By Ashish Karve, Practice Advisor
Wyoming lawyers were expected to die in their office with their boots on. But Larry Clapp’s observation was that he owned a small business. It had employees, customers, and a name brand. He owned something that in many respects was now independent of him personally. He wanted to be able to recognize this value that he had created. Luckily today there are many options to selling a law practice. In 2002, an ABA rule change made it possible to have an outright sale to a third party in addition to the traditional transactions that transferred shares to other partners and associates. A sale can mean a complete exit or it can mean continued involvement for an intermediate or an indefinite period of time as a shareholder, an employee, or consultant. You could choose to be paid immediately or could extend terms. The sale amount may be fixed or may be tied to performance over a period of time following the sale. If you have created the right asset, these choices will be yours to make.
One of our clients has systematically begun preparing his practice to function in his absence. This year he is taking several prolonged vacations from the practice. Next year, he will take a complete year away from the practice before making the final decision on whether he will completely transition out. On the other hand, Jan Copley of Jan Copley, P.A. was clearer about her decision. She set targets for amounts and dates, and purposefully embarked on a path to reach those goals.
What Is Included
According to one personal injury attorney we work with, everything comes along with his name. In other words, he believes that name recognition is the primary component of the goodwill of his practice. Many theories exist related to the marketing impact of a law firm’s name. These theories relate to the length of the name, the use of initials and abbreviations, and the use of other descriptors other than attorney names. Often a transition involves a name change. Larry Clapp was previously the sole owner of Clapp and Associates. Now he is one of the partners at Clapp, Ingram, and Olheiser. He believes that changing his firm’s name had the positive effect of communicating to the marketplace that the firm was growing. However, he thought there could also be a negative effect if it was perceived that the firm was changing how it functioned. The firm’s name, in its current or modified form, should facilitate a transition that capitalizes on the goodwill already created.
Although your name brand is the repository of your firm’s goodwill, Larry Clapp observes that the real value to a buyer lies in the implemented systems that helped create that goodwill. Good systems will help a buyer take over a brand and hopefully grow it. You create this value when you put various resources to function together in your practice. It appears in the organization of staffing, marketing, and procedures.
Marketing systems include procedures that helped generate market awareness and create the existing goodwill. These systems include techniques you use for building referral relationships, creating client satisfaction, branded events, mailing lists, newsletters, seminars and advertising programs. Jan Copley enhanced the value of her practice by creating a defined recurring revenue stream in the form of an annual estate maintenance program in her estate planning practice.
A well trained staff is a very valuable asset of your law firm. Their value is proportional to the degree in which they function independent of you. A transition will be most effective when your staff has well defined roles in the firm rather than relationships to you personally. Much of the uncertainty arising out of a sale can be mitigated with a solid structure. A clear methodology for handling human resource issues will create reassurance in the knowledge that an accepted set of procedures are in place to handle issues when they arise. Compensation systems that recognize staff needs and reward behavior beneficial to the firm will be valuable. Staffing could also include outsourced systems. Jan Copley said that she outsourced every function that she possibly could. Such relationships could be attractive to a potential buyer because they may offer not only a high degree of flexibility, but imply a level of predictability and transferability on both the execution and expense sides.
Procedural systems include client interaction systems, delegation systems, and case organization systems. A written procedures manual, which the staff utilizes and adheres to, will be a valuable asset that will aid in an ownership transition. Systems that include forms and worksheets will be more valuable than informal ones. These systems can be part of your electronic information systems that systematize workflow, scheduling, billing and collections. Clear and understandable accounting systems maintained consistently over an extended period will be of immense value. Reporting and tracking of business performance with clarity will create a sense of authenticity.
Copley observed that, as in any other transaction, price is ultimately an agreement between a willing buyer and a willing seller. She did engage experts to value her practice. However, valuation formulas served only to form the basis upon which to begin a dialogue. In a valuation calculation, one set of components carry a better defined value. Those are the parts that are valued as individual parts – fixed assets, lease and other obligations and the value of cases in process. Another set are not as clearly defined. This is the extra value created as a result of the various parts functioning well together. This value must be determined indirectly and this will generally become the focal point of discussions and negotiations. There will have to be agreement on replacement cost of the owner in all of the roles he or she occupies – owner, manager, and technician so that you can arrive at the value being transferred. Finally, you will have to agree on a multiple of either earnings or revenue that the ongoing business justifies. Earnings multiples typically have ranged between 0.5X to 2.5X annual earnings. Revenue multiples generally have been between 0.75X and 1.25X. Higher multiples are justified by higher predictability of future earnings and a greater growth potential. The terms of the sale will impact the multiple – an outright sale may yield a lower multiple than a gradual transition. The identity of your buyer will also play a role in the value he or she will attach to a particular practice. For example, an attorney that is already associated with the practice may value the practice differently than an outside buyer who has no familiarity with the operations. An attorney wishing to practice exactly the same type of law will also value that practice more than someone whose interests differ.
Michael Chiumento III entered into an agreement to buy his father’s practice over a five year period with both parties being active in the practice during that period. However, during the transition, his father had to undergo triple bypass surgery. His father’s outlook on his legal practice changed dramatically. Based on his experience, Chiumento observes that in extended payout arrangements, it is critical that both parties align their interests so that all parties work toward a common goal. Otherwise there can be many opportunities for disagreement due to perceptions of unfairness. José Latour sold his practice, Latour Law, on extended terms and tied to future performance. He made a point to create a formula that smoothed extreme deviations, high or low, in revenue and earnings in those years. One of our clients that is transitioning out with an extended payout said that agreements should specifically and clearly place restrictions on management practices related to things like retaining existing offices and maintaining advertising and staffing levels. One attorney granted a unilateral option to close the deal earlier. He regretted that decision when he was caught unprepared.
Latour described the experience of selling his practice as an exercise in ego destruction. The perceived value of your practice will be greater if you make your operation “look easy.” That is, show that the practice now functions in large part in your absence.
For 30 years, Clapp was the sole principal at his firm. He is now one of three partners. He says that one of the hardest parts of transitioning out of his practice was simply letting go. He sometimes misses the autonomy he previously enjoyed. Being answerable only to himself made many things easier. But he recognizes a deeper value in creating a team with whom to share victories and agonies. It is a way for him to immortalize his experience. Many attorneys mentioned that it was difficult to accept that things would go on without them or that they would proceed differently.
When asked what they would miss the least, one attorney said, “When I first set-up my practice, I never thought that I would have to drag my staff over the goal line.” Most attorneys stated that they did not miss the day-to-day management of staff. Although all had developed fond relationships with their staff, it was clearly not what they had expected coming out of law school.
What would those who were involved in a legal practice buy/sell transaction do differently? For those considering a buy/sell transaction in the near future, the primary advice offered was to start early and then take it slow. Both the buyers and sellers were advised to talk to as many people as possible – others who have gone through the process, more potential buyers and sellers. Finding the right combination of buyer and seller generally will mean deriving a higher value by both parties. Several of our clients mentioned that engaging outside help in business building was the best thing they did to make their transition successful. It better exposed the perspective to create processes that buyers would value. In fact, Larry Clapp states that the only thing he would have done differently is to access those resources earlier.
When to Start
Even though Michael Chiumento has fairly recently bought into his practice, his plans already include creating a marketable firm that he himself will sell one day. He observes that, when he is the seller, he should be viewed as the operator of a vehicle that is known as Chiumento and Guntharp. Also, even if an attorney is not currently contemplating a transition out of his or her practice, it would be useful to engage in sale preparation as an exercise. This exercise will improve your current practice. The steps that will enhance the value and marketability of the practice will improve the current operation and create options for you and your heirs. It will allow you to better visualize the concept of working “on your business” rather than in it. It may also uncover ideas on how to load up the practice with the potential energy that will make both your professional and personal life better. Chiumento predicts that you will get considerably more for the vehicle that the buyer can drive and not have to push.
“Will you resign or will you be dismissed?” That is to say, will you exit on your terms? Allowing for a transition period, it will take at least five years to effectively sell a law practice. Ideally, you should consider building the practice into a transferable asset at least 10 years prior to a projected sale date. A proactive approach will let you dictate your terms.