Practice for Sale: Selling a Practice

Vol. 29 No. 4

By

Brian H. Cole practices law in Manhattan Beach, California, with a focus on corporate and transactional work, primarily for companies and individuals involved in franchise and distribution matters.


One can argue whether sole practitioners have advantages over law firms. Many would argue that they do. There is, however, one area in which many law firms have a clear advantage—succession. Almost all law firms have some sort of mechanism to address what happens when one lawyer wants to (or must) leave the firm. Sole practitioners are much less likely to have plans in place for this eventuality. This article will discuss some of the considerations for lawyers who want to sell a practice (either immediately or at a future time).

 

Sell or Close?

Businesspeople seem to be more likely to realize the value of a business than lawyers. Someone who has been operating, say, a flower shop for many years is likely to see the business as an asset that can be sold. By contrast, many lawyers think of their practices as something with value only when they are actively billing time, but with no residual value. Although it may not be possible to sell every lawyer’s practice, most practices have some value. At the very least, the lawyer probably has some furniture and used computers, perhaps some forms, perhaps some books. But more than that, the lawyer probably has valuable intangible assets.

The lawyer may have a staff with valuable skills and valuable relationships with clients. The lawyer may have recurring clients that keep coming back to the lawyer every month or every year. The lawyer may have been in the same location for an extended period, or may have used the same telephone number for a long time. Finally, the lawyer probably has some sort of reputation—hopefully good—in the community. Each of these things has value, and it may be possible to realize some or all that value by selling the business. If the business is simply closed, the lawyer walks away empty-handed.

 

Reasons to Sell

Why would a lawyer want to realize this value? The most common reason is that the lawyer has decided to retire, but the lawyer also may have decided to relocate a long distance away or may have accepted an in-house job or been appointed as a judge. The lawyer may have decided to leave the law to pursue another calling. Or, of course, the lawyer may have died or become disabled, and it is the lawyer’s family that is trying to sell the practice.

 

Timing

Depending on the reasons for selling, the lawyer (or the lawyer’s family) may have either a lot of time or only a little time to make the sale. As a general rule, it will be easier to obtain a higher price if there is more time for the sale to be made. Conversely, the shorter the time available to market the lawyer’s practice, the harder it can be to obtain full value for the lawyer’s business. Retirement may be the situation in which the lawyer has the greatest flexibility as to timing, whereas death or disability may lead to the most compressed schedule for selling the business.

 

Ethical Issues

Perhaps the most important question in selling a law practice is whether there are any ethical limitations on the ability to do so. In the 2011 version of the ABA Model Rules of Professional Conduct (variations of which have been adopted by most states), the sale of a law practice (or of an area of a law practice) is specifically endorsed by Rule 1.17. Although Rule 1.17 now allows sales, it does have several requirements, including that the fees charged to the client cannot increase solely as a result of the sale, and a written notice must be given to all 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.”

Anyone selling (or buying) a law practice should certainly check the ethics rules in the affected state(s) before proceeding.

It has not always been the case that sales of a law practice were explicitly condoned. For instance, under the ABA Model Code of Professional Responsibility (originally enacted in 1969 and subsequently amended as recently as 1980), DR2-107 severely limited the ability of lawyers to share fees, with one of the exceptions relating to “payment[s] to a former partner or associate pursuant to a separation or retirement agreement.” Although that provision would give comfort to a lawyer retiring from a firm, it did not necessarily help the sole practitioner.

There are other ethical issues to consider as well. Prominent among them is what it means to sell a practice. Beyond the furniture, the law books, and other physical assets, the major asset being sold is goodwill—the lawyer’s reputation and the tendency of clients to continue to call the same telephone number or to go to the same office to obtain future legal services. If a lawyer sells a practice, then immediately reopens the same type of practice across the street, the buyer is not getting the benefit of buying the goodwill. Even if that behavior is not explicitly contrary to the terms of the sales contract, it is certainly a violation of the spirit of the sale. As importantly, in jurisdictions that follow Model Rule 1.17, sale of a practice is permissible only if the “seller ceases to engage in the private practice of law, or in the area of practice that has been sold. . . .”

 

Pricing

After the decision to sell has been made and the potential ethical issues have been addressed, a lawyer selling a law practice must determine the sales price. There are many factors that can go into this calculation, but in many ways the issues come down to this: What is the value of the increased amount of business that the buyer can expect to have as a result of buying an existing practice instead of starting from scratch?

There are all sorts of factors that can affect the price: the nature of the practice (for instance, estate planning practices are often particularly valuable), the amount of recurring business, the length of time the selling lawyer has been in practice, the number of clients (and the concentration of work in a small number of clients), how long the seller has to make the sale, the likelihood that clients will remain with the practice after a sale, the stability of the practice’s revenue flow from month to month and year to year, and the overall reputation of the firm. Many experts suggest that prices typically range from 40 percent to 100 percent of annual revenues for the last 12 months, although some experts suggest that a practice may sell for as much as 300 percent of the prior year’s annual revenues.

The lawyer buying a practice may also want to pay the purchase over time and may even want an “earn-out” (in which the purchase price is tied to the amount of business done over a certain number of months after the sale, or the percentage of clients who remain with the practice). Earn-outs can be appealing because they allow for a higher overall price, but they carry some risk as well. The amount of business done in the future (and the number of clients retained) can be influenced as much or more by the quality of the services provided by the buyer as by the seller’s performance before a sale. In addition, an earn-out lengthens the time to receive the sales price. Still, an earn-out may be a way to increase the sales price and can therefore be a good approach for the seller to take.

Finally, in connection with setting the price, remember that some factors affecting the price of a law practice can be improved in the short term. These factors range from the purely cosmetic (repainting the conference room and uncluttering the office) to the more substantive (updating all client files and making sure that the financial records are fully up-to-date).

 

Identifying Potential Buyers

A decision to sell has been made, the ethical issues have been cleared, and an asking price has been determined. But who will buy the practice? For the seller who is not a “true solo”—who has one or more additional lawyers working in the practice, even on a contract or part-time basis—the best choice as a buyer is likely one of these lawyers. They are likely to know the strengths of the practice, may be familiar with the clients, and may be very interested in becoming “in charge” of the practice.

Even for the true solo who practices with no other lawyers, there are many potential classes of buyers. There are competitive lawyers who may want to expand, or out-of-town firms that want to establish an office in a new location. There are recent law school graduates who would like to “jump-start” a new practice. There are lawyers from another jurisdiction who want to relocate (perhaps because a spouse is moving) and who would welcome the opportunities that buying an existing practice presents. And then there are lawyers who have left a large firm (perhaps because they don’t make partner or because they made partner but later are “de-equitized” or down-sized), and decide to go out on their own; even a displaced partner could use a ready-made client base if this lawyer’s former clients are unlikely to leave the large firm.

 

Transition

When the time comes to make the sale, should the bandage be ripped off all at once (metaphorically speaking), or should it be removed slowly? It might make sense to consider a transition period, in which the selling lawyer stays on to introduce the buyer to clients while phasing out of active practice. This transition can be particularly useful in jurisdictions that do not allow the sale of a practice but do allow payments to a former partner. In these jurisdictions, the buyer is brought in as an associate or a partner, and the seller continues as a member of the firm for some period of time before “retirement,” with payments being structured as a retirement payout. This approach cannot always be used, however. For instance, if the seller is going into government service or taking a corporate job, it may not be possible for the seller to simultaneously work at the old firm. And such a transition is obviously out of the question when the practice of a deceased lawyer is being sold.

In the context of a transition, it can also make sense for the name of the firm to reflect the new arrangement. For example, if John Smith is the selling lawyer and Fred Jones is the buyer, the name of the firm could be changed from Law Office of John Smith to Smith and Associates, and then to Smith and Jones. By this process, the clients can become accustomed to the idea that Mr. Jones is just as much a part of the firm’s activities as Mr. Smith has been. Note that some states require that if the name of a retired partner is included in a firm’s name, that the dates on which the retired partner was associated with the firm must also be shown.

If the sale is structured to include an earn-out component of the price, these forms of transition arrangements can be appealing to the seller as well as the buyer. The seller can stay involved for the period of the earn-out to try to ensure that the buyer is serving the needs of the clients well enough that the full earn-out sum is generated.

 

Notice to Clients

As noted above in the section on ethics, Rule 1.17 of the ABA Model Rules of Professional Conduct (variations of which are in place in most states) requires all clients to be informed of certain issues. But that does not mean that these required disclosures are all that should be said to clients. The buyer is going to want the clients to hear something about the buyer—preferably including a recommendation (or at least an expression of confidence) by the seller. Even without that, the buyer is at least likely to want to say something about his or her education, experience, and suitability for the job.

 

Marketing

There are many ways that a lawyer selling a practice can try to find buyers. Perhaps the classic method is an ad in the classified section of bar association magazines or newsletters. A more up-to-date method might be to advertise on Craigslist or similar online forums, although it is not clear how many potential buyers will be looking there to find practices for sale.

One method that has many things to recommend it is the use of a broker. There are brokers who specialize in finding buyers for law practices, as well as more generalized business brokers. Other persons who are not specifically brokers (such as accountants, appraisers or valuation firms, and law firm management consultants) can also help to find buyers or at least to spread the word that a lawyer is interested in selling. One reason to use an actual broker is that an experienced broker can do many things besides simply finding a buyer. The broker can assist in setting the asking price, can pre-qualify buyers, and can even help to negotiate the final sales price. Even lawyers who are experienced negotiators should not underestimate the advantages of having a third party negotiate for them. A broker does not have the emotional connection with the practice, and a good broker can not only assist in maximizing the price but can keep the seller’s spirits up—especially useful when a high percentage of potential buyers “wash out” (as they inevitably will).

Conclusion

There are many good reasons to sell a practice—the most prominent being the ability to maximize the value of an asset that has been built up over years or decades. If handled correctly, the sale is ethical and can generate a sum of cash that can be used for retirement or other needs. Consider these issues and feel more confident when the time comes to consider a sale.

 

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