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Law Practice Today

September 2022

How to Value, Sell & Purchase a Law Practice

Jeremy E Poock

Summary

  • Are you thinking of selling (or buying) a law practice? Here’s what you need to know.
How to Value, Sell & Purchase a Law Practice
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As thousands of baby boomer attorneys (senior attorneys) consider retiring during the next five to 20 years, they often wonder: “What is my law practice worth?” and “Who wants to purchase my law practice?”

Law firm valuation consists of the cumulative value derived from the following components (each, a Value Chip):

  1. The firm’s client list;
  2. The sources who refer clients to the firm;
  3. The goodwill that a senior attorney and the attorney’s law firm has earned over the course of decades locally, regionally, and sometimes nationally or even internationally;
  4. The subject matter knowledge that senior attorneys have developed in their given areas of practice; and
  5. The firm’s digital value.

Three Options for Selling a Law Practice

Senior attorneys have the following options when considering selling their law practices:

  1. Sell to a growing law firm (preferred);
  2. Structure an internal sale (potential); or
  3. The non-option of maintaining the status quo (risky).

The Preferred Option: Sell to a Growing Law Firm

Growing law firms present the preferred sale option because firms in growth mode want and need what senior attorneys have, namely:

  1. The instant growth that a senior attorney’s client list can deliver;
  2. Well-trained, reliable lawyer and support staff;
  3. The cumulative experience in shared practice areas that lawyers and non-lawyer staff of a selling law firm present to a growing law firm; and
  4. A wealth of potential, digital value stemming from opportunities to:
  5. Repurpose a senior attorney’s subject matter knowledge into thought leadership content for print, video, and audio platforms (podcasts, blogs, e-newsletters, LinkedIn posts, YouTube videos, and more); and
  6. Expand upon a senior attorney’s contacts from a typical once per year holiday card to a quarterly or perhaps monthly e-newsletter, plus connecting with clients and referral sources via LinkedIn and Facebook, and sharing meaningful content on a regular basis.

The Potential Option: Pursuing an Internal Sale

Many senior attorneys would prefer to sell their law practices to an internal successor, or recruit a lawyer to succeed to their practice, but most internal successors do not want to purchase a senior attorney’s law practice for the following reasons:

  1. they joined a law firm as a key employee, and years later, they prefer having a job rather than becoming a small business owner;
  2. they went to law school and not business school, i.e., they have no interest and often minimal know-how to operate a business that needs to make payroll twice per month and pay rent by the first of every month;
  3. they cannot afford to purchase a law practice at this point in their careers as they worry about paying for such personal expenses as their mortgages, car payments, college tuition for their kids, and plan for their own retirement; and
  4. for some reason, most internal successors assume that their “boss” will never retire.

The Risky Option: Maintaining the Status Quo

Post-2020, those senior attorneys who maintain their status quo risk the value and future salability of their law firms for two reasons:

  1. Senior attorneys who do not make meaningful investments in digital marketing for their law firms will likely not add as many new clients and referral sources as in years past, because today’s consumers of legal services increasingly ask “Uncle Google” to recommend the best attorney for their legal needs, as compared to the word-of-mouth era, when new clients learned about lawyers from friends, family members, co-workers, other professionals, etc.; and
  2. By maintaining the status quo for too long, senior attorneys risk a “random Tuesday” event that can instantly and negatively impact the value of their practices, such as an unexpected physical or mental health occurrence, the untimely departure of a key lawyer or support staff employee, or a senior attorney’s premature death.

Sale Price Options

Post-2020, the fair market value price that willing purchasers pay for a law practice primarily involves negotiating an earnout price (Law Firms Sales 1.0). As the decade progresses and the brand value of law firms becomes quantifiable, purchase prices will evolve to include an earnout price, plus a fixed price attributable to a firm’s brand value (Law Firm Sales 2.0). For the purposes of this article, the sale options described here do not contemplate law firm sales per a given state’s version of Model Rule of Professional Conduct R. 1.17, Sale of Law Practice, and instead presume terms negotiated per a merger or lateral recruitment with respect to joining a growing law firm, or a transfer of equity over time with respect to an internal successor (see also Montana’s Rule 1.19, its variation on the Model Rule).

Law Firm Sales 1.0: Earnout Price

In Law Firm Sales 1.0, a selling law firm and its purchaser negotiate an earnout price  based upon the following Value Chips: the client list and the referral source list, which taken together, represent a selling firm’s book of business.

When negotiating an earnout price, the purchase terms typically relate to: (a) applying a fee sharing percentage to the collections derived from a selling firm’s book of business; and (b) assigning a number of years in which the fee sharing applies.

Negotiating an earnout price represents fair market value to the seller and purchaser in Law Firm Sales 1.0 because for the purchaser, an earnout price minimizes the risk of over-payment in the event that the clients and referral sources of a selling firm do not continue retaining the legal services and referring new matters to the purchaser respectively. For the seller, the earnout price provides appropriate compensation for the portion of the book of business that continues engaging and referring new clients to a senior attorney’s successor.

Law Firm Sales 2.0: Fixed Price + Earnout Price

As time progresses, sellers and purchasers will begin adding fixed prices attributable to a selling law firm’s brand value, plus negotiating an earnout price, ushering in Law Firm Sales 2.0.

The introduction of fixed pricing for law firm brand value results from today’s digital era, where law firms continue collecting data analytics from their multi-channel digital marketing efforts and client origination data maintained by their customer relationship management (CRM) software, such as designating client origination between clients originated digitally and those originated per traditional referrals.

As Chip LaFleur wrote in his 2020 book, Digital Marketing for Law Firms, the Secrets to Getting More Clients and Better Cases: “The single greatest advantage of digital marketing tools compared to traditional advertising methods is that is that the digital tools generate data that you can use so that you can improve your campaigns so you can keep getting better and better results.”

As a hypothetical example, let’s say that a group of trusts and estates lawyers organize a trade name-based law firm called the Atlantic Estate Planning Group to offer services to middle-class young families in eastern Virginia (like most state bars, Virginia’s Rules of Professional Conduct allow trade names as long as they are not misleading). Recognizing that most of its potential clients search for attorneys online, the firm:

  1. Develops a website with tactical search engine optimization (SEO) that includes a “contact” button for visitors to schedule an initial Zoom consultation or submit an online inquiry;
  2. Regularly posts digital content via multiple social media outlets;
  3. Invests in pay-per-click (PPC) search terms;
  4. Subscribes to listings within relevant, online legal directories (Justia, AVVO, and Super Lawyers); and
  5. Hosts monthly webinars about estate planning trends for young families.

As a result of its digital marketing efforts, the firm:

  1. Achieves first page of Google search results as a branded “go to” trusts and estates firm for young families in eastern Virginia;
  2. Maintains multiple years of data analytics showing click performances, visitor time on page, numbers of quarterly and annual new client inquires, text for online reviews, etc.; and
  3. Collects data from its CRM software designating the source of all new clients, as well as revenues received per client origination category.

In Law Firm Sales 2.0, this data will support and justify selling firms seeking a fixed price for the brand value that a purchaser will receive.  In addition, unlike Law Firm Sales 1.0 where banks remain hesitant to lend upon the value of a selling firm’s book of business due to the uncertainty of clients and referral sources remaining with a purchasing firm, Law Firm Sales 2.0 will include commercial bank financing because of reliable data supporting a firm’s brand value.

Additional Law Firm Sale Price Options

In addition to the fair market value approach that Law Firms Sales 1.0 and 2.0 present, law firm sale price options also include:

  1. A fixed price amount based upon a multiple of revenues or net profits, which typically applies either to those law practices that feature significant, repeat business (ex. a collections law firm with long-time retail clients), or to those sellers willing to accept less than the fair market value that an earnout price presents;
  2. Transferring an attorney’s files to one or more colleagues for no consideration, or fee sharing on a case-by-case basis per an applicable state version of Model Rule of Professional Conduct 1.5;
  3. No sale, and simply wind-up the affairs of a law practice; or
  4. the sale or transfer of a lawyer’s practice by a personal representative of a lawyer in the event of premature death, or a physical or mental health incapacity.

Logistics Involved When Considering Selling a Law Practice

When considering selling a law practice, the following logistics apply:

  1. How the five components of value apply to a senior attorney’s practice;
  2. Whether to pursue a sale to a growing law firm, an internal successor, or maintain the status quo;
  3. Whether a Law Firm Sale 1.0 or 2.0 applies;
  4. The roles of the selling firm’s lawyer and non-lawyer staff post-sale;
  5. How to address closed client files;
  6. Malpractice insurance, including the applicability of purchasing a tail policy; and
  7. Whether to involve an intermediary or pursue a for sale by owner (FSBO).

Logistics Involved When Growing Law Firms Consider Purchasing a Law Practice

When growing law firms consider purchasing a law practice, the following logistics apply:

  1. Due diligence to determine that the practice areas and firm culture of a senior attorney’s practice present the right “fit;”
  2. Negotiating financial terms that include incentivizing senior attorneys to transition their books of business to lawyers at the growing law firm;
  3. Establishing a 30-60-90-180+ day plan to integrate a senior attorney’s practice into practice groups of the growing law firm; and
  4. Co-developing a marketing strategy to introduce a senior attorney’s clients and referral sources to lawyers at the growing law firm; and publish digital marketing content in written, video, and/or audio formats based upon a senior attorney’s subject matter knowledge and experience.

Rules of Professional Conduct to Review when Considering Selling or Purchasing a Law Practice

When considering selling or purchasing a law practice, lawyers should review pertinent rules of professional conduct applicable to their home jurisdiction. Referencing here the Ninth Edition of the Annotated Model Rules of Professional Conduct, examples of rules to review include:

  1. Rule 1.17 Sale of Law Practice;
  2. Rule 5.4(a)(1)-(2) with respect to exceptions to fee sharing with non-lawyers per an agreement by a firm to pay a lawyer’s estate or other representative after the death of a lawyer;
  3. Rule 1.6 relating to confidentiality;
  4. Rules 7, 1.8, 1.9, and 1.10 relating to conflicts of interest; and
  5. Rule 7.1, which addresses firm names in the comments.

Conclusion

Law firms have value, and lawyers have three options to consider when contemplating selling their practices. Law firm value will continue developing digitally because consumers will increasingly find lawyers via Google and other digital platforms, instead of the old-fashioned word-of-mouth referral method.

For those lawyers who have developed a book of business during the course of their careers, growing law firms, in particular, want and need those books, together with the goodwill, subject matter knowledge, experienced workforce, and marketing value that senior attorneys and their practices offer.

Today’s sellers benefit from the earnout price that Law Firms Sales 1.0 offers. Coming around the proverbial corner, the legal industry will begin seeing fixed prices in law firm sales as we pivot toward Law Firms Sales 2.0, in which law firm brand value will generate stand-alone fixed pricing. Those senior attorneys who continue maintaining their pre-2020 status quo approach to business development unfortunately risk a decrease in the value of their law practices, because their books of business will not replenish at the same pace in today’s digital era as compared to the traditional word-of-mouth referral era.

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