The Law Practice Market
The legal practice market is a vibrant and competitive one today, marked by increasing demand and rising prices for practices in the right location and condition. The State Bar of California 2021 Statewide Report on Lawyer Specialty Distribution reveals that demand for practice sales has increased in recent years, particularly among solo practitioners and small firms getting ready for retirement.
Even with the increasing competition, nationwide average practice sale prices are climbing. Numbers from Southern California in July 2021 reported an average sale price of $353,000, a 35% increase over the previous year . Nationally, practice sales are on average $400,000, mostly remaining constant between 2020 and 2021. Many are seeing strong cash flow and asking prices from $250,000 up to $500,000.
Just like retail businesses, location is key to valuing and selling your practice. Areas with high income or desirable settings for business improvement tend to be more valuable for practice sales, as they continue to attract clientele. Looking for new office space before selling your practice can help your overall cash flow at the time of sale.
Making Your Law Practice Saleable
Lawyers considering selling their practice need to take a few steps to prepare so they can maximize the value when launching their sales campaign, and after the sale.
Steps to get your house in order financially include:
- Getting up to date on accounting practices,
- Getting firm books and records in order,
- Organizing firm retention and storage of client files to best display your inventory of clients and matters,
- Preparing a pipeline report showing representative pending matters.
- Getting firm financials in order (e.g. – income statement, balance sheet, 2017 and 2016 tax returns, etc.) and readying up a Confidential Business Memorandum for distribution to Buyers.
- Understanding your firm’s billing and collections history (you should also be able to explain any lumpy or uneven cash or revenue collections) and getting a recent lock dated aged receivables report.
Client retention strategies are not as difficult as they seem at first blush. Many lawyers have no idea how much of their firm’s revenues are either contingent or unbilled. These items do not create real wealth unless they are converted into receivables and billed (generally this means selling off all legal work for a matter at hand). Many law firms would increase their value considerably if they were to review their legal inventory on a monthly or quarterly basis and simply demand that bills be issued in order to convert contingent work and unbilled matter into revenues. Not doing this creates a very strong buyer concern and will be reflected in a very low purchase price from prospective buyers.
Lawyers will also wish to ensure that they are in compliance with their firm’s closing obligations under Rule 1.16 and the applicable state’s ethical canons or rules. The closing obligations affect receivables, refunds of retainers or unused pre-paid legal fees, future billing upon file closing where the firm is allowed dispute resolution by contract (such as most commercial leases), and other matters. While there are many state by state variations on these obligations, this is yet another area that can kill a deal if not prepared and understood prior to going to market. It is simply not worth leaving these $100,000 or more dollar matters to chance.
Valuing a Law Practice
Valuation of a legal practice is not as difficult as it once was. Many law firms engage business brokers that specialize in law firm sales to assist in the process. A business valuation is a process to estimate the economic value of a business, which in this case is a law firm. These estimates are used to help sell a business, and will be relevant to prospective buyers for the law firm.
Their are several methods of valuation that can be used to obtain a value for your law firm. The most popular rule of thumb is 1 times revenue. However, there are many factors that are considered when assessing a value for your firm. Factors such as quality of practice, practice type, area, efficiency, location, the necessities that buyers are looking for, and how long your firm has been in business, amongst many other factors come into play when valuing your firm.
Your firm may have a book value of $500,000 and sell for $800,000. If you do not like the value your firm has, resulting from that assessment, there are several things you can do to optimize the value of your firm and maximize your exit strategy. Consider employing the services of a legal consultant or business broker to help bring the value of your firm up. These professionals are able to analyze your firm, pinpoint areas that need to be improved, and introduce you to others who have help successfully optimize their value of their firm.
Identifying Potential Buyers
As you now know, if you want to have success selling your practice, you have to meet a buyer. Beyond just broadening your network so that you’ve got enough people who know you, it’s important to begin thinking about "where" you’re going to find someone who’s actually interested in buying your practice.
Here’s a breakdown of some of the ways you can see if someone is a qualified buyer for your practice, and how you can connect with them.
This is the easiest way to find potential buyers, as you’re already connected to them both personally and professionally. Generally, these will be attorneys who you know, or have worked with before, and who may actually have an active interest in your practice, or moving to your area.
Some other places where you’ll likely be able to find buyers are:
These three types are also known to most law practice owners, but that doesn’t make them any less useful. You should actively be cultivating all three of these sources.
Networking
Brokers
Online platforms
Negotiating the Terms of the Sale
When negotiating the terms of the sale of your practice, ask the buyer to put its deal in writing — "a letter of intent." The "letter" spells out the key points of the deal, such as the purchase price and how it is to be paid, as well as other important details, such as payment of the financing.
The most contentious negotiations tend to be over the purchase price, whether an earnout (a share of future profits) is part of the deal, the amount of financing and what is actually being purchased. In recent years, attorneys have had to make concessions on some or all of these elements, particularly in light of the recent reduction in fees related to PIP (personal injury protection) insurance claims.
All the details take on additional importance if you plan to retain a piece of the practice. For instance, if you want to stay with a portion of the practice or continue to work briefly with the new owner, you need to build in compensation for your earned value for the transition period. On the other hand, the buyer may want to make certain that you are not going to poach clients once you’ve sold the practice.
Like other potential sticking points , some deal points are hotly-contested. These include:
The best buyers are not interested in dragging out negotiations over the deal. If they have asked you to submit financial data for a value appraisal, the valuation will be reported and you should be able to close fairly easily if the parties agree to deal terms.
Negotiations can get bogged down over details that are less important than the over-all deal. Be a willing participant in the give-and-take process. But remember that the seller is taking the bigger risk. You still have to provide a professional and successful service to a satisfied client base. The buyer is taking the plunge. He or she has to weigh the risks and the opportunities for increasing profits on something that has not been bought and paid for yet!
Calculating the value of a practice can be contentious. The American Bar Association suggests doing so through a standard valuation method, such as earnings-capitalization, discounted cash flow, prevailing price-earnings, or the burden of goodwill method.
In the end, the price and terms of a sale of a legal practice are determined by multiple factors: the practice’s size, the market, and the personal situation of the seller. Finally, what the seller will accept in terms of price and payment are the defining factors (among many) determining the best deal.
Law Practice Sales Documentation
As with the sale of any business, the transfer of ownership of a legal practice must be conducted in compliance with all relevant legal requirements. The characteristics of the firm will be the starting point for determining the legality of the transfer. For instance, where a practice is housed within a corporation the reflexive choice may be for a stock purchase transaction rather than an asset purchase transaction.
In addition to the form of the legal entity operating the practice (or combination thereof), state and federal laws relating to the transfer of personal goodwill ("a lawyer’s reputation and skills") will shape how ownership can be transferred without impairing the connections that those lawyers have with their clients. Each state sets its own rules for how a lawyer can deal with his or her own legal practice, whether bought and sold in whole or in part.
The "ancillary" documentation that will be a part of normal sale and transition planning will vary depending upon the desired mechanics of the purchase and sale transaction, as well as the structure of the legal practice. For example, where a legal practice is housed within a law firm, in addition to the purchase and sale agreement that covers the transition, the transaction will likely involve the drafting of one or more concurrent client communications letters, a collaborative disclosures and transition letter to employees and staff members, as well as one or more employment agreements relative to how those employees and staff members will transition.
Clearly, when it comes to the sale of a legal practice, the issues will differ from law firm to law firm, practice area to practice area and jurisdiction to jurisdiction. The issues are too varied and have too great of an impact to rely upon the use of some form buyer’s guide. For a number of reasons, there is no cookie cutter approach that is going to guarantee the smoothest possible transition.
That is why prudent attorneys who are making plans to transition their practices will seek the advice of professionals that have experience in handling the sales of other legal practices.
Transitioning after the Sale
The transition process after a legal practice has been sold may be as simple as handing over current files and job descriptions to the buyer after the sale is officially closed. It will depend on the circumstances of each particular sale – staff integration and transferring vital client relationships across a number of years may often be fundamental steps in the process. Buyers may require a period where they can consolidate and integrate their new practice into their existing practice; where they can learn about their new clients and the team that services them. A transitional support plan can be discussed in principal with the buyer prior to sale, but will need to be re-confirmed closer to the date of sale and organisation of a final handover. Confidentiality agreements can be signed by the buyer in relation to clients and staff with whom the seller communicates and interacts during this period so that the buyer can prepare themselves for the transition process, secure in the knowledge that the seller will not be damaging the value in the practice or competing with them in the key lead up months post-sale. It is likely that the buyer will request full access to all of your files so that they can complete their own due diligence and start preparing for the bulk of the transition following sale . These files can be provided earlier than the settlement date so that there can be an overlap of time for the buyer to be introduced to clients and work out strategies regarding the continuation of their matters. Electronic files can allow the buyer immediate and easy access to the precious data that is often not available from standard case management software systems. These files will assist considerably with the protection of the goodwill in the practice, details about client conversations, any discussions you may have had with your client and the substance of these discussions. Immediately following the sale, the buyer may require you to deal with clients on an ongoing basis regarding the transition process until they are comfortable and confident that they are across all matters that you may have been managing or advising on at the time of sale. The buyer may wish to pay you by way of performance fees for maintaining the relationships for a defined period of time (for example, 6-12 months) after the sale of the practice, to mark their ongoing commitment to the relationship and to the transition process. The buyer may also request that you respond to clients’ queries for a shorter period after settlement, so they can develop relationships with clients face-to-face in the lead up to settlement and beyond.