Law Practice Management Asked and Answered Blog

Category: Succession/Exit Strategies

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Jul 11, 2018

Law Firm Goodwill and Valuation

Question: 

I am the owner of a six-attorney litigation firm in San Francisco Bay area. I am sixty and starting to give though to gradually transferring my interest to associates in the firm. I have heard other attorneys mention that I should get some goodwill out of my practice. I would appreciate your thoughts.

Response: 

Many law firm owners prefer to leave a legacy and keep the firm “within the family” and transition the firm to non-equity partners or associates in the firm at a discounted value and buy-in as an incentive to stay on with the firm and a reward for their years of dedication to the firm.

Some law firms – typically second generation or later firms – allow non-equity partners or associates to become equity owners with no buy-in whatsoever. The thought being that the real assets of the firm are its talent – its people and the firm’s priority is to retain and keep the best talent that it can. These firms also do not have hefty buy-outs for partners or shareholders leaving the firm other than possibly the initial founders of the firm. Over the years, such firms fund retirement through 401ks, profit sharing plans, and other mechanisms. When partners or shareholders leave the firm, they get their cash-based capital account, or share of retained earnings and their share of current year earnings.

A “founders benefit” is sometimes put in place for firm founders in which they may be paid a share of the accrual-based capital or retained earnings – WIP and A/R. They may also be paid a goodwill value as well either in the form of a multiple of earnings or a specific sum based upon a multiple of gross revenue.

The problem in many firms is that associates are still paying off student loan debts and they don’t have cash available to purchase the owners interests. As a result, if you don’t start early, the cash often has to come from future cash flows that are available after the owner leaves the firm from the compensation that the owner is no longer receiving.

You need to start early, get people committed and start selling affordable minority shares years before you retire so you can get at least half of your ownership interest paid for before you leave the firm and the other half paid out over a five-year time period.

Wait too long and your associates may feel they can just wait you out and inherit your clients without having to pay you anything.

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

Jun 06, 2018

Law Firm Succession Planning – Getting the Conversation Started

Question: 

Our firm is a seventeen attorney business law firm in Chicago. Our clients consists of mid-size companies and a few Fortune 500 companies. There are eight partners and nine associates in the firm. Four of the eight partners are in their early sixties and the other four partners are in their forties and fifties. The four senior partners are the founders of the firm. Consequently, we have not had to deal with succession of partners until now. While we realize that we need to be thinking about succession planning we have not made much headway. The senior partners are reluctant to discuss their retirement plans and timelines. We would appreciate your thoughts and suggestions.

Response:

Client transition, management transition, and talent replacement are the major succession planning issues for law firms. Such transitions take time, especially with clients such as yours, and law firms can not wait until a senior partner comes forward, announces his intentions, and gives his required notice. Law firms should begin having conversations with senior attorneys and begin transition planning five years prior to a partner’s actual retirement. Having these conversations can be difficult. Senior attorneys may not know their plans themselves and may not have even discussed this topic even with their family. In some cases there can be trust issues at the firm and in other situations the firm’s compensation system may be a barrier. Law firm management must force the issue by institutionalizing a transition program and requiring conversation and discussion at a certain age. Some firms have mandatory retirement and others have a five year phase-down requirement with a formal client and management, for those partners that have management roles, transition program. Personally, I prefer the phase-down requirement with an individual tailored transition plan over the phase-down period. I suggest that transition plans be tailored for each retiring partner and reflect partner, firm, and client perspectives. Use compensation to reward successful client transitions.

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

May 08, 2018

Of Counsel Arrangement as a Law Firm Exit Strategy

Question: 

I am the owner of a solo real estate practice in Merced, California. I have two staff members that work for me. I am the only attorney in the firm. I am sixty years old. While I am concerned about the long term exit from the practice I am also concerned about office coverage in case something would happen to me in the short term. I appreciate any recommendations that you may have.

Response: 

Forming an Of Counsel relationship with another firm is an option that many solos are taking. Sometimes it is a final arrangement where a solo winds down his or her practice and then joins another firm as an employee or independent contractor. He or she is paid a percentage of collected revenue under a compensation agreement with different percentages depending upon whether the practitioner brings in the business, services work that he or she brings in, or services work that the firm refers to the practitioner. In other situations, an Of Counsel relationship is used as a practice continuation mechanism that provides the solo with additional resources and support if needed. An Of Counsel relationship can also be used to “pilot test” a relationship prior to merging with another firm. We have had several law firm clients that has taken a phased approach to merger with Phase I being an Of Counsel “pilot test” exploratory arrangement and Phase II being the actual merger.

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

 

Mar 21, 2018

Law Practice Acquisition Proposal

Question:

I am a partner in a three partner six attorney in Chicago. We have been having discussions with another law firm in the city regarding us acquiring their practice. The owner is seventy years old and wanting to retire and exit his practice. My partners and I have looked over the numbers and believe this would be an excellent opportunity for us to expand our client base. The practice handles the same type of work that we do. We are unsure what our next step should be? Do you have any suggestions?

Response: 

I would start by asking for all the due diligence information that your can get your hands on. For example:

  1. Profit and loss statements and balance sheets for the past five years
  2. Income tax returns for the past five years
  3. Copy of office lease
  4. Copy of all equipment leases
  5. Copy of most recent malpractice application
  6. Equipment and furniture inventory list
  7. Personnel list with current compensation and benefits paid, length of time with the firm, current job duties, etc.
  8. Information pertaining to benefits offered employees.
  9. Copies of marketing and business plans.
  10. Reports showing billable hours, fees collections by timekeeper, etc. for past five years.
  11. Reports showing fees collections by clients and practice areas for past five years.
  12. Current work in process and accounts receivable report.

Insure that you have done a thorough conflict of interest check and insure that you review the Illinois rules of professional conduct concerning sale of law practice. Give consideration to the value of the firm and what you are willing to pay for it and how? What assets do want to purchase – just the goodwill or will fixed assets be included? What about work in process and accounts receivable? Is there a building involved and if so do you want to purchase the building and real estate? Do you want to take on any of the employees? Do the numbers work for you? What terms would be acceptable to you?

The next step is to prepare and present a proposal. Some of the following elements would be included in a proposal:

Once you have prepared the proposal present it to the owner of the firm and go from there.

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

 

 

 

 

 

 

Feb 28, 2018

Selling My Law Practice to My Associate

Question: 

I am the owner of a general practice firm in Chicago’s west suburbs. I have three associate attorneys in the firm and three staff members. I am sixty-four and contemplating my retirement and exit from the practice. I would like to start phasing back over the next three years and be out of the practice by December 31, 2021. There is one associate in the firm to whom I would like to sell the practice and he has expressed an interest as well. What are your thoughts as to how I approach this?

Response: 

Client, referral source, and management transition will be major concerns and will impact the value you can receive for your firm. You will need to use the next couple of years to effect a successful client, referral source, and management transition to your associate. Clients and referral sources will need to have a relationship with your associate and perceive him as a partner.

I have seen law firm owners approach this in the following ways:

  1. The associate is elevated and given the title of partner (non-equity) with the execution of practice sale agreement for the sale of the practice to occur in the future with a non-refundable deposit. The practice sale agreement outlines the sale price (which includes a goodwill value) and specific terms for the sale of the practice. Upon purchase of the practice  the associate would setup a new practice entity. This approach is often taken by firm’s that don’t want to “play partner.”
  2. A value is determine for the practice and price per share. Often this includes a goodwill value. The associate buys in and initially becomes a minority partner – say twenty to twenty-five percent. Over the next several years the minority partner buys additional shares based upon the valuation formula and the price per share determined at that future time. When the owner retires his or her remaining shares are acquired with the payment for these shares often paid over a period of three to five years.
  3. An associate becomes a minority partner and makes a capital contribution (usually based on cash-based-capital) that has no relationship to the value that the owner is seeking to receive from the practice. The partnership agreement has a “founder benefit” provision that provides that the founder receives a multiple (1.5 to 2) of the average of his or her last three year’s earnings upon retirement. For example, if the founders average annual earnings for the past three years was $350,000 – $525,000 (multiple 1.5) would be his founder benefit. Typically this would be paid out over three to five years. This would be in addition to a return of the founder’s capital account.

In each of the above scenarios it will be critical that you put in place an action plan with dates, timelines, and activities to ensure that activities that have to occur for a successful client, referral source, and management transition get accomplished. Your biggest challenge will be client and referral source transition. Both of you will need to ensure that clients and referral sources stay with the firm as that will effect the value of the arrangement for both of you.

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

 

Dec 27, 2017

Associate Attorneys as a Succession/Exit Strategy

Question: 

Our firm is a Tucson, Arizona business litigation firm. We have four founding partners and four associates. The partners are in their late fifties and early sixties. All four of us are contemplating retirement in the next eight to ten years. We are assuming that our associates will be willing to step up and buy-out our interests. We have not had any discussions with our associates concerning this. Your thoughts will be appreciated.

Response: 

Do you have the right associates on the bus for the long term? In other words, has the firm hired associates that want to be business owners and own a law firm? Many owners and senior partners in law firms are approaching retirement age and are beginning to think about succession strategies. As they examine their associate lawyer ranks, some partners are often surprised to learn that there may be few takers. While their associates may be great lawyers, they may not bring in business or even be able to retain clients that the firm has. They may not be interested in ownership or partnership. Such firms have hired a bunch of folks that just wanted jobs and have no interest in owning a law firm. While this hiring approach may have satisfied the firm’s short-term needs – it may fall short in the long term.

While partnership/ownership is still important to many – do not assume that all your associates will even want to be equity partners – especially if it means a hefty capital contribution and signing personal guarantees for a large amount of firm debt.

I suggest that you talk with your people – individually and as a group – and see where they really stand. Help them to begin developing client development and business skills. Depending on you and the other partner’s retirement timelines – you may have to consider other options such as laterals or merging with another firm.

A key suggestion is to look for entrepreneurial associates when hiring future associates. The desire for ownership of a business is often in a person’s blood. Do not start the interview with a discussion from law school until the present. Dig deeper into hobbies, family, etc. that will provide clues as to whether you may be hiring someone that just wants a law job or someone that eventually wants to own or be a partner in a law firm.

The sooner you begin the better off you will be especially if several partners are close to the same age and looking to retire about the same time. Not only does it take years for associates to be groomed for management and client transition it can also take years for them to be able to pay for their ownership interest.

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

 

Dec 13, 2017

Law Firm Owners Use of a Leadership Team

Question: 

I am the owner of a fourteen-attorney law firm in South Bend, Indiana. The firm is a health care firm that represents various medical facilities in the area. All of the other attorneys in the firm are associates. Currently I function as the managing attorney and make all of the management decisions. I also bring in the bulk of the clients into the firm. I am wanting to retire in the next five years and I would like to sell my interests to three associates in the firm. However, I am not sure that they would be good partners with each other, whether they have the management skills and client development skills to lead the firm, or whether they would even want to be partners. My other option would be to merge with another firm. However, I would prefer to sell my interests to the three associates rather than merge if at all possible. What are your thoughts?

Response: 

I appreciate your situation. I think you need to sort of “pilot test” the three associates. If you had other equity partners I would suggest that you form a three member management committee to begin transferring some of your management responsibilities and client relationships. Since you don’t have any equity partners I would not create or label a management committee which is usually a decision-making body with each member having a vote. You might consider forming a committee that you call the Leadership Team with the three associates and yourself serving as members on the team. This would be an advisory group with you retaining control. You would try to run the group by consensus but you would still be the ultimate decision-maker. I would start by starting the team with limited areas of management, responsibility, and authority. Teach them how to work as a group and gradually increase the team’s responsibility and authority. See how it goes and observe the interpersonal dynamics. After a year you should have a good idea whether they can work together as partners and whether an internal succession strategy will work for you. You might want to create a different category for these associates – senior associate or non-equity partner at the time that you do this as well.

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

Oct 25, 2017

Law Firm Equity Partner Succession – Transition in a Multi-Partner Firm

Question:

I am an equity partner in a thirty-six attorney firm in Miami. We have seven equity partners, eight non-equity partners, and twenty one associates. Our practice limited to civil litigation defense and our clients are institutional clients consisting of business firms, governmental agencies, and insurance companies. The ages of our equity-partners are: 64 62, 60, 58, 54, 48, and 44. The firm does not have a succession plan for the senior partners and has not even discussed the matter. I am not sure what the partnership agreement provides. I am concerned about our future if we don’t start addressing this. I would appreciate your thoughts.

Response:

With three members already in their sixties you are going to have some retirement bunching issues before long and I agree that you should start planning and deal with this sooner than later.

The partners as a group need to start talking and the senior partners should begin sharing their ideas and plans concerning their retirement goals. There should be an ongoing dialog with your senior partners. Review the firm’s partnership/operating/shareholder agreement. After reviewing these documents, determine how the firm’s policy regarding retirement, if there is one, will affect various partner’s retirement timelines, compensation, and payout. Does the policy require mandatory retirement at a certain age? Ascertain whether the policy provides for phase-down. How does the phase-down handle management and client transition? Is there an “Of Counsel” provision after retirement? The firm needs to reach an agreement with its senior partners nearing retirement concerning their retirement timelines, client and management transition, and retirement payout or return on invested capital.

The initial challenge in a larger firm is to determine who the successor or successors will be to transition clients and management responsibilities. This may be no easy task especially if the firm is in first generation and the retiring partner is one of the founders.

Client Transition

In firms your size, clients are more likely to be large sophisticated clients, possibly Fortune 500 companies, which refer many matters to the firm during the course of a year. Often such clients may be both a blessing and a curse for the firm. A blessing in that their business provides the firm with huge legal fees during the course of a year. A curse in that their business represents a large percent of the firm’s annual fee collections and a significant business risk if the firm were to lose the client. An effective client transition is critical, takes time, and must be well planned.

Successful client transition – moving clients from one generation to the next – is a major challenge for larger firms. Shifting clients is not an individual responsibility but a firm responsibility. To effectively transition clients the individual lawyer, with clients, must work together with the firm to insure the clients receive quality legal services throughout the transition process. Both the individual lawyer and the firm must be committed to keeping clients in the firm when the senior attorneys retire. Potential obstacles include:

Management Transition

In larger firms, partners may have management responsibilities as well as client responsibilities. A retiring partner may be a managing partner, executive committee chair or member, or serve as a chair or member on other firm committees. Retiring partners will have to transition these responsibilities to other partners in the firm.

Transitioning client relationships and management responsibilities effectively can and where possible should take a number of years – preferably five years – typically not less than three years. For this reason, many firms use five-year phasedown programs for retiring partners. These plans provide detailed timelines and action steps for transitioning client relationships and management responsibilities.

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

Sep 13, 2017

Institutionalizing Your Law Practice

Question: 

I am the sole owner of a six-attorney estate planning practice in Phoenix, Arizona. The five associates have been with me from five to fifteen years. I just turned fifty-five and would like to retire when I am sixty-five either by selling my practice to another firm or to one or more of my associates. I would like to receive some remuneration for the sweat equity that I have invested (goodwill). I have tried over the years to setup my practice in a way that it is not “just me.” I changed the name of my firm to a trade name that does not include my name, arranged the lawyers names on our letterhead and website alphabetically, and eliminated designations such as principal and associate. I believe that I have made it difficult for clients and prospective clients to know who the boss is. I hope that this will make my firm more salable and appealing in the future. I would appreciate your comments.

Response:

I took a look at your website and thought it was pretty easy to see that you are the firm. For example:

I suspect that you are the rainmaker and in spite of any advertising that the firm does and your website most of the firm’s business comes from your referral sources, past clients, and your reputation.

I believe you have to do more than what you have done to institutionalize your practice. Here are a few suggestions:

  1. Motivate and push if necessary your associates to write and publish and get these works posted to the website.
  2. Motivate and push if necessary your associates to give presentations at bar and other professional association and community events.
  3. Motivate and push if necessary your associates to present firm seminars.
  4. Post your associates works to your website and to their bios.
  5. Require your associates to become certified as estate and trust attorneys with the Arizona Bar.
  6. Consider revamping your compensation system to motivate and reinforce the above activities.
  7. Incorporate the above as “performance factors” in annual performance reviews.
  8. As time passes if you find that your associates are unwilling to step up to the plate consider hiring different type of lawyers in the future.
  9. Do more advertising to increase the business that comes into the firm from other than your personal reputation.
  10. If you have not already, fully document your office procedures and automate your practice.

If you are able to accomplish many of the above suggestions you will be on your way to institutionalizing your practice.

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

 

 

 

 

 

Jul 26, 2017

Law Firm Succession Planning – Impact of Firm Size for a Solo

Question: 

I am a solo practitioner in upstate New York. I am 66 years old and I am looking to retire and am trying to figure out what to do with my practice. My practice is a general practice and there is just me and one secretary. I welcome you suggestions:

Response:

The size of the firm will present different retirement succession, transition, and exit challenges. Firm size will affect the number of moving parts, specific steps that a firm will have to take, and the overall timeline. Solo practitioners and sole owners will have the most moving parts and face the greatest challenges.

You will have the greatest challenge since you have no associates or anyone in place to transition the practice. Therefore, you could both hire and groom an associate that could buy the firm or become a partner and buyout your interests, sell the firm to another firm, or merge with another firm. Other options would be to become Of Counsel with another firm or simply close down the practice. This takes time.

Hiring and grooming an associate can be problematic for the solo. If he or she does not have sufficient business and does not originate business, the associate will be an expense and the your net earnings will suffer. Other issues include:

You could sell the firm to another lawyer or law firm. This option works best when the practitioner is actually ready to retire and quit practicing. Often this is not the case and the restrictions on sale of law practice levied by a state’s rules of professional conduct, in particular Rule 1.17, may make this option undesirable. Locating desirable candidates will take time and a well-planned search process may have to initiated.  Our experience has been that this can take a year or longer.

Merger with another lawyer or law firm is another option. This is often a better option for solos that want to gradually phase-down yet continue to practice for a few more years. In essence, they join another firm as either an equity or non-equity partner, member, or shareholder and subsequently retire from that firm under agreed terms for the payout. The odds are improved for clients and referral sources staying with the merged firm and the merged firm is more committed that a buyer might be under a payout arrangement based upon collected revenues. The solo practitioner has more flexibility with regard to the ability to continue to practice longer, reduced stress, additional support and resources, and gradual phase-down to retirement.

Forming an Of Counsel relationship with another firm is an option that many solos are taking. Sometimes it is a final arrangement where a solo winds down his or her practice and then joins another firm as an employee or independent contractor. He or she is paid a percentage of collected revenue under a compensation agreement with different percentages depending upon whether the practitioner brings in the business, services work that he or she brings in, or services work that the firm refers to the practitioner. In other situations, an Of Counsel relationship is used as a practice continuation mechanism that provides the solo with additional resources and support if needed. An Of Counsel relationship can also be used to “pilot test” a relationship prior to merging with another firm. We have had several law firm clients that has taken a phased approach to merger with Phase I being an Of Counsel “pilot test” exploratory arrangement and Phase II being the actual merger.

Click here for our blog on succession

Click here for out articles on various management topics

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

 

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