Law Practice Management Asked and Answered Blog

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John W. Olmstead, MBA, Ph.D, CMC

Oct 18, 2017

Law Firm Merger – Pitfalls to Avoid

Question:

I am a partner in a twelve attorney firm in Rockville, Maryland. We are a corporate transactional and litigation firm. We are a first generation firm. The firm was founded by the present four equity partners twelve years ago. We have been very successful over the years and this is borne out by out by our excellent financial performance. While we have done well in our core practice areas we have been considering diversifying our practice into government sector work due to our proximity to Washington D.C. and we have been considering merging with a six attorney (three partner) firm in D.C. that is totally focused on such work. Can you share with us any pitfalls that we should look out for.

Response:

It sounds like this might be an opportunity if the cultures and people are compatible, the practice area makes sense for your firm, there are no conflicts, the billing rates, and other factors are in line. Start getting to know the firm and its people. Then move to conflicts checks and ask for five year’s of financial statements and tax returns, internal financial reports, attorney and staff compensation data, partnership agreement and other partnership documents, schedule of billing rates, client lists, copy of building and equipment leases, and malpractice applications. Assess the stability of the revenue stream, repetitive ongoing clients, client dependency, etc. Make sure there are no pending malpractice claims or other liability issues.

Obviously you will want to do all the due diligence that you can. Initially examine and make the following calculations:

Headcount by the number of equity partners, non-equity partners, associates, Of Counsel and other attorneys, paralegals, secretaries/assistants, and admin staff.
Fee Revenue
Total Revenue
Total Expenses
Net income available to equity partners. (Add back guaranteed payments and other income that equity partners received)
Profit Margin
Fee Revenue per Lawyer
Fee Revenue per Equity Partner
Expense per Lawyer
Net Income Per Lawyer
Net Income Per Equity Partner
Schedule of billing rates (current only)
Compensation ranges by Equity Partner, Non Equity Partner, Associates – past five years
Current malpractice insurance coverages and with whom.
Current Lease obligations – office space and equipment

Examine the balance sheet items such as bank debt, large tapped out credit lines, equipment leases and other liabilities. Take a look at the partner capital accounts. Then examine the items that are not recorded on the balance sheet – namely unfunded partner retirement buyouts and long term real estate leases. What are the ages of the partners in the candidate firm and are there partners close to retirement? What are their provisions for retirement of these partners? These are often major deal breakers in mergers and scare away potential merger partners.

Keep in mind that the financials are only part of the equation – the other part your gut feel. Does the potential deal make sense? Will one plus one equal three – will a synergy result? Do you feel comfortable with the people (partners) in the other firm? Do you share common vision and philosophies and will you make good partners?

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John W. Olmstead, MBA, Ph.D, CMC

Aug 30, 2017

Law Firm Practice Acquisition – Acquiring a Personal Injury Practice

Question:

I am a non-equity partner in a four attorney personal injury plaintiff law firm in Newport Beach, California consisting of the firm owner, two associates, and myself. The owner is planning on retiring and has provided me with a proposal to sell me his practice. How do I determine whether this is an opportunity or a potential curse? You advise is appreciated.

Response:

I would start by asking yourself if you have the desire, inclination, and ability to manage a business – a law firm? Do you have the self discipline required? Do you have the needed capital or access to appropriate level of credit line? A personal injury firm will have to fund client advances as well as operations until cases are brought to conclusion and this will require capital or a credit line. I would check with the firm’s bank and other banks to see if you will be able to obtain the same credit line that the firm has enjoyed in the past.

Ask the owner for the following documents:

Income tax returns for the past five years.
Profit and loss statements for the past five years.
Balance sheets for the past five years.
Headcount expressed as full-time equivalents for the past five years by year for attorneys, paralegals, legal assistants, staff.
Firm lease if the firm leases office space.
A spreadsheet listing of all open cases providing the name of the case, the date opened, type of case, expected value of the case, expected referral fees due others, expected fee due firm, client advances invested in the case, and date the case is expected to conclude and fees will be received.

I would then prepare a firm financial profile spreadsheet spreading the revenue, total expenses, net income, owner earnings, and balance sheet summary over the five year period. Using the headcount data calculate fee per lawyer, expense per lawyer, and net income per lawyer and compare to general benchmarks. Hopefully fee revenue is in neighborhood of $400,000 or more per lawyer. Examine what the owner’s earnings have been over the five year period as well as the assets and liabilities on the balance sheet. Keep in mind that accounts payable and the firm lease are not usually reflected on a case-basis balance sheet. Consider the information that you have gathered and ask yourself the following questions:

Has the firm been successful and well managed?
Are revenues in line with what a four attorney personal injury firm should be generating?
Is the firm’s overhead in line?
How much additional income can I expect over the next five years?
What is my “payback” period – in other words if I pay X for the practice how many years of extra income as an owner will it take me to pay for the practice?
Considering what I have to pay for the practice, could I do better by starting my own practice?
Where are the firm’s cases coming from and what is the quality of the existing cases in process?
What level of case flow can I realistically expect when the owner is no longer here?
Using the open case listing, what do the future cash flow projections look like?
When the owner leaves will you have to hire another attorney? What level?
How much debt does the firm have?
What is the remaining lease obligation – term and amount?

This review will give you a good idea of whether this is a deal that makes sense for you.

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John W. Olmstead, MBA, Ph.D, CMC

Jul 04, 2017

Law Firm Merger Agreement

Question:

Our firm, a fourteen-attorney litigation firm in Sacramento, California, is planning on merging/acquiring a three-attorney firm in the area. We have completed our due diligence and both firms have agreed on the terms of the merger. What type of agreement and legal documents do we need to effect and implement the merger?

Response:

If business law is not your forte you may want to consult with a business attorney to determine the appropriate legal agreements that should be used to effect the merger. The agreement may be as simple as a Letter of Intent signed by the two law firms, a Memorandum of Understanding, or as formal as a merger agreement covering the major details and terms of the merger which have been approved by required vote of the partners of both firms including:

Merged firm name
Effective date of the merger
Method of integration, assets and liabilities contributed by each firm, and whether accounts receivable and work in process will be pooled and contributed
Management and governance structure and names of partners from each firm that will hold key management roles/positions
Compensation system for partners, non-equity partners, associates, and staff
How employee benefits will be handled and integrated
Capital contributions
Employees and their respective roles in the merged firm

Typical exhibits to agreements often include:

Employee Benefits Summary
Asset/Equipment Purchase Agreement
Employee Roster and Wage Rates
Proforma Balance Sheet
Proforma Income Statement
Partner Compensation Plan
Non-Equity Partner Compensation Plan
Associate Attorney Compensation Plan
Staff Compensation Plan
Attorney Career Advancement Plan
Office Lease
Partnership Agreement

John W. Olmstead, MBA, Ph.D, CMC

Mar 10, 2017

Law Firm Merger – Are We a Suitable Candidate

Question:

Our firm is a two partner firm in Columbus, Ohio. We have two staff members. There are no other attorneys in the firm. We have been in practice together for seventeen years. I am sixty two and my partner is in his fifties. My practice is limited to intellectual property and my partner’s practice is limited to medical malpractice defense. Recently, as a result of lack of coverage, our unwillingness to hire associate attorneys, and our frustrations with dealing with management issues we have decided that we would like to merge with a larger firm. However, we are concerned that our numbers may not be satisfactory. Our five year averages are as follows:

Gross Revenue – $500,000
Expenses – $240,000
Net Income – $260,000

Since we split the pot evenly we each made $130,000 on average.

With these numbers are we a suitable candidate or are we just whistling in the wind? We would appreciate your thoughts.

Response:

Obviously these are not great numbers. Depending on firm size and type of practice – most firms (small firms) are looking for revenue per lawyer in the range of $360,000 and up. Many firms are looking for books of business that will keep the candidate and an associate busy – $750,000 plus.

However, law firms are also looking for new sources of business (clients) and lawyer talent. There are firms out there that have the work and need help with the work and might be interested in your talent and skills as well as the clients that you could bring in. You may not be able to join the firm as an equity partner but may be able to join as a non-equity partner. (Depends on firm size) Due to the very different practice areas that each of you have you may not find opportunities in the same firm.

I encourage you to look around, start your search, and see what happens.

I have seen many situations similar to yours that have resulted in successful mergers and lateral or Of Counsel positions.

John W. Olmstead, MBA, Ph.D, CMC

Aug 31, 2016

Law Firm Lateral Growth Strategy – One Plus One Equals Three

Question:

Our firm is a sixteen lawyer firm – eight partners and eight associates located in Memphis. We handle business transactional work and litigation for small to mid-size companies. However, for the past forty years our mainstay has been small community banks. With recent bank mergers and new banking regulations our banking business has dropped off significantly. We have reached a desperate stage and we must replace this business quickly or consider possible dissolution. We have talked with a possible lateral partner that has a $300,000 book of debtor bankruptcy business. Is adding a lateral partner a good strategy for us?

Response:

Lateral partner acquisition is a growth strategy being used by many firms today. However, many lateral hires are not successful as a growth strategy. In a recent survey conducted by Lexis-Nexis and ALM Legal Intelligence only 28 percent of the respondent law firms found lateral partner acquisition a "very effective" strategy for growth.

I suggest you start with the following two questions:

Does the lateral candidate's book of business fit within your strategic plan? If you do not have a strategic plan develop one. A strategic plan can be a useful guide in keeping the firm focused on the right opportunities. It can help the firm clarify the type of work that it does not do.
Does One Plus One Equal Three. This question should be asked when considering any lateral or merger candidate. In other words is there is business case? How will the addition of the lateral result in more business than either the firm or the lateral currently has separately? Does the lateral have enough business to keep himself or herself busy plus a couple of associates?

I would question whether debtor bankruptcy fits within the firm's overall business strategy. I also don't believe a $300,000 book of business satisfied the one plus one equals three rule.

A lateral strategy may be a good strategy for the firm. However, I believe you need to expand your search and it may be difficult to attract candidates given your present financial situation.

Click here for our archive blog on strategies

John W. Olmstead, MBA, Ph.D, CMC

Aug 24, 2016

Law Firm Acquisition – Acquiring Another Practice

Question:

Our firm is a twelve lawyer firm in Austin, Texas. We have been approached by the owner of a three attorney firm in an adjacent city who has a complimentary practice consisting of institutional business clients. He is looking to retire within the next thirty days and he would like us to acquire his clients. We have reviewed his practice and we would be willing to take over his clients but not his personnel or other fixed assets. He has no interest in a merger or an lengthy relationship with us. It could add $800,000 per year to our practice. We would appreciate your thoughts.

Response:

It sounds like a great opportunity if there are no conflicts, the clients actually transition, and the billing rates are in line. Start with conflicts checks. Then ask for five year's of financial statements and tax returns, internal financial reports, schedule of billing rates, client lists, copy of building and equipment leases, and malpractice applications. Assess the stability of the revenue stream, repetitive ongoing clients, client dependency, etc. Prepare a letter of intent with terms for acquiring the practice. I would lead with a down payment of say $25,000 and then a percentage of collected revenue for say five years at 20% and see how he responds. He will want more certainty and a fixed price. If you have to go with a fixed price to seal the deal structure it with an initial down payment, payments over three to five years with provisions for reduction in the purchase price if the clients and revenues don't materialize. Make sure there are no pending malpractice claims or other liability issues.

John W. Olmstead, MBA, Ph.D, CMC

Aug 02, 2016

Law Firm Acquisition Due Diligence – What Should I Ask For

Question:

I am the managing partner of a five lawyer firm in Denton, Texas. We have the opportunity of acquiring a sole owner practice in a nearby city with a complimentary practice area. We have had one meeting and our firm is interested. We want to initially do a quick and dirty due diligence so see whether this firm is really a qualified opportunity. What sort of information should we ask for?

Response:

I would initially ask for the following:

Five years profit and loss statements and balance sheets and tax returns. (2011, 2012, 2013, 2014, 2015)
Lawyer and staff headcount for each of those five years.
Current hourly billing rates.
Description of his mix of clients by dollars and by time expended – practice type and geography.
Description of how the firm bills (hourly, flat rate, contingency)
Copy of leases (space and equipment)
Copy of malpractice insurance policy and last application.
Salaries and benefits for attorneys and staff members.

This will give you a good idea of what you are dealing with and whether the opportunity is worth pursuing further. If you decide you want to pursue this opportunity you can ask for additional information as the discussions unfold.

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Apr 05, 2016

Law Firm Debt – Impact of Debt and Other Liabilities Upon Future Growth Options

Question:

I am a member of a three member management committee of a 16 lawyer firm located in Akron, Ohio. We have 10 partners and 6 associates. Several of our partners are in their 50s and 60s. Recently, we have had discussions with a couple of potential merger partners and laterals and in all cases they have backed out advising us that they were uncomfortable with our balance sheet. What can we do to better position ourselves. We desperately need to bring in new talent with books of business?

Response:

First there are the obvious balance sheet items – bank debt, large tapped out credit lines, equipment leases and other liabilities. Then there are the items that are not recorded on the balance sheet – namely unfunded partner retirement buyouts and long term real estate leases. These are often major deal breakers in mergers and scare away laterals. If you have bank and other debt on the balance sheet work at cleaning it up. More importantly if you have unfunded partner buyouts begin either rethinking the desirability of these programs or begin funding this liability now with a goal of the liability being totally funded over the next five to seven years. Then shift to a retirement program that is totally funded. Unfunded partner retirement programs are becoming a thing of the past.

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John W. Olmstead, MBA, Ph.D, CMC

Jan 26, 2016

Law Firm Merger – Initial High Level Summary Financials to Provide

Question:

I am the managing member of an 14 attorney firm in Miami. We initiated discussions with a large firm in Boston concerning the possibility of our firm merging with their firm. We met with one of their partners recently at their offices and he presented our interest to his other partners. He has advised us that there is an interest in having us meet the other equity partners and taking discussions to the next level. He would like some initial financial information from us. We feel that we must provide them with some financial information at this point but unsure as to what to provide them with at this stage. I would like to hear your thoughts.

Response:

Law firms exploring possible merger partners often move to quickly to financials and I try to hold on providing financial information until after three get acquainted meetings. I like to see the initial focus on the people, culture, and general fit. Poor fit causes more merger failures than practice economics. However, in your situation the door has been opened and the large firm is going to want to see some initial financial information to "qualify" you and determine whether further discussions is worth their time investment.

I suggest that both firms sign a non-disclosure statement and that you initially provide them with the following high-level summary information in a spreadsheet in columns for the last five years of history. The per lawyer/equity partner calculations can be calculated in the spreadsheet based upon the headcount data inserted in the spreadsheet.

Headcount by the number of equity partners, non-equity partners, associates, Of Counsel and other attorneys, paralegals, secretaries/assistants, and admin staff.
Fee Revenue
Total Revenue
Total Expenses
Net income available to equity partners. (Add back guaranteed payments and other income that equity partners received)
Profit Margin
Fee Revenue per Lawyer
Fee Revenue per Equity Partner
Expense per Lawyer
Net Income Per Lawyer
Net Income Per Equity Partner
Schedule of billing rates (current only)
Compensation ranges by Equity Partner, Non Equity Partner, Associates – past five years
Current malpractice insurance coverages and with whom.
Current Lease obligations – office space and equipment

I would not provide any more data at this stage pertaining to clients or detailed financials. The next step will be for the other firm to share information with your firm.

Good luck!