By Mark Powers & Shawn McNalis
Originally published in Lawyers USA
For many of you shareholders, the economic downturn means you’ll be retiring later than you planned. And while there are many variables you can’t control in an uncertain future, there’s one asset some of you shareholders may be able to maximize in the near future: your law firm. If you are a sole practitioner or the owner of a small firm, its sale may be the key to funding your retirement. And we believe that there are client development and practice management tips you can utilize now to help maximize your firm’s value down the road.
There are two ways your firm can be transitioned. It can be sold outright to another attorney, or transitioned internally to a successor who becomes your partner for a period of time until you depart entirely.
In either scenario, you must know what your firm is worth. What follows is a quick, rule-of-thumb formula for self-valuation that you can use to get to a ballpark value. Keep in mind that an actual sale will require an official valuation by a neutral CPA – someone who is an expert in performing service-based business valuations. That individual will take into account additional variables in your marketplace, plus the value of the tangible assets associated with your firm.
But this quick overview will enable you to establish the ballpark value of your firm, and give you the opportunity to see some of the more important factors considered during the valuation process. If time is on your side, you can use this information and take the next several years to improve those areas that pull your firm’s value down. Keep in mind that the earlier you start, the more likely you are to maximize its worth.
Here’s the formula:
- Start by taking the last five year’s gross receipts, subtracting the high and the low, and averaging them. This is your starting place. Later on, this average will be affected by a multiplier, ranging from .5 to 3.0.
- Answer the following questions to determine your multiplier:
- Conservatively speaking, what is the value of the 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 firm is less valuable today than it was three years ago, due to the economic downturn and collapse of the real estate market. Many estate planning firms are similarly less valuable.)
- What is the firm’s potential for repeat business?
- Do clients have reliably recurring business with the firm? Does the firm have “complimentary” practice areas that attract and service the same clients?
Putting it together
Your answers to the above questions will lead to the selection of a multiplier in the range of .5 to 3.0. That multiplier is then applied to your average of the last five years’ gross receipts.
In other words, your 5-year average number will either be cut in half (.5) or multiplied up to three times depending on how you score on the most important value factors.
A firm that scores in the upper ranges on all the value factors will merit the highest multiplier.
If, for example, your average gross receipts for the last five years are $1 million, and your scores on the value factors are excellent, your multiplier would be the highest possible, or 3.0. Apply this to $1 million and the value of the intangibles associated with your firm becomes $3 million.
Keep in mind that when all is said and done, you will sell your practice for what a buyer is willing to pay for it in your market. The level of urgency that you feel at that time will also influence the final figure. But that is all the more reason to identify and shore up the value factors where you can – ahead of time.
One key area is the degree of “transferability” in both your client and referral source relationships. Here are a few tips to help you make the most of your firm’s value in this area:
- 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. To facilitate the team approach, be sure you have case management software which allows the appropriate team members to access current information on clients.
- 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.
- If you are training a successor, introduce him or her to your referral sources well in advance of the hand-off. As rapport and trust begins to grow, slowly hand over more of the communication to your successor.
- If you are selling the 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 (six months to two years) to ensure a smooth transition.
- 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.
- 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 him have center stage once the public begins to associate his face with the firm.
Recurring business is at the heart of what many people think of as “goodwill” in the community, which also encompasses the firm’s reputation. But measuring something as elusive as reputation is difficult, while determining whether clients come back with additional work and recommend you to their friends and family is measurable.
Your firm will increase in value 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, start to investigate them now. You can 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.
As we noted earlier, when all is said and done you will ultimately sell or transition your practice for whatever a buyer/successor is willing to pay for it. The 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.