Law Practice Management Asked and Answered Blog

Category: Ownership

Feb 21, 2017

Law Firm Equity Partnership/Admission Requirements

Question: 

Our firm is a sixteen-attorney business law firm in Cleveland, Ohio – six equity partners and ten associates. We the equity partners have been discussing putting in place an associate attorney career advancement program and outlining equity partner admission requirements. Can you share your thoughts on what we should be considering and how we should get started.

Response: 

You might want to consider developing a competency model. Rather than using a timeline – how long an associate has been with the firm – base career advancement to senior associate, non-equity partner, and equity partner upon achievement of competencies at various levels. These include:

Examples of core competencies might be legal excellence, client orientation, leadership, career commitment, etc.

In addition to competencies typically required to be  a Level Three attorney equity membership has additional requirements and obligations. For example:

  1. Equity owners will be sharing in the risk and reward of ownership and will invest their time and capital in the firm. They will have a firm-first orientation and they will share the vision and core values of other equity owners in the firm.
  2. Equity owners must add value to the firm. They must not just be good worker bees – they must pay for themselves, cover their cost and their share of the firm overhead, and generate enough work to keep other attorneys busy.
  3. Equity owners must be client finder, minders, and grinders.
  4. Equity owners must act like owners of small businesses.
  5. Equity owners must contribute to management and marketing of the firm.
  6. Equity owners must mentor younger attorneys.
  7. Equity owners must follow firm policies, system, and procedures – no lone rangers.
  8. Equity owners should contribute capital and sign for the office lease, firm credit line, and share in other financial obligations of the firm.
  9. Finally, future equity owners must be good marriage partners considering the other equity partners in the firm.

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

 

 

Nov 10, 2015

Law Firm Building Ownership

Question:

I am a partner in a fourteen attorney firm in Chicago's western suburbs. We have five equity partners and nine associates. We are currently leasing office space that we have outgrown. As we are approaching the end of our lease we are considering buying our own building. We would appreciate your thoughts?

Response:

I find that many firms have difficulty dealing with all of the moving parts of buying and building out a building and the distractions and time that it takes away from the law practice. Owning your own building can provide numerous financial and tax advantages and If you decide to go this route hire professionals to help expedite the process and a real estate building management company to manage the building when it is completed.

I strongly suggest that you create a separate entity that will own the building and separate building ownership from the law firm ownership structure. I suggest that participation in ownership of the building be optional for law firm equity partners that want to invest in the building.

It is hard enough for new partners to fund their capital accounts or buy-ins without having a mandatory building buy-in. Recently I have seen a few merger and lateral partner opportunities go south as a result of buildings, real estate, and mandatory buy-ins.

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

 

 

Jul 07, 2015

Law Firm Ownership – Acquiring a Founding Partner’s Interest – Question from a Reader

Question:

I have a quick question on a recent column of yours that appeared on last week's blog and Illinois State Bar Association (in an ISBA email).

You refer to the following:

“One to one and a half times the owner's average earnings for the past five years is typical. "Does this mean the total firm revenues or the amount the owner attorney received as income? I thought I have seen that multiplier to be on total firm revenue.

Thank you!

Response:

I was speaking in terms of net profit or earnings – not gross fee income.

It is true that we often speak in terms of a multiple of gross fee income when trying to value a firm. Typically a best case is a multiple of 1.0 – often less – .60 – .75 or even less. Downward adjustments are made to the multiple based upon practice risk, how high the overhead is, likelihood of clients or referral sources remaining etc. 

For example:

Law Firm A – has $1,000,000 in gross income and the net earnings of the owner is $600,00

 vs.

Law Firm B – is a collections practice – very high overhead intensive practice- has $1,000,000 in gross income and the net earnings is $150,000.

Using a multiple x gross has to be discounted substantially for law firm B due to risk, overhead, etc.

It is sometimes simpler to think in terms of net profit – with the typical ranges between 1.5 – 2.0.

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

Jul 01, 2015

Law Firm Ownership – Acquiring a Founding Partner’s Interest

Question:

I am a senior associate in a eight attorney elder law firm in Miami. There is one owner (founder) and seven associates including myself. The owner has approached me with a proposal to over time buy out his interests. I am the only senior associate in the firm and the only associate that he has approached concerning selling his interests. Specifically his proposal is as follows:

  1. Pay him $825.00 for the practice over five years.
  2. After five years I will own 100% of the shares.
  3. My compensation arrangement will remain the same (salary plus formula percentage incentive bonus based upon my responsible attorney collections) until I have acquired 100 percent interest of the firm.
  4. The owner wants to work in the firm indefinitely after his interest are acquired as an employee or Of Counsel.

I don't know how to respond to this proposal and would appreciate your thoughts? Is it fair? Does it make sense?

Response:

It makes sense for him. Seriously, you are going to need much more information that this proposal. To get started you need to ask for and review the following:

  1. Profit and Loss statements and Balance Sheets for the past five years.
  2. Tax returns or Schedule C for the past five years.
  3. A report showing the current accrual based assets – mainly unbilled work in process and accounts receivable. There are often the largest assets that a firm has and it is not on a typical cash-based profit and loss statement.
  4. A list showing any off-balance sheet liabilities.
  5. Copies of the office lease and other leases to determine lease liabilities.

From these documents you can get a feel for the cash-based net equity, the accrual-based net equity after considering work in process and accounts receivable and unrecorded liabilities.

Two numbers that may be even more important is the average fee revenue generated over the past five years and the average compensation (net profit plus compensation – W2 and K1 earnings) that the owner has been earning over the past five years.

Here are a few thoughts:

  1. One to one and a half times the owner's average earnings for the past five years is typical. So from this guideline you can evaluate the appropriateness of the $825,000.
  2. What assets are included? Will he exclude any assets?
  3. Will you be able to acquire minority interests over the five years as you pay towards the payout? I will insist on such.
  4. If you do acquire minority interests as you go will there be a profit pie for you to share in or will the owner increase his compensation, personal perks he passes through the firm, cut down on his working time, etc.? You should get a handle on compensation as well.
  5. I would not have the owner's employment open ended after you acquire 100% interest. Have some protection in case he fails to produce or has physical or mental problems that affects his performance. Suggest an Of Counsel agreement that gets reviewed and renewed annually.
  6. Consider whether there is a transition that insures that the clients and referral sources stay with you after he retires. If he has not groomed you, involved you in relationships with clients and referral sources, had you giving seminars, and plugged you into referral sources future business could drop off dramatically. This should be factored into the value.
  7. Weigh the cost-benefit of starting your practice v.s. purchasing his practice. 

Good luck!

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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