Law Practice Management Asked and Answered Blog
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Apr 15, 2014
I am an associate in a law firm in Akron, Ohio. The firm is an estate planning practice consisting of the owner/founder of the firm, myself, and two legal assistants. I have been with the firm for ten years and this is the only firm that I have worked with since law school. The owner is 67 and has announced that he wishes to retire. He has approached me and provided me with a proposal to buy his practice via an arrangement where I would initially pay him a down payment of 50% of his asking price and after two years the other 50% would be paid over a period of five years. The arrangement would be structured as a partnership and for the two year period we would be 50-50 partners. Compensation would be based upon these ownership percentages. The owner's asking price is two times his average net earnings ($125,000) – $250,000. Average revenues – $210,000. I would appreciate your thoughts and suggestions:
Buying a law practice is a major commitment and major investment. To a large extent you are buying a job as well as hopefully a book of business. Here are a few ideas that you may wish to consider:
- A general rule of thumb for establishing a value for when a law practice is being sold to an outside buyer is a multiple of 1.0 times average gross revenue or a multiple of 2.0 times average net earnings. Typically this is a best case scenario for an outside buyer. Buy-ins for associates that have invested "sweat equity" over the years is usually less. In addition you must consider the extent of repeat client business, talent of those that will remain with the firm, management skills and ability of the new owner, and management infrastructure. (IT, databases, case and document management systems, automated billing and accounting systems, etc.) Personally, I think the asking price/buy-in figure is high. Try to get the owner to do better for you.
- Review at least the last five years financial statements and insure that there are no surprises.
- Insure that all debt and potential malpractice claims are disclosed.
- Review the office and equipment leases.
- Create a demographic profile of the firm's clients and referral sources.
- Have you been able to generate a book of business? If no, why not? Do you believe you will be able to in the future?
- Create a business plan for the future practice and share with the bank when applying for any needed financing.
- Are you sure you want to own and manage a business?
- If you will be borrowing money from a bank determine all the interest that you will be paying as well as any interest on the five year payout to the owner. Determine the time it will take to receive a return on your investment – how many years. If you pay $250,000 for the practice plus interest – say $300,000 over five years – will you earn this amount in additional income over and above what you are presently earning and is there upside potential? Does the deal make sense?
- Insure that you develop a partnership agreement for the new partnership. Insure that is provides for retirement of the owner after two years – if not be careful of the compensation arrangement.
- Insure that the owner makes a commitment to timely transitioning client and referral source relationships.
Click here for our blog on succession
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John W. Olmstead, MBA, Ph.D, CMC
Mar 25, 2014
I am the managing partner of a 16 attorney insurance defense law firm in Kansas City. We have two equity partners, four non-equity partners, and ten associates. Only the two equity partners bring in client business. Since our clients are insurance companies most of our work is new business from existing clients. Unlike other firms doing insurance defense work our billing rates are low and we have to put in a lot of billable hours and maintain a high ratio of associates and non-equity partners to equity partners.
In the past our associates stayed for a while and left after several years. As a result about the time they reached the higher compensation levels they left and we replaced them with lower cost associates. In the last few years – with the economy and the oversupply of lawyers – they are staying much longer. While we – the equity partners – want to be fair and are willing to share – we are concerned about our reducing profit margins and at what point an associate or non-equity partner's compensation is "maxed out." We would appreciate your thoughts.
Law firms of all types of practice are experiencing this dilemma. The problem is even more evident in insurance defense firms where much of the work is routine discovery work that can be handled as well by an attorney with two years' experience as by an attorney with ten years' experience at lower cost. Here are a few thoughts:
- Use the formula – 3 times salary as a general guide to determine where you are regarding working attorney fee production from each of your attorneys. If you are paying an associate or non-equity partner $100,000 a year salary you should be collecting $300,000. The goal is that 1/3 of each fee dollar goes to association of the attorney, 1/3 to overhead, and 1/3 to profit – this a 30% profit margin.
- Dig into your financials and determine your contribution to profit from each of your attorneys. Allocate all direct expenses and indirect overhead and calculate profit margin. Click here for an illustration on how to allocate overhead
- Profit margin should be between 25%-30%.
- Use the margin to establish a theoretical salary limit in absence of other contributions such as management, client origination, additional business from existing clients, etc.
- Cap salaries with the exception of periodic cost of living adjustments.
- Use a client or referral commission bonus, production/hours bonus, and bonus pools to reward exceptional performance.
Click here for our blog on compensation
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John W. Olmstead, MBA, Ph.D, CMC