Law Practice Management Asked and Answered Blog

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Apr 03, 2019

Valuing a Personal Injury Law Practice

Question:

I am the owner of a three attorney personal injury practice in Columbia, South Carolina and I am contemplating retiring in seven years. I have an associate on board that I would like to sell my practice over the seven years. How do I go about valuing my practice and determining how much I should ask for?

Response: 

A few of the various methods used solely or in combination with other methods for valuing a law firm include:

  1. Asset Based – ignores the importance of a firm’s earnings and cash flow (Goodwill Value)
    1. Book value – adjusted to accrual-based financials
    2. Replacement cost
    3. Appraised value
    4. Market value
  2. Comparable firm transactions
  3. Discounted cash flow – based on projected future financial performance of the firm.
  4. Rule of thumb using multiples
    1. Multiple of gross revenue
    2. Multiple of net profit or earnings
    3. Multiple of EBITDA (Earnings before interest, income tax, depreciation, and amortization. (EBITDA is a measure of a firm’s operating performance)
    4. Multiple of SDE – seller discretionary earnings after owner compensation adjustments (expensing appropriate salary)
  5. Rule of thumb variables
    1. How much repeat business is expected
    2. Number and type of clients
    3. The transfer-ability of client and referral source relationships
    4. Dependence on only a few large clients
    5. Whether the firm has been institutionalized or is a personal practice and uniquely the firm owner
    6. Other attorneys and staff
    7. Firm infrastructure and systems
    8. Historical reputation of the firm
    9. Contingency fee practices

Personal injury firms are difficult to value due to the variability in cash flows that are often the case with many firms.  Some personal injury firms have relatively predictable cash flows and others have very large swings. When this is the case the typical solution is cash-based book value plus a percentage of case fees as they are concluded with a percentage of completion factor applied.

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

Jan 23, 2019

Law Practice Exit Strategy – Internal or External

Question: 

I am the owner of a criminal defense practice in Bloomington, Illinois. I have been practicing for forty years and I have just turned sixty-five. I have one associate that has been with me for two years and two staff members. I would like to retire by the end of this year and I would like to receive some value from my practice. Would I be better off to sell my practice to my associate or another firm?

Response: 

One year is a very short timeline for putting together an effective exit strategy. Criminal defense practices are often based on the reputation of the owner-practitioner and more difficult to sell to other firms than other practices. I believe the best option for most firms is an internal exit strategy via sale of the practice to other attorneys working in the firm (non-equity partners or associates). However, this assumes that the firm has attorneys that have the skills and competencies to carry on the practice and have an interest in owning a law firm. Often this is not the case. The other problem is that most associates don’t have any money so any sale usually has to be paid out of future revenues after the owner retires. Other options include selling the practice to another law firm, merger with another firm, or winding down the firm and joining another firm as an Of Counsel for a few years and then retiring from that firm with a payout in the form of a percent of revenue from your clients for a few years.

Your associate has only been with the firm for two years. If he or she is straight out of law school you will have to assess whether he or she has the skills, competencies, and desire to take over your firm? If he or she does, this might be your best option. If not, you will need to explore an external exit option – sale, merger, or Of Counsel arrangement. I have had clients that have had successful exits from their practices with each of these arrangements.

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

Nov 08, 2018

Selling an Owner’s Law Practice to an Associate Gradually

Question: 

I am the owner of an elder law firm in Phoenix, Arizona. I have one full time associate, one part-time associate, and three staff members. I am earning around $300,000 a year from the practice and my full time associate’s salary is $100,000 a year. I am sixty and would like to retire and be out of the practice in five years. I would like to begin phasing down and working part time in the next year or two. My full time associate has been with the firm for ten years and she is an excellent attorney and has an excellent relationship with our clients and referral sources. While she has not brought in many clients through her own referral sources she has done an excellent job signing up new clients from the firm’s referral sources, website, and seminars that she has conducted. I have talked with her in general terms about her buying my practice when I retire and she has expressed an interest.

I feel that I should be entitled to some sweat equity from the practice in the form of retirement compensation or buy-out. With this said I would prefer that my practice “stay in the family” and be sold to my associate rather than selling my practice to an outside buyer. I would appreciate your suggestions.

Response: 

One of the issues today with many associates is they have large student loan debt and have little in the way of capital and little or no borrowing capacity. As a result many firm owners in your situation have to get much of their payout from future earnings after their retirement if they wait too long. Your best bet is to start selling shares as soon as you can based upon a valuation method that you determine. You have five years remaining – ten years would have been better. In essence you determine the value of the firm, determine the price per share, determine how many shares that associate will acquire, and then calculate the price for the number of shares being acquired. For example, let say you practice is valued at $600,000. Divide by 100 = $6,000 per share or percentage point. For an initial twenty percent interest or twenty shares the buy-in price would be $60,000. Then over the next five years gradually sell the associate additional shares. Upon your retirement you would have sold all of your shares.

Typically the problem is the associate does not have any cash or ability to borrow on their own. You may be able to help the associate borrow the money from your bank. If you can – this would be the preferred approach. If the associate cannot raise the capital they you will have to finance the buyout. For a $600,000 buyout a five-year timeline will be impossible for you to have all your cash by retirement. How you structure your compensation as you begin working part time and your associate’s compensation as a partner will have a bearing on capital that your associate will have available. Be careful that you are not funding your own buyout. You will more than likely have to get a large portion of your payout after retirement via a secured promissory note with the associate for the balance.

The sooner you start the better your chances for a successful outcome.

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

Apr 11, 2018

Law Firm Practice Groups

Question: 

I am a partner and a member of our three-member executive committee. Our firm is a twenty-five attorney litigation defense firm in Kansas City, Missouri. We handle matters such as personal injury, medical malpractice, professional malpractice, products liability, and health care law. Each attorney handles and manages his or her own cases and operates in isolation of the other partners in the firm. Other than attending a quarterly partnership meeting there is little interaction among the partners. We have been discussing whether we should form practice groups. We would appreciate your thoughts.

Response: 

Practice groups can be excellent vehicles for enhancing communications, attorney and staff skill development and training, practice management, and marketing. Practice groups should share the mission and vision of the firm as well as goals of enhancing services to clients by developing the skills of the members of the group in a particular legal specialty or industry niche and developing business for that particular group. Practice groups should not operate as isolated islands but should be structured and integrated with the firm. Specifically, functional practice groups should:

Practice groups can be structured around legal specialties such as personal injury, product liability, and professional malpractice. Other practice groups can be structured around industry niches such as energy, health care, etc. In cases where a firm has a very large client a practice group can established for that specific client.

While practice groups can have their advantages, I have found that in many firms they are dysfunctional. They do not meet on a consistent basis, have no goals, or direction, poor leadership, and seem to accomplish little. To be effective  practice groups must:

  1. Be setup by the executive committee with specific goals and have a written charter developed by the executive committee.
  2. Effective leaders should be appointed by the executive committee to serve as chair of the practice group assigned. Specific roles should be identified as well as expectations.
  3. Practice group chair leadership effectiveness should be a factor in the compensation system.
  4. Practice groups should have written strategic plans that integrate with the firm’s strategic plan.
  5. Practice groups should meet monthly.

I believe a practice group would be a logical direction for your firm. You might want to start slow and try a “pilot” test group where there appears to be significant interest and see how it develops.

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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:

  1. Income tax returns for the past five years.
  2. Profit and loss statements for the past five years.
  3. Balance sheets for the past five years.
  4. Headcount expressed as full-time equivalents for the past five years by year for attorneys, paralegals, legal assistants, staff.
  5. Firm lease if the firm leases office space.
  6. 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:

  1. Has the firm been successful and well managed?
  2. Are revenues in line with what a four attorney personal injury firm should be generating?
  3. Is the firm’s overhead in line?
  4. How much additional income can I expect over the next five years?
  5. 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?
  6. Considering what I have to pay for the practice, could I do better by starting my own practice?
  7. Where are the firm’s cases coming from and what is the quality of the existing cases in process?
  8. What level of case flow can I realistically expect when the owner is no longer here?
  9. Using the open case listing, what do the future cash flow projections look like?
  10. When the owner leaves will you have to hire another attorney? What level?
  11. How much debt does the firm have?
  12. 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

 

May 23, 2017

Solo Practitioners Best Friend – Law Practice Continuation Plan

Question: 

I am a sole practitioner in Peoria, Illinois. My firm is a general practice firm that services clients throughout Central, Illinois. I have four staff members. I am fifty eight. While I have enjoyed having my own practice for the past twenty years I am concerned – what if something were to happen to me today or tomorrow – what is my backup plan in the event of short-term illness, disability, death, and even vacations. How would the firm keep operating? Who would take care of the client’s needs? How would my staff be taken care of?

Response: 

Sound practice continuation arrangements can solve this dilemma and preserve practice value and can help prevent a lawyer’s spouse or immediate heirs from facing a hasty sale or disposition of the practice in an emergency. A practice continuation arrangement can also give lawyer practitioners, their staff, and their family’s peace of mind.

A practice continuation arrangement is an arrangement – typically in the form of an agreement or contract made between an individual lawyer or a small law firm and another lawyer or law firm. The arrangement describes a course of action to transfer a lawyer’s practice and sets payment for its value. In the event of vacation, temporary or permanent disability, or death, a practice continuation arrangement protects the practice, the business interests of the lawyer or law firm’s clients and the financial interest of the lawyer and his or her family.

Approaches

There are different kinds of practice continuation arrangements. Typically, a lawyer enters into a one-on-one agreement with another sole proprietorship, partnership, limited liability company, or professional corporation in the community. Agreements can range from simple “dual coverage for each other” for vacation or other temporary absences to sale of the practice in the event of long-term disability or death.

A practice continuation agreement’s provisions for the sale of a practice must contain a reasonable valuation and a realistic payment structure. What lawyers really want is to leave to their surviving spouses or heirs is something from all the hard years of work it took to build the practice. To accomplish this end, selling the practice at a buyer friendly price may be necessary. Law practices can lose value very quickly, so timing is vital.

Lawyers must invest time and effort to find suitable successors for their firms and to create useful, equitable, practice continuation agreements. The key is to finding the right person or firm. The investment of time is a good investment, however, because a good practice continuation arrangement will ensure that if a lawyer is unable to continue managing the practice, the value he or she has built over the years will not be lost. An orderly transfer of a practice to another lawyer or law firm is a substantial financial benefit to the lawyer’s family. At the same time, through the handpicked successor, the lawyer fulfills his professional responsibility to his clients. Lawyers who do not have these agreements should learn more about preserving the value they have created.

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

Feb 07, 2017

Law Firm Partner Compensation – Collaborative Team Practice

Question: 

Our firm is a 25 attorney firm based in San Antonio, Texas. We have 15 equity partners. We are equal partners and have equal ownership interests. Our partners are paid based upon ownership shares. Thus, each are paid the same. The system has worked well for us for many years and has supported our team-based collaborative culture. However, we are having issues with non-productive partners and some of the productive partners feel that the compensation system is no longer fair.  Some of the partners have suggested that we more to a formulaic system. Other partners in the firm feel that such as system would destroy the collaborative culture that we have built. We would appreciate your thoughts.

Response: 

I agree that the compensation system must shift to a system that rewards performance and overall contribution to the firm and yet preserve the culture that you have built over the years. I think that a pure formulaic system would shift your culture to a “lone ranger” culture with everyone out for themselves. I believe that for your firm a subjective or a hybrid system incorporating quantitative and qualitative performance factors would be the best approach.

In order to implement such a system you will need to set up a compensation committee that will made partner compensation decisions. I suggest a three member committee elected by the partners on three-year staggered terms. The committee will determine and publish performance factors that will be considered, conduct annual face-to-face performance evaluations, approve each partner’s annual personal goal plan for the following year, and make their partner compensation recommendation to the partnership regarding the upcoming year salary and bonus for the year ending year.

The partnership agreement or other compensation policy document should specify the procedure and what happens when the partnership does not approve the recommendation of the compensation committee or when a partner requests reconsideration.

A system such as this requires more time and work but usually yields better results, especially in a team-based collaborative practice. More and more larger firms are using subjective or hybrid systems.

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

Jan 24, 2017

Law Firm Practice Sale – Selling a Personal Injury Plaintiff Practice

Question:

I am the owner of a personal injury plaintiff practice in downtown Chicago. I am the only attorney in the firm. I have two legal assistants. I am sixty-six years old and am starting to think about retirement and how to exit my practice. I would like to sell the practice to another law firm or practitioner. Does my practice have any value and can it even be sold?

Response:

After you pull out all the cash and pay down any liabilities the general the value of your practice will be the value of your fixed assets, goodwill (if any), and the value of your contingency fee cases in process. The largest asset of value is your cases in process and often that value cannot be determined until the cases are concluded. If you are an advertising type firm and have   built a sustainable brand beyond your individual reputation there could be a goodwill value. However, since you are a solo I doubt that there is a goodwill value beyond the value of your cases – it all depends whether you end up farming out your cases to another firm or whether you can find someone to come in and take over your practice.

If you have to sell your practice to another firm they will probably not have a need for your fixed assets. You will have to sell or otherwise dispose of them. More than likely you will not be able to come to an agreement with the other firm on a specific sale price for the cases in process. Therefore, you will have to agree on a fee split formula where you are paid as the cases are concluded. This formula will need to consider a percentage of completion factor based on how much work was done while a case was in your possession and while in the possession of the new firm.

Your best bet would be to find an attorney that would come in and take over your practice. He or she would have a need for the fixed assets, your employees, and if you transition properly could benefit from the goodwill that you have generated. In this situation you could receive payment for fixed assets, goodwill, and cases in process. This would also provide continued employment for your employees.

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

Dec 27, 2016

Law Practice Management – Goals for 2017

Happy New Year and Best Wishes for a Personal and Professional 2017

As 2016 comes to an end we begin with a clean slate for 2017. As with anything new – the uncertain future can be scary and exciting at the same time. Year-end provides an opportune time for reflection on the past year and setting goals for the next year – both personal and professional. Goal setting can improve your personal life and your practice.

Here are a few ideas for 2017:

  1. Whether you are in a small firm or a large firm have a sit-down with your team and discuss the past year business results, (successes and failures), what went right and what went wrong, what can be done this year to improve over the past year, and aspirations for the upcoming year.
  2. If billable hour/revenue goals are not set for attorneys and paralegals set expectations for each individual, measure accomplishment, and provide feedback monthly on how they are tracking toward expectations/goal.
  3. Writing and speaking are excellent ways for attorneys to develop their referral networks and enhance the firm’s brand as well as their individual brands via their bios on the firm’s website. Published articles – on the firm’s website and elsewhere – lead to speaking opportunities as well as interviews by reporters and writers as sources for articles that they are writing for other publications. Multipurpose your articles in more than one publication and venue. Turn an article into a webinar, webcast, or live presentation. Commit to writing one article a quarter in 2017 (4 during the year). If you have been writing four articles a year consider writing a book in your field of expertise.
  4. Consider adding a new skill set this year. It may a new legal skill set such as a LLM in tax, litigation, etc. or it may be a non-legal skill set such as in management, counseling, medication, etc.
  5. For attorneys in their late fifties or early sixties give some though this year to your retirement/succession/transition goals.

Best of luck for a prosperous 2017!

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

 

Dec 13, 2016

Law Firm Marketing – Marketing a Litigation Defense Practice

Question:

Our firm is a fourteen attorney general practice firm located in Dayton, Ohio. Two of our attorneys focus their practice on personal injury defense and the other attorneys are transactional attorneys. While the practice is doing well overall, our litigation work is dropping off. I would appreciate any ideas that you have pertaining to marketing a litigation defense practice.

Response:

Insurance carriers are a leading purchaser of insurance defense services – but so are self-insureds – big box retainers, national restaurants and food chains, sports arenas, shopping centers, and municipalities. Typical decision-makers:

The law firm needs to know who they want to target and often have to make application to get on the panel/list of approved counsel, respond to RFP’s, submit proposals, etc. to get the business.  In other words, the law firm needs to first get on the list. Then the law firm needs to cultivate relationships with the typical decision-makers.  This is getting harder as many companies have policies against such other than education formats such as seminars, presentations, etc.

Some marketing tools needed to market a defense litigation practice:

I would start by developing a target client list, an action plan, and go from there.

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

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