It would not be a stretch to say that every law practice has value. However, it is a stretch to say that every law practice is salable. And it is even more of a stretch to say that every law practice is salable for the determined value. Certainly, not every law practice is salable for the price that the selling lawyer would like to receive.
However, even the smallest and most personal practices may be salable for the right price and under the right terms. More specifically, if the buyer can be assured that he will receive that which was negotiated—say, a law practice of a certain volume of revenue or a certain client base that will remain with the practice for a designated period of time—then a sale becomes likely even for the smallest and most personal practice.
Determining the value of a practice, or the sale price obtainable for it, can be challenging. This is why the first stage of selling a practice is to engage a professional who is familiar with appraising law firms and ask him or her for an opinion of value.
Many commercial appraisal companies, real estate brokers, real estate appraisers, certified public accountants, “forensic” certified public accountants, auctioneers, economists, university business administration professors, attorneys, and law firm management consultants are willing to and capable of rendering an opinion of value. As a lawyer, of course, you will be best served by retaining someone who knows the nature and characteristics of a law practice. The experience, qualifications, and skills of the individual appraiser will be important factors in the merits and persuasiveness of the final valuation. Ask colleagues, business associates, and friends if they can refer you to someone with the appropriate expertise.
You must be aware up front, though, that you may not be able to sell your firm for what you think it is worth or the appraiser’s opinion. Rather, the expert valuation estimate that you will obtain as a seller will guide you in establishing an asking price for the practice. Serious prospective buyers will hire their own experts to conduct a separate valuation of the practice and, consequently, will have a different figure to serve as their guide.
Neither “value,” clearly, will be the precise sale price. After all, just as the seller desires to obtain the maximum price, so, too, the buyer wants to purchase the practice for the least amount of money. The valuation figures will be the basis of negotiations between the seller and the buyer.
Typically, the result is that you will sell your practice at a price generally between what you think it’s worth and what the buyer actually wants to pay. Perhaps neither of you will be magnificently pleased by the final price, but it is vitally important to remember that the final price you negotiate may not be the asking price. In fact, in the right circumstances, and with an appropriate presentation of salient facts, some sellers may not want to set a specific asking price. Rather, they might want to develop an agreed-on price through discussions with the buyer.
Goodwill and Valuation
Your valuation expert will need a full range of financial records and data related to your law practice, since he or she must have sufficient information to make an informed estimate of value. The process will also require you, as the seller, to specifically identify each asset of the practice—including tangible assets, such as cash, furniture, real property, etc., and intangible assets, such as goodwill.
One of the thorniest issues in selling a practice involves goodwill and how to value it. “Goodwill” in this sense is the reputation, client base, and client loyalty that the selling lawyer has created over the life of the practice. Firms with bad publicity and malpractice or disciplinary matters hanging over them have little goodwill.
Typically, small-firm lawyers understand the value of their client relationships and reputations and, when negotiating for the sale of a practice, discuss compensation for goodwill. However, buyers may argue that there is no goodwill. This often is the stance of large law firms seeking to buy practices. Actually, the parties may not even talk about goodwill; the buyer may simply refuse to buy if the seller insists on being compensated for goodwill.
Often, however, a “credit” is given for a factor that might be analogous to goodwill in terms of the cost of the capital buy-in or increase in valuation of other assets. Some adjustment must be made for this factor, irrespective of what it is called.
Reaching agreement on this issue at the outset addresses the concern that arises if the new lawyer seeks to buy the firm outright and change the name that the seller’s clients have come to know. Often, when a firm is bought by outside interests, buyers assert that few clients will remain with the firm once its proprietor leaves, and thus they offer a lower purchase price. The selling lawyer then needs to assert that goodwill infers that the reputation of the firm continues beyond the removal of any one individual. With that reputation comes the client list, the phone number, and the ongoing nature of the practice (with staff and systems in place).
Expected Future Earnings
When buying a law practice, look at valuation in terms of the expected future earnings of the practice. Many people believe that the price to be paid needs to be based only on the figure generated by the existing practice, but that price also can include future earnings that may be based on the buyer’s talents brought to bear on the purchased practice.
For example, the law practice may expand the depth of the buyer’s existing practice, or it could increase the areas of practice of the buyer. These are reasons that the buyer may be willing to pay more than otherwise would be the case.
Sellers generally prefer to settle on a fixed sum. Buyers generally prefer the contrary. Even with a fixed price, bonuses and payment terms can take into account the parties’ legitimate concerns. While many lawyers believe that a percentage of revenues, not a fixed price, should be paid, this approach tends to lock both sides into an agreement that allows no upside for a buying lawyer. Both parties’ concerns can be addressed with a fixed sum. This also moves away from ethical concerns about selling files.
In many cases, lawyers have not adequately thought through what they might ultimately get from a buyer. Their first thought often is just to sell their practices, but with unrealistic expectations. For example, the seller might think, “I’m earning $650,000 a year, and I don’t want to sell for less than $1 million.” However, a practice is worth what a buyer will pay, not what a lawyers wants to receive. So, if you have not defined what that amount might be, consider setting aside specific amounts each week for living expenses and future retirement, and then put the rest into maintaining the value of the practice. To do so meaningfully, you’ll need to start well before you approach retirement. Granted, that will be tough and take a lot of discipline, but the alternative of failing to get an acceptable price for your practice is far tougher.
About the Author
Ed Poll is the founder and principal of LawBiz, a law practice management consulting firm. Follow Ed on Twitter @LawBiz, or contact him at 310.827.5415 or EdPoll@lawbiz.com.