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Jun 14, 2014

Law Firm Succession: Buying Out the Owner of a Personal Injury Plaintiff Practice

Question:

I am the founder and owner of a personal injury plaintiff practice located in Lexington, Kentucky. I have two associates and four support staff members. All of our cases are handled on a contingency fee basis and our swings in fee collections from year to year can be substantial. I am 64 and would like to transition my practice and retire within the next three years. Both of my associates would like to take over my practice. I believe I am entitled to compensation for my practice and am desiring a fair buy-out. I would appreciate hearing your ideas concerning a buy-out approach.

Response:

You could look at the value of your practice from either a historical or a future perspective. Personally, if I were a law firm or your associates I would be more interested in the future perspective. In other words what fee revenues/cash flows will the practice generate over the next three to five years? In traditional time bill/flat fee firms a multiple of gross revenue is often used as a proxy. In a contingency fee firm such as yours the primary value beyond cash-based book value is the expected value of your cases. Sometimes a firm is able to review a list of cases and estimate the expected value of these cases or estimate a fee range per case. (High-Low, or Conservative-Optimistic estimate).

More often than not it is simply not possible to estimate the value of the cases until they are concluded. In this situation the values will be determined in the future as the cases are settled. If this method is used you would provide a list of cases in progress at the time of your retirement and when the cases are concluded apply a ratio of the time the case was with the firm before and after your exit, apply an overhead factor, and apply your ownership percentage to determine your share of the fee for that case. Your share of the case fees as the cases settle and cash-based book value is your buy-out.

Of course in the end you will have to balance your buy-out against what your associates are willing to pay. If your deal is too high you may run them off – if you make it too low you are leaving money on the table and not realizing the value of your sweat equity.

Click here for our blog on succession

Click here for out articles on various management topics

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

 

Apr 15, 2014

Buying a Law Practice: What Should I Be Considering

Question:

I am an associate in a law firm in Akron, Ohio. The firm is an estate planning practice consisting of the owner/founder of the firm, myself, and two legal assistants. I have been with the firm for ten years and this is the only firm that I have worked with since law school. The owner is 67 and has announced that he wishes to retire. He has approached me and provided me with a proposal to buy his practice via an arrangement where I would initially pay him a down payment of 50% of his asking price and after two years the other 50% would be paid over a period of five years. The arrangement would be structured as a partnership and for the two year period we would be 50-50 partners. Compensation would be based upon these ownership percentages. The owner's asking price is two times his average net earnings ($125,000) – $250,000. Average revenues – $210,000. I would appreciate your thoughts and suggestions:

Response:

Buying a law practice is a major commitment and major investment. To a large extent you are buying a job as well as hopefully a book of business. Here are a few ideas that you may wish to consider:

  1. A general rule of thumb for establishing a value for when a law practice is being sold to an outside buyer is a multiple of 1.0 times average gross revenue or a multiple of 2.0 times average net earnings. Typically this is a best case scenario for an outside buyer. Buy-ins for associates that have invested "sweat equity" over the years is usually less. In addition you must consider the extent of repeat client business, talent of those that will remain with the firm, management skills and ability of the new owner, and management infrastructure. (IT, databases, case and document management systems, automated billing and accounting systems, etc.) Personally, I think the asking price/buy-in figure is high. Try to get the owner to do better for you.
  2. Review at least the last five years financial statements and insure that there are no surprises.
  3. Insure that all debt and potential malpractice claims are disclosed.
  4. Review the office and equipment leases.
  5. Create a demographic profile of the firm's clients and referral sources.
  6. Have you been able to generate a book of business? If no, why not? Do you believe you will be able to in the future?
  7. Create a business plan for the future practice and share with the bank when applying for any needed financing.
  8. Are you sure you want to own and manage a business?
  9. If you will be borrowing money from a bank determine all the interest that you will be paying as well as any interest on the five year payout to the owner. Determine the time it will take to receive a return on your investment – how many years. If you pay $250,000 for the practice plus interest – say $300,000 over five years – will you earn this amount in additional income over and above what you are presently earning and is there upside potential? Does the deal make sense?
  10. Insure that you develop a partnership agreement for the new partnership. Insure that is provides for retirement of the owner after two years – if not be careful of the compensation arrangement.
  11. Insure that the owner makes a commitment to timely transitioning client and referral source relationships.

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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