Law Firm Succession/Exit Strategies: Practice Continuation Arrangements

A Must For Solos, Sole Owners, and Small Firm Lawyers

By John W. Olmstead, MBA Ph.D CMC

While many lawyers and law firms are beginning to think about long range succession issues and the need for long range succession plans, many have not yet addressed the shorter range issues.

Many solo lawyers are in “reactionary mode” and have not adequately prepared backup plans in the event that, in the short term – prior to retirement – something would happen to them.

For example:

How would the firm keep operating?
Who would take care of the client’s needs?
How would the firm’s staff be taken care of?

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.

What is a Practice Continuation Arrangement?

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.

Typical Components of Continuation Agreements

There are many components to a practice continuation agreement. It is important that temporary disability, permanent or total disability and retirement are outlined and defined appropriately.

Permanent disability is total disability due to poor health, either physical or mental. In contrast, temporary disability is defined as a physical or mental disability that does not last more than approximately six months. Retirement is simply defined as the exit from the practice of law on an immediate or phase-out basis.

Temporary disability. The agreement should call for the successor firm to provide employees to assist in the practice’s daily business. The employees generally would be attorneys and staff. However, an attorney or attorneys must be available in the successor firm to review the work of paralegals and staff and provide the necessary experience and background to make needed decisions. The attorney(s) would be in contact with and under the supervision of the temporarily disabled practitioner. Each of the two law firms would negotiate a compensation arrangement for the assisting firm. The agreement would provide for a conclusion of the arrangement once temporary disability ends. The temporarily disabled practitioner probably would give advance notice of his return, but the agreement would not require it.

Permanent disability or death. The provisions called for in these cases are much more detailed. They must allow for an orderly transfer of firm clients to the successor firm with no assistance from the practitioner and for the beginning of predetermined regularly scheduled payments to his heirs.

Payment for the Practice

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.

One approach would be to list each client in the agreement and assigned individual values that equal the total valuation agreed on for the practice. Payment for each is made to the lawyer’s heirs from cash received by the successor firm from billings to these clients for future services. The agreed-on percentage of current collections to be paid depends on the contract’s term. If the term is 5 years, then 20% of each collected amount would be paid each year. The maximum amount to be paid for any client is its agreed-on value. If the client terminates the successor firm’s services, payments for that client cease.

The surviving spouse or heirs don’t participate in any future client growth once the practice continuation agreement takes effect. Be careful about executing a note since it fixes the price for consideration and prevents payments that correspond with cash flow. It is inflexible to client loss. The buyer could end up paying for a client it may not keep.

While this article does not discuss the different valuation methods, lawyers should keep in mind that there are no hard rules on valuing a law practice. All law practices are unique, and a different set of criteria must be used for each. Many intangibles can affect the valuation. However, the valuation method must be agreed to by both parties to the agreement and be an integral part of the agreement.

Notification

The predecessor firm should notify all clients of the agreement in accordance with their state bar requirements and assure them there will be no interruption of services when the practice changes hands. It is important to ensure that the surviving spouse or heirs are aware of the existence of the practice continuation agreement and understand its provisions. In addition, the attorney for the predecessor lawyer’s estate should be familiar with agreement terms, if he or she did not draft and negotiate the agreement.

An Investment – Well Worth Your Time Investment

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 don’t have these agreements should learn more about preserving the value they’ve created.

John W. Olmstead, MBA, Ph.D., CMC, is a Certified Management Consultant and the president of Olmstead & Associates, Legal Management Consultants, based in St. Louis, Missouri. The firm helps law and other professional service firms improve the operations and management of their practices and the lives of their practitioners. The firm, founded in 1984 serves clients across the Globe assisting them with implementing change and improving operational and financial performance, management, leadership, client development and marketing.

Dr. Olmstead’s assignments have covered the spectrum of management issues. However, in recent years most of his time is focused on engagements helping firms with:

Partner Compensation
Governance
Succession/Exit Planning
Strategy & Competitive Business Models
Profit Improvement programs
Client Service Programs

Dr. Olmstead is the Editor-in-Chief of “The Lawyers Competitive Edge: The Journal of Law Office Economics and Management,” published by Thomson West. He is currently serving as Past Chair, Illinois State Bar Association Standing Committee on Law Office Management and Economics and as a member of the Legal Marketing Association (LMA) Research Committee. Dr. Olmstead may be contacted via e-mail at jolmstead@olmsteadassoc.com. Additional articles and information is available at the firm’s web site:

Law Firm Succession/Exit Strategies: Practice Continuation Arrangements

By John W. Olmstead, MBA Ph.D CMC

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