For Sale by Owner: Getting the Most for Your Law Practice
By Maria Kantzavelos
How much is your practice worth? How can you maximize its value? How do you find buyers? Even if you aren't ready to sell, experts say the time to ask yourself these questions is now.
Given the effect of the financial crisis on 401(k) plans, shrunken home values, and tanked stock portfolios - and the American Bar Association prediction that an estimated 400,000 lawyers of the Baby Boom generation are poised to retire by 2020 - interest by lawyers in selling their practice is on the rise, said California-based management consultant Ed Poll.
"I get a call or two every week about wanting to sell a practice, or a lawyer intrigued with the idea of how to buy a practice," Poll said. "Most of the calls I get are from folks in their sixties and seventies wanting to know how to get out. And none of them have a plan on how to do it."
Poll, who practiced law for 25 years and wrote Selling Your Law Practice: The Profitable Exit Strategy, likes to say that virtually every law practice does have value.
"If you've got a Bentley, you know the car has value. Does a Cadillac have value? A Chevy? It's a different car, a different value, but they all have value," Poll said. The same can be true of the value of a law practice, Poll said, whether the practice generates $1 million per year, $500,000 per year, or $100,000 per year.
"We're not saying they're all going to be sold overnight and for the same amount of money and under the same terms," Poll said. "But they all can be sold. The fact that a law practice has value doesn't mean that you can get a million dollars for every practice. But whatever you can get is more than closing it down."
The IBJ recently talked with Poll and other consultants to the legal profession for some tips that a sole practitioner or owner of a small firm may want to consider in the process of selling a practice at the highest possible price.
Knowing the rules (especially Rule 1.17)
For starters, said Theodore M. Mann Jr., a lawyer from Ohio who has written on practice valuation for the Ohio State Bar Association, consider what you can actually sell. The answer may be dictated not just by what you have, but also by the Rules of Professional Conduct in your state, Mann said.
For example, unlike in some states that allow the sale of an area of a practice, in Illinois, lawyers must sell the entire practice.
For the retiring solo and small-firm practitioner in Illinois, putting their practice up for sale rather than taking down their shingle has been an option governed by Rule 1.17 of the Illinois Rules of Professional Conduct since the Illinois Supreme Court adopted the measure in 2005, permitting the sale of a law practice by either a lawyer or a lawyer's estate under certain conditions. The rule, last modified in 2010, reads as follows:
RULE 1.17: SALE OF LAW PRACTICE
A lawyer or a law firm may sell or purchase, and the estate of a deceased lawyer or the guardian or authorized representative of a disabled lawyer may sell, a law practice, including good will, if the following conditions are satisfied:
(a) The seller ceases to engage in the private practice of law in the geographic area in which the practice has been conducted;
(b) The entire practice is sold to one or more lawyers or law firms;
(c) The seller gives written notice to each of the seller's clients regarding:
(1) the proposed sale;
(2) the client's right to retain other counsel or to take possession of the file; and
(3) the fact that the client's consent to the transfer of the client's files will be presumed if the client does not take any action or does not otherwise object within ninety (90) days of receipt of the notice.
If a client cannot be given notice, the representation of that client may be transferred to the purchaser only upon entry of an order so authorizing by a court having jurisdiction. The seller may disclose to the court in camera information relating to the representation only to the extent necessary to obtain an order authorizing the transfer of a file.
(d) The fees charged clients shall not be increased by reason of the sale.
"Once you know what you can sell," Mann said, "you identify and put values on that information."
What's it worth?
Valuation formula. While it's been said that the specifics of placing a value and price tag on a law practice can be more art than science, a "rule-of-thumb" method is often used as a starting point.
Although a standard has not yet been set for law firms, a general multiplier for estimating the value of good will and the future value of cash flows - after valuing physical assets - is in the range of between 0.6 to 1.0 (60-100 percent) of annual year's gross fee revenue, said St. Louis management consultant John W. Olmstead, a former chair of the ISBA Law Office Management and Economics Committee.
Olmstead suggests averaging the firm's gross fee revenue over the past five years to even out any peculiar ups or downs in the revenue stream. Then, he said, multiply that average year's gross fee revenue by a given factor within that range.
"If you're billing an average of $300,000 a year you don't have a million-dollar practice, you have a $300,000 or less practice," Olmstead said.
According to Olmstead, whether the multiplier is in the lower or higher level of the range depends largely on factors like how much repeat business is expected, the number of clients, the transferability of client relationships, dependency on a few large clients, and whether the firm is a personal practice and uniquely the owner's.
Selling relationships. A law practice has some hard assets that are relatively easy to put a value on, such as computer equipment, a phone system, and furnishings.
However, said James D. Cotterman, a principal with Altman Weil Inc., a management consulting firm to the legal profession, "The main assets you're selling are the relationships with the clients and the future stream of revenue they represent." Also, Cotterman said, it's the relationships that give you client referrals.
"Let's say you're the leading family law practice in your community and that's all you do. You get a lot of referrals from CPAs or other law firms that don't want to handle those kinds of matters," Cotterman said. "You may have a lot of relationships that give referrals. Those relationships are also important."
That said, will these clients and their matters as well as these valuable referral sources stay with the firm if the lawyer with whom they have the relationship is no longer with the practice? This may very well be the million-dollar question.
"Do you have [transferable] referral sources? Or are they just your buddies from Sunday golf and when you're gone they're gone, too?" Ohio attorney Mann said.
In looking for the right practice, Mann said, "a buyer will want to know: How many assets am I going to be able to hold on to as the new owner?"
"It's more than just a simple math formula. You're selling an intangible - the good will, trust factor."
Maybe, too, you have a brand to sell, "something that has value as opposed to just saying 'I do deeds or wills,'" Mann said. For example, he said, "If you are the go-to person for bond work, you then have a way to put a higher valuation on your practice."
Maximizing your return
An official definition of good will in business can be found in Black's Law Dictionary. But the unofficial definition Poll provided is this: That which makes you special.
"Why is it that clients come to you? What about your service and your reputation are different from other lawyers and other firms? That's the good will," Poll said. "Good will is your legacy. How well are you thought of in the community that uses your services and how can you transfer that legacy to somebody else?"
Helping with the transition. As such, consultants said, the selling lawyer is well advised to be involved to some degree with the transition of the practice to the buying lawyer.
"If you want to maximize your return you've got to be willing to invest some time in the post-sale," Mann said.
Introduce clients to the new owner, saying something like, "'This is Sara; you can trust her,' as opposed to grabbing the money and heading to Florida," Mann said. "Give it your seal of approval that the replacement is someone you [the client] can trust as well as you did me for the past 25 years and therefore you should keep doing business with them."
In many cases, the sale of a practice takes the form of an "earn-out," where the purchase price is tied to the amount of business done over a specified amount of time after the sale, or the percentage of a seller's clients who remain with the buyer's practice.
"If you're really lucky you might get a deposit of half of what you agreed to. The other half would be conditional upon X clients staying with that practice," Olmstead said.
Frankly, Mann said, "Most smart buyers have a post-sale adjustment period for the amount of work retained and generated [as a result of the acquired practice]. You as a seller have an interest in staying engaged long enough so that the new owner can pay you."
Associating with another firm. Altman Weil's Cotterman offered the following advice for "the best way" for a solo or small-firm attorney to sell a practice: "Find a firm that he or she believes will be a good fit for the clients - [taking into account the buying attorney's] personality, type of work, philosophy to the practice of law - and then associate with that firm."
This option, Cotterman said, may or may not mean merging the firms. And, he added, it may mean a three to five year process leading up to a sale.
"Generally, the buyer's willingness to pay is based on what they'll be able to keep and hold on to," Cotterman said. "An association in advance of retirement is the easiest way to make this happen. By the time I'm ready to retire, my clients are going to be comfortable with everyone I've associated with."
Another way to help in the transition and therefore get more bang for your buck, Poll said, is with a letter to clients "saying, 'I value our relationship. The time has come for me to retire. I'm selling the practice to John. I trust and hope that you will call John when you have a need…I will be available to consult with you and John as the case may be,' " Poll said.
With bigger clients, meetings among the client, the selling lawyer and the buying lawyer could be arranged, Poll said, where the selling lawyer could "let John meet and learn about the client."
"John has to be sympathetic to the way Bill did his work and be at least, if not more, service-oriented than Bill was," Poll said. "Under those circumstances, the majority of the time the client will engage John."
Putting your business in order. Beyond the hard assets like furniture and computers, which on the open market generally have little value, Poll said, another of a law practice's selling-points is its systems, "how and what it is that you do," Poll said.
Just as a house can appreciate in value with such home improvements as a new roof or the construction of an addition, if a practitioner is not in a rush to sell, there are some things he can do in advance of retirement to improve the value of a practice, like implementing management practices that will systemize the firm (see sidebar).
Then there is the accounts receivable factor.
"The last thing a successor wants to find is that they don't have engagement letters, or that they bill between Thanksgiving and Christmas for the entire year or 'when I get around to it,' " Cotterman said.
As part of putting your financial house in order before it comes time to sell, Poll said, "You want to make sure you have a real high realization rate, at least above 95 percent so that when you finally close the book you're in a position to have a healthy accounts receivable that will be collected."
And a good staff, which may include the paralegal or assistant who has been with the practice for 20 years and can recognize a client just by the sound of his voice on the phone, can be worth its weight in gold. "In the short-term, there may be a value in negotiating that the buyer will want to have them involved," Mann said.
Selling a going concern. Keep in mind that a law practice that's on a downward slope, where the owner no longer thinks of it as a going concern, is "like a fish wrapped in newspaper for three years," Poll said. "Nobody wants to get near it because everybody understands that it's a business being closed. If you've got a going concern, that's something somebody wants."
Poll recalled the advice he offered an attorney client who came to him when the client was in his late seventies and said, "'Whether you sell my practice or not, by the time I have my eightieth birthday I'm turning in my bar card.' He told me one way or the other he's going to close everything down by the time he's 80 years old."
"I told him, 'If you start retiring now and the revenue goes down then you're destroying your own law practice and the value of what you have to sell,' " Poll said.
Taking Poll's advice, the veteran California attorney kept on plugging away with his practice and succeeded by 30 days in meeting his own mandate. He was 79 years and 11 months old when the transaction concluded, Poll said.
"What's unique about it is that he practiced for so long and he had a very definitive timetable in his mind," Poll said. "We happened to be fortunate. My client knew of several people who might be interested. I started to make some calls and happened upon one of the people that really was interested, worked with him for a while, and was able to put the deal together."
Timing can also be key. "Keep an eye on the marketplace to see what practices are hot," Poll said. "If bankruptcy is hot today and you have a bankruptcy practice, start looking around now."
Finding a buyer
Spreading the word without showing your hand. Once you have a rough idea of what you think you want to ask for your practice - and maybe even sought some advice from outside professionals who might be law firm management consultants, exit planning professionals, certified public accountants, commercial appraisal firms, and attorneys - consider where your leads are for prospective buyers, Olmstead said.
For many solos, the place to start might be with your professional relationships, whether it's an associate you have on board or a peer who handles the same sort of matters. Or, Olmstead said, prospective buyers could come in the form of another law firm that might be a competitor outside of your market area who would like to have a footprint in your locale, or a firm that would like to add to its mix the specialty you have.
"It's just like looking for a job. If you've got some folks you know, then begin to approach some people and talk with them," Olmstead said.
Taking such a step to generate leads can be tricky in the beginning, Olmstead and others said, so sellers are advised against disclosing too much information too soon.
The trouble is the psychology factor: Once I know Joe Jones is selling his practice am I going to try to raid his clients? That's why lawyers are very private about the process," Ohio attorney Mann said.
Consider this recently posted online advertisement featuring a "Confidential law firm" for sale in Tampa, Fla.: "Highly respected twenty-year Law practice with over 1,000 estate plans in place with business and individual clients, business continuation planning, guardianship, probate, business transactions, family law and civil litigation (approximately 50% of 2011 revenues). Residual legal services anticipated as estate planning clients modify their estates, sell business or expire. Very well managed practice with significant growth opportunities serving the North Tampa residential and business communities. Asking $550,000."
Placing ads like this in website listings, bar journals, and other legal trade publications reveal just enough information to pique a prospective buyer's interest, Olmstead said.
Creating an offer package. A first step toward casting your practice in its best light, Olmstead said, is to work on putting together an offer package that can be provided to other firms that the buyer may approach directly or indirectly.
A good offer package, Olmstead noted in an Aug. 2, 2011 entry of his Law Practice Management Asked and Answered Blog (blog.olmsteadassoc.com) consists of a firm profile, a nondisclosure agreement, and a detailed offering memorandum or confidential descriptive memorandum.
The firm profile serves as the first point of contact with potential buyers, Olmstead said.
"It summarizes the key points and describes the firm without revealing any identifying information," Olmstead said. "If an interested party wishes to go to the next step, a nondisclosure agreement is executed and an offering memorandum with more specific information is then provided."
The offering memorandum, Olmstead said, tells the firm's story in a more detailed way and provides facts that prospective buyers would want to know, including the legal structure of the firm, ownership and governance, key management, an organizational chart, client breakdown, practice areas, marketing, historical financial performance, potential growth opportunities, potential synergies or economies of scale, and proposed deal structure.
'Look immediately above you.' For a solo or small-firm lawyer, targeting a 50-lawyer firm as a prospective buyer probably wouldn't work, Cotterman said. "They have a different strategy and different area of the market they're going after.
"If you're looking to sell you have to look at people maybe just a little larger than you to take on your practice," Cotterman said. "The solo or five-lawyer shop may not be able to take on another solo or firm's clients.…Look immediately above you in terms of scale. They will probably be close enough to the kinds of clients you work with and they may have some capacity so they can take it on with a little less difficulty, and they might be able to handle the cost of your buyout easier because they can spread that cost along more people."
Marketing to new admittees. That may be so, but Mann pointed to another source for a potential buyer: A law school placement officer who can fill a practitioner in on whether there are any new graduates looking to acquire a practice.
Just as a generation of lawyers is retiring, another is entering the practice. "Now that lawyers can sell their practices, [new lawyers are] looking at ways to buy practices and get instant clients," Mann said.
Of course, Mann said, there can be a downside to limiting your search for a buyer to newer lawyers: "Most of them have a lot of student loan debt."
"But that also may be a situation where, in transitioning them, they're going to pay you out of future earnings post-sale. And, he said, the selling lawyer can, in a sense, "serve as a mentor."
More than just the money
While lawyers contemplating retirement have built something of value that could be sold, possibly serving as one way to help substitute shrunken savings due to the economic woes of recent years, selling a law practice to the right buyer can also be an option for seeing to it that clients are put in good hands.
"Most practitioners care very deeply about their clients and they don't want to leave them high and dry," Cotterman said.
Olmstead put it this way: "You've got Law Firm A and Law Firm B. A is offering more money, but Law Firm B is the firm you think would be more compatible with clients, that basically your staff will be more comfortable in. That might even be more important to you than the dollars."
He recalled the wishes of a client he recently worked with, a 70-year-old attorney whose stated main priority was, "'When I need to leave the practice, I want my clients to be taken care of and I want my paralegal to be taken care of,'" Olmstead said.
He asked the attorney: "'What about sweat equity?'" Her response, Olmstead said: "'Well, that'd be a bonus.'"
Maria Kantzavelos <firstname.lastname@example.org> is a Chicago-based freelance writer focusing on legal topics.
Not only do sound management techniques increase your efficiency and effectiveness, they can bump up the value of your practice when it comes time to sell, consultant John Olmstead said.
Which techniques? Examples include written procedures and policies, checklists and forms, organized client files and accounting systems, and automated case management systems that would make it simple for another attorney to pick up exactly where the case left off.
"If I've got to start digging through files and looking through every piece of paper and talking to the client, I can't be charging the client again to learn everything," Olmstead said. "The better that's organized so I [the buyer] can make sense of it in a consistent way, the more it's going to be of interest to me."
"Those are the kinds of things that would take you from a multiple of 0.6 to maybe a multiple of one," Olmstead said. "As you're trying to value the practice, the more you have those kinds of things the more you'd feel comfortable with having that asking price be higher."
For example, he said, if you handle wills and trusts, "Have you extracted that knowledge out of your head and documented it - procedures and protocols, steps on how you do things?"
"It's kind of like buying a McDonalds restaurant. You don't just have a restaurant, but you're basically buying a complete system," Olmstead said.
Maybe your practice has a marketing or business plan. "If you can sell a system, now you have something of greater value," consultant Ed Poll said.
- Maria Kantzavelos