How to Value Your Law Firm: The Law Firm Valuation Formula
Published on
Dec 20, 2024

For many of you, legislative changes and the recent economic downturn may mean you’ll be retiring later than planned. While there are many variables you can’t control in an uncertain future, let’s explore an often-overlooked aspect that you might be able to maximize soon: how to value a law firm as a salable asset.

If you own a small firm, selling it could be crucial for funding your retirement. Recognizing this early allows you to apply client development and practice management strategies now to maximize future value.

How to Value a Law Firm for Sale

For those who think their firm isn’t valuable or sellable, consider two possible transition options. It can be sold outright to an attorney, avoiding a startup, or transitioned internally to a successor with an overlap period.

In either scenario, you must know what your law firm is worth in the marketplace. What follows is a quick, rule-of-thumb formula for self-valuation that you can use to get to a ballpark value. A sales transaction requires a neutral CPA for an official law firm valuation agreed upon by both parties. The CPA will assess marketplace variables and the value of your firm’s tangible assets during the valuation process.

This overview of the law practice valuation formula highlights key factors used to establish your firm’s ballpark value. If time allows, use this information to improve areas that lower your firm’s value over the next few years. Starting early increases your chances of maximizing your firm’s worth when the time comes to transition.

The Law Firm Valuation Formula

Back to the formula. By the end, you will have an approximate value of your law practice, provided you can gather the information you need, do the math correctly, and are conservative with your estimates. 

What you’ll have is the value of the intangible assets associated with your firm – separate from any property, furnishings or equipment that may be part of the package. This is the hardest area on which to place a value. Following the formula are marketing and practice management tips to increase the worth of your law firm in very specific areas.

Here’s how you find your law firm’s valuation:

  1. Start by taking the last five year’s gross receipts and averaging them. This is your starting place. Later on, this average will be affected by a multiplier, ranging from .5 to 3.0.
  2. Answer the following questions to determine your multiplier. These are the most important factors a business valuator will examine:
    • Conservatively speaking, what is the value of the law firm’s present book of business?
    • How many clients does the firm have now?
    • How “transferable” are the firm’s relationships in the following two areas: clients and referral relationships?
    • What practice areas does the firm handle?
      • For example, a real estate law firm is less valuable today than it was 3 years ago, due to the economic downturn and collapse of the real estate market. Many estate planning law firms are similarly less valuable. Should you wait until your law firm recovers to start calculating your “5 year average”? Yes, if you can.
    • What is the firm’s potential for repeat business?
      • Do clients have reliably recurring business with this law firm? Does the firm have “complimentary” practice areas that attract and service the same clients?

Putting the Value of a Law Firm Together

Your answers will determine the multiplier within the range of 0.5 to 3.0. This multiplier applies to your average gross receipts from the past five years.

The five-year average will either be halved (0.5) or tripled (3.0), depending on your scores in key value factors. Firms scoring high on all value factors receive the highest multiplier.

For example, if your five-year average is $1 million and you excel in value factors, your multiplier would be 3.0. This makes your law firm’s intangible value $3 million.

Ultimately, your practice will sell for what the market buyer is willing to pay. Your urgency during the sale also affects the final price. Identifying and improving value factors in advance can maximize your firm’s worth.

Important Factors Impacting How Much a Law Firm is Worth

One of the most critical factors in law firm valuation is the degree of “transferability,” in both your client and referral sources’ relationships. Here are a few tips to help you make the most of your law firm’s value in this arena.

Maximize Transferability of Client Relationships

  1. Don’t be ego-centric. From intake on, introduce clients to the “team” approach, so they will be less attached to you and trained to interact with the firm as a whole.
  2. To facilitate the team approach, be sure you have case management software which allows the appropriate team members to access current information on clients. Put in place a “Designated Hitter” system for client communications.
  3. Set high standards for serving your clients, and train everyone in the firm to do the same, especially any partners/associates who may inherit them down the road.

Maximize Transferability of Referral Relationships 

  1. If you are training a successor, introduce them to your referral sources well in advance of the hand-off. As the rapport and trust begins to grow between them, slowly hand over more of the communication to your successor.
  2. If you are selling the law firm outright, make it part of the contract that you will introduce your buyer to your referral sources and you will stay to manage the relationship for a period of time (6 months to 2 years) to ensure a smooth transition.
  3. Some sellers remain with their firm after the transition and serve in an of-counsel position specifically to manage referral relationships and acquire new ones. If you have a “marquee” name that draws new business, you can offer this incentive as part of the purchase agreement.
  4. If your firm relies heavily on advertising which features you prominently, create a partnership in which you begin to feature the buyer, or your successor, in your ads, along with you. Ultimately, plan to withdraw and let them have center stage once the public begins to associate their face with the firm.

Secure Recurring Business at Your Law Firm

Here is a tip to improve the likelihood of scoring high on the question of recurring business. Recurring business is at the heart of what many people think of as “goodwill” in the community, which also encompasses the law firm’s reputation. But measuring something as elusive as reputation is difficult. 

Whether or not clients come back with additional work and recommend you to their friends and family is measurable. This will also show up in the number of overall clients you have.

  1. Your law firm value will increase if you serve clients in a variety of related areas. Not only do your marketing costs go way down and profits go up, but your firm will be more highly valued if you can demonstrate reliably recurring business from established clients. If you don’t have complimentary practice areas that can serve clients in a variety of areas, start to investigate them now.
  2. You can add a complimentary practice area, or expand your services in two ways: Acquire the knowledge yourself through study and additional training, or hire someone who brings with them the requisite skills.

Final Thoughts on the Valuation of Law Firms

When all is said and done — you will ultimately sell or transition your law practice for whatever a buyer/successor is willing to pay for it. The law firm valuation process influences, but does not guarantee, a final sales price. 

But we believe that being forewarned is forearmed. Once you know which aspects of your practice count toward making it as valuable as possible, you’ll be better able to make decisions that maximize its future value. And its future value could mean all the difference in financing your life — and lifestyle — in the future.

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