Ready Set Sell Your Law Firm - What and How - Part I
Version published in Jan/Feb 2015 89 (1/2) Law Institute Journal p79
You have decided to sell your small or medium-sized legal practice.
There are many reasons for a sale. Maybe it is your choice after New Year reflections, as a business strategy or it’s “just time”, or maybe it is forced on you due to poor health, poor business results or poor partner relationships.
Generally it is better to plan in advance for a sale as part of your exit strategy for the business-(and yourself). The sale process is likely to be a roller coaster: emotional, time-consuming and stressful, especially if a new experience. The more investment you make in understanding value and what buyers may value, the more likely it will be a better experience.
Like many small and medium business owners new to a sale of their law firm, you will be asking questions such as what’s the value of my legal practice? What happens in a sale? Who would buy my business? Do I need an advisor? And so on….
What is its value?
The value of your law firm will depend on a number of factors including its size and buyer.
Traditionally, for a larger legal business, it is likely that the expert valuation will be financially-based and address future cash flow or “goodwill”, adjusted by a risk factor. Methods include “future maintainable earnings” based on “discounted cash flow” (QLS) and net profitability (EBIT) less commercial salaries to owners (NSWLS).
Occasionally accountants also assess the net value of assets. For example WIP, debtors, equipment less creditors, loans, employee entitlements). This can be confusing as it may be used to allocate price after the overall deal.
Calculation of the risk factor (also called capitalisation rate) is “more challenging and something of an art form” (QLS). It assesses how much a buyer is willing to pay based on the risks and rewards of the economy, legal industry and your particular legal practice. For legal businesses, a rough rule of thumb is 1 to 3 times the future cash flow with smaller the business, the lower the multiple.
For smaller businesses, it’s usually all about meeting key performance indicators (KPIs). That is, owners are required to transition by remaining as employees in the business with payment on success in meeting KPIs with “perhaps a little upfront”.
In addition, be aware that each potential buyer will value your business differently. M Kerr gives an example. If you gave 10 potential buyers the same information about your business and forced them to put an offer, each would put a different dollar value and different deal terms. This is because the buyers all have different business and personal needs. Say there are two genuine buyers. Buyer 1 needs to sell their existing business first. Buyer 2 has just lost their job, has a payout and needs to generate an income rather than spend their capital. Buyer 2 will be far less likely to negotiate the price down. Buyer 1 would be happy to put in a low offer and wait.
Who will buy?
The traditional - and arguably tried and tested - process for small and medium business sales is to advertise widely using media and websites. Steps include getting valuation/s, writing an information memorandum and undertaking internal due diligence, followed by large scale advertising and marketing to potential buyers. Then qualifying buyers, handling enquiries, assessing offers, negotiating final offers and coordinating legal requirements.
This ‘bait and wait’ approach may not always work well for legal practices. It’s a one way mindset of selling the business to the buyer. It favours the buyer as the seller gives out commercially sensitive information, negotiates down on price and is led by advisors seeking fees. It tends to ignore hidden costs of time, reputational risk and stress.
As an alternative, consider targeting the “natural owners” as potential buyers of your law firm. Natural owners are people with a good understanding of your industry although they are rarely actively looking.
Finding the natural owners requires a new mindset. Start to engage now. Research your industry and identify potential buyers from your staff, suppliers, long standing customers, competitors, and supporters. You tend to know who’s who and you can access industry associations or specialists such as head-hunters. Next aim to understand the opportunities (financial and non-financial) your business can bring to potential buyers with their different needs. Summarise your key business information. Actively target and contact buyers who could be interested, ask questions to establish credentials and find out needs, motivations, strategy. Be creative about advertising, for example, using an expression of Interest process to attract buyers prepared to put in the effort of an offer.
For law firms, the most likely buyers are your employees. Also consider competitors such as firms looking to expand their customer base, service areas or geography, or lawyers seeking to set up on their own.
Need an Advisor?
It will nearly always be worthwhile using professional advisors as it is difficult to be objective about your own business. However if your business is worth less than $100K, it may not be economic. Pick your advisors well: make sure they understand the legal industry, have strong experience in business sales, can project manage and can deliver. Use an expert for financial valuation. Use a broker for the sale. Be clear about what you want when briefing your advisors.
Understand that you will be on a rollercoaster ride during the sale process. To help keep strong, pick trustworthy advisors, understand your acceptable outcomes for a sale, accept that potential buyers will come and go, and ensure you have a back-up plan or BATNA.
When you sell your small or medium-sized legal practice, while you have an expert financial valuation of your business, remember that each potential buyer will value your business differently according to their needs. Understand the sales process and how to find the best price and buyer. Use professional advisors. With time and understanding on your side, prepare your legal practice to build and improve its value.