. 

Firm management contribution is important. If both partners do not share in the firm management responsibilities then the partner committing non-billable time to firm management should be compensated in the form of an agreement to amount or a fee credit that is run through the compensation system. If both partners participate in firm management, implement and document a management structure that clarifies management roles, responsibilities, and accountabilities for the partners, the office manager, etc. Respect the boundaries and avoid stepping over each other.

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

May 12, 2015

Law Firm Marketing and Advertising – How Much Should a Bankruptcy Firm Spend on Marketing

Question:

I am the sole owner of a debtor bankruptcy practice. I have one other attorney and three staff members. Last year we spent $50,000 of advertising. Our fees collected were $550,000 and Net Income was around $160,000. Are we spending too much?

Response:

You are spending 9% of fee revenue. I believe that in a consumer practice such as personal injury and debtor bankruptcy you have to spend around 10% of fee revenue to get the business you need to sustain the practice. I have some practices spending 19% of revenue.

So, I don't think you are necessarily spending too much if the advertising is working for you. You have to constantly measure the ROI on your advertising and fine tune it when needed.

Also, insure that the business is actually coming from the advertising – in other words don't advertise to get business you would have had anyway or in a market that you have saturated and more advertising will not yield any additional business.

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

Feb 17, 2015

Transitioning to a More Business-Like Law Firm

Question:

I am a partner in a 12 attorney general business firm located in St. Louis, Missouri. I was elected as managing partner earlier this year. I have been a lawyer and with this firm for eight years. I also have a MBA degree and managed a small business before becoming a lawyer. Frankly, I have been amazed at how law firms conduct business and I would like to change our thinking and our culture. Do you have any thoughts?

Response:

Here are five tips that you might find useful.

TIP #1: Work with the attorneys in the firm and help them develop more of a business mindset. Try to get them to become more entrepreneur and learn how to think like businesspersons. Encourage them to look at the world from their client’s perspective and consider their clients their business partners. 

TIP #2: Encourage all attorneys to select their clients carefully. Establish client acceptance criteria. Learn how to say no. Dump undesirable clients.

TIP #3: Encourage all attorneys to brand themselves. Ask them to look for was ways to differentiate themselves from their competitors and to become perceived as the only attorney that can do what they do. Ask them to make a decision – what do they want to be known and remembered for? Unique services, unique client groups, different service delivery strategy, personal style. Have the firm and each attorney create a five-year plan for goal accomplishment.

TIP #4: Encourage each attorney to become “solutions orientated” and become consultants – trusted advisors to their clients as opposed to simply their task and process attorneys. Solutions may involve activities and services other than legal services. Ask each attorney to think out-of-the-box and outside of typical frameworks in which they are comfortable.

TIP #5: Conduct a firm-wide management and leadership assessment and identify strengths and weaknesses. Enhance management and leadership skills through skill development training and personnel acquisitions.

Good luck!

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

Jan 07, 2015

Law Firm Marketing – Focusing on a Niche

Question:

I am with a 17 attorney general business firm located in Boston and chair of the firm's three member marketing committee. At this year's planning retreat we discussed the concept of niche marketing and whether we should focus on a specific niche. Your thoughts would be appreciated.

Response:

A niche marketing strategy can help you stand out from the crowd by focusing on a particular segment. Here is an outline of a typical niche marketing program.

1. Reach Out to Existing and Potential Referral Sources
1. Contact existing and past client that would be willing to provide leads, give you written testimonials/references and involve you in their professional and trade associations
2. Contact non-client influentials – attorneys, bankers, editors, executive directors of industry associations, media, and community leaders and work with these people.
3. Existing practice profile and factors as well as referral sources form the bedrock of a law firm.
2. Targets of Opportunity
1. Additional targets of influence
3. Offer Silver Bullets – Solutions to hot button issues that potential clients have.
4. Targeting a Niche
1. Selecting a Niche Target
1. Size
2. Location/Zip Codes
3. Type of Business/Industry
4. Practice Area
5. Competitors
2. Develop an insider understanding of the niche industry (industry success factors)
1. Critical success factors
2. Key ratios
3. Key publications of the niche
4. Writing, speaking, leveraging memberships with key organizations
3. Objectives and desired outcomes
4. Prospective niche client profile
5. Library of niche publications
6. Niche database
1. Existing clients
2. Prospective clients
3. Non-client influentials

Often a niche strategy does not involve a new area of practice – it may involve delivering services that you already perform – but marketed to a specific industry group. In essence you are learning the unique needs of a specific industry group, learning their language, and demonstrating that you understand their business better than your competition. An example would by an insurance defense firm that handles the defense for a couple of trucking cases and then creates a niche around the trucking industry.

Place your niche marketing strategy carefully. It takes time, financial resources, and commitment to successfully pull off a niche marketing strategy. Don't try to focus on more than one or two niche markets and insure that the niche that you are targeting is large enough to satisfy your objectives and justify the time and resources that you will be required to invest.

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

Dec 17, 2014

Law Firm Valuation – Establishing a Value for a Family Law Practice

Question:

John, where do you begin to get a value on a family law practice? It seems that one times gross revenue is unfair since it is usually one time business. I saw you speak at an ISBA event and this question was not addressed.

Response:

Regarding your question – it sort of depends on whether you are buying or selling and where you want to start. In general I agree with you that a multiple of one times gross for a family law practice is probably high. It depends on whether the practice has built up more of a firm brand vs. an individual brand. In other words institutionalized the practice. Also on where and how the firm gets business – advertising, referral sources, etc. A firm that has practice (institutional) goodwill might very well start at a multiple of one whereas a practice where the goodwill is personal goodwill the multiple might be .75 or less – in some cases even zero. I know of a few family law practices in the Chicago area that have been sold for .33 of gross revenue. 

Often the initial asking price has little to do with regard to where you end up. Often, due to the concern that the clients and business might not materialize for the new buyer many firms are sold on various forms of an "earn-out" or a small payment at closing with the remainder paid and based on a percentage of revenues collected over a period of time – 3 to 5 years.

I have seen PI and other one shot matter firms sell for one times gross revenues but this is a best case scenario. CPA firms fare much better.

If you are the seller and your practice is a personal practice you probably will have to start with an asking price around .75 or less – if you have branded the practice and have others besides yourself – you might ask for more.

If you are the buyer I would balk at 1 times gross and would want to discuss provisions for reduction in purchase price if revenues fall below a certain level over a certain time period. Better yet – no payment at closing with the payout totally based and paid as revenues are collected in the future.

Getting to "the number" will involve balancing the seller's concern that the buyer will let the practice die on the vine versus the buyer's concern that the clients and referrals with not materialize.

Click here for our blog on succession

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

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