Best Practice Tips: Gradually Selling a Law Practice to an Associate
Asked and Answered
By John W. Olmstead, MBA, Ph.D, CMC
Q. I am the owner of an elder law firm in Phoenix, Arizona. I have one full-time associate, one part-time associate, and three staff members. I am earning around $300,000 a year from the practice and my full-time associate’s salary is $100,000 a year. I am 60 years old and would like to retire and be out of the practice in five years. I would like to begin phasing down and working part time in the next year or two. My full-time associate has been with the firm for 10 years. I feel that I should be entitled to some sweat equity from the practice in the form of retirement compensation or buy-out. With this said I would prefer that my practice “stay in the family” and be sold to my associate rather than selling my practice to an outside buyer. I would appreciate your suggestions.
A. One of the issues today with many associates is they have large student loan debt and have little in the way of capital, and little to no borrowing capacity. As a result, many firm owners in your situation have to get much of their payout from future earnings after their retirement if they wait too long. Your best bet is to start selling shares as soon as you can based upon a valuation method that you determine. You have five years remaining – 10 years would have been better. In essence you determine the value of the firm, determine the price per share, determine how many shares that associate will acquire, and then calculate the price for the number of shares being acquired. For example, let's say your practice is valued at $600,000. Divide by 100 equals $6,000 per share or percentage point. For an initial 20 percent interest or 20 shares, the buy-in price would be $60,000. Then over the next five years, gradually sell the associate additional shares. Upon your retirement you would have sold all of your shares.
Typically, the problem is the associate does not have any cash or ability to borrow on their own. You may be able to help the associate borrow the money from your bank. If you can, this would be the preferred approach. If the associate cannot raise the capital, then you will have to finance the buyout. For a $600,000 buyout, a five-year timeline will be impossible for you to have all your cash by retirement. How you structure your compensation as you begin working part time and your associate’s compensation as a partner will have a bearing on capital that your associate will have available. Be careful that you are not funding your own buyout. You will more than likely have to get a large portion of your payout after retirement via a secured promissory note with the associate for the balance.
The sooner you start, the better your chances for a successful outcome.
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John W. Olmstead, MBA, Ph.D, CMC, (www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics and author of The Lawyers Guide to Succession Planning published by the ABA. For more information on law office management please direct questions to the ISBA listserver, which John and other committee members review, or view archived copies of The Bottom Line Newsletters. Contact John at firstname.lastname@example.org.