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Excerpted and adapted from Passing the Torch without Getting Burned: A Guide to Law Firm Retirement and Succession Planning, now available from LPM. Order your copy today at www.ShopABA.org.
For law firms, succession is a fact of life: founding partners retire, rainmakers depart, and in the meantime, client relationships must be preserved. In some cases, the partners might decide that the best option is to sell the firm to another party.
It is now permissible in a number of jurisdictions to sell a law firm. The purchaser of the firm must be a lawyer or another law firm, and ethically, the sale of the firm cannot be construed to be a sale of client relationships.
The ideal time to start planning for selling a firm is when the firm is in its early and active stages of existence. Waiting until the last minute will most assuredly limit the number of options available. Furthermore, with a possible sale on the long-term horizon, the founders may choose different strategic planning and management initiatives than they might otherwise choose, if the goal is to operate the firm to maximize current incomes of the partners.
To effectively sell a law firm, the firm’s owners and managers need to be thinking about creating long-term sustainable value, and not just paying out the maximum amount of income each year. Investments need to be made in establishing a market identity for the firm that has value separate and apart from the owners. These investments may include:
1. marketing initiatives aimed at establishing a “brand” identity for the firm in its area(s) of specialty;
2. cultivating and maintaining a network of referral sources;
3. joining and becoming active in one of the national or international networks of law and/or accounting firms, such as MSI Global, Primerus, et. al.;
4. investing in training and career development of younger lawyers who will be valuable contributors to the practice of the acquiring firm;
5. creating proprietary systems, procedures, and technologies that uniquely support the practice of the firm, like such as document drafting systems, form books, systems to manage cases in the pipeline, etc; and
6. investing in and focus on creating institutional approaches for managing for the long term, especially in the key areas of client development, talent development, and work-flow management.
These are but a few examples of how a firm can invest in creating lasting value that a buyer might be interested in acquiring. Needless to say, these and other techniques require the diversion of otherwise distributable profits into investments that will benefit the firm over the long haul.
Another important step is to have in place a fully formed law practice entity, like a PLLC, LLC, LLP, or PC. Even a solo practitioner should have a formal operating agreement that contemplates bringing in new co-owners and affords a well-planned exit strategy (see Model Partnership Agreements for New York Law Firms [Giuliani 2008]).
A solo practitioner should already have a plan in place that takes care of the firm’s clients if something happens to the solo practitioner. This is like having an estate plan and executor agreement for the law firm, and it simply makes ethical sense to have such a plan in place.
The sale of a law practice is generally part of an orderly plan for the founder’s (or founders’) retirement. First, the founder or the owners of the practice must decide what is meant by “retirement” and then structure a sale transaction that aids in accomplishing this goal. Does the founder expect to completely cease the practice of law? Is emeritus or of counsel status a goal? Or does the founder simply want to cash out and continue to practice on a reduced schedule?
Next, the founder should develop an exit strategy that accomplishes the goal. This can involve transferring equity to a junior partner or an associate already at the firm. Alternatively, it may involve a search for a merger partner or an outside lawyer to acquire the practice. In the extreme, it may involve a detailed and orderly plan to gradually dissolve the firm and refer clients to lawyers in other firms.
In any of these strategies, the founder will have to identify a successor, if one is not already obvious. If the firm already has a junior partner, the choice may be clear. That said, if the junior partner cannot afford the terms of sale, the founder will need to look outside for a buyer. That would require the firm to conduct an orderly search for a successor.
The process of finding a successor is similar to a strategic expansion process involving acquisition of lateral practitioners with portable practices. The firm first needs to formulate a search plan. Such a plan would involve answering the following questions:
1. What do you want to accomplish and why? What are your retirement and succession goals, and how do you plan to achieve them?
2. What alternatives make sense initially? Merger? Outright sale to another lawyer or law firm? Passing the torch to a junior partner? Winding down?
3. What is the ideal profile of the person or firm to take over the practice? Age? Experience? Practice specialty?
4. What does the firm have to offer that person or practice? Referral network? Will vault? Proprietary systems or software?
5. In twenty-five words or less, what is the seller’s “pitch” to the successor? Essentially, this is a statement of all of the above, coupled with a statement as to how the seller envisions the successor helping to accomplish the goals. It should also state why the seller has selected the successor, as opposed to other possibilities.
The next step in the process is to establish what a reasonable, qualified, and informed person might pay to acquire the practice. The seller(s) might want to engage and accountant or other professional to prepare an independent valuation of the practice. That should add credibility to the seller’s asking price, and the valuation methodology should provide various detail points of negotiation for both parties. In the end, there are three major terms on which the two parties need to agree: the valuation (i.e., purchase price), the plan for transfer of ownership, and the method of financing the transaction.
The purchase price is usually determined in a valuation exercise. As for the transfer of ownership, there are generally two basic options, depending upon whether the firm in question is an incorporated entity or a partnership or sole proprietorship.
In its simplest form, buying an incorporated law practice can be structured as a straightforward cash transaction, much like buying any other business. The buyer and seller agree upon a price for the shares in the corporation. In consideration for cash, stock, or other valuable assets, the seller transfers title of the business to the buyer.
The buyer records the new asset on a balance sheet, along with any debt incurred to finance the purchase. The seller realizes a capital gain on the sale of his or her stock and pays tax on that capital gain. The tricky question is how to determine the tax basis of the shares sold, so that the capital gain can be measured. This is a task best left up to professional accountants.
Here are some words of advice for those who are contemplating selling their practices:
1. Do not attempt to sell your practice without retaining competent transactional and tax counsel. Accountants can be helpful in valuing your firm and advising on tax issues. Elder-law lawyers are good advisers in the area of estate and post-retirement financial planning. Finally, you may need a lawyer well versed in local corporate and/or partnership law to advise on terms and maybe “paper the deal.”
2. Do not represent yourself. There is truth in the adage that a lawyer who represents himself has a fool for a client. You are too close to your practice to be objective in negotiating terms. This is the only time in your life that you will sell your practice. There are others out there—accountants, lawyers, and other advisers—who have experience in selling businesses. Let them guide and advise you.
3. Put everything in writing, even among family members. Memories are often short, sometimes conveniently so. Buyers can also suffer from “selective recall” when they are forced to make “earn-out” payments when business isn’t so good. There is no substitute for having a written agreement, especially when things don’t turn out the way you expected.
4. Make sure you are able to regain ownership of the practice if your buyer defaults, commits malpractice, etc. In any kind of “earn-out” plan, you, the seller, are at risk throughout the “earn-out” period. Bad things can happen, and you will need a preplanned remedy in case the seller fails to live up to the bargain.
5. If you bring in a partner, have a plan to gradually cede voting control over time—say, three years. Since you are not getting paid for all of your equity in a lump sum, you will need to retain control of your practice for some period of time until the seller has effectively purchased most of your equity interest. This goes hand in glove with the provision that lets you regain the practice if the buyer fails.
6. Do your due diligence; know your buyer well. If you are counting on the sale of your practice to provide retirement income, you need to be reasonably certain that the buyer has the skills to manage your practice successfully and that he or she has the financial wherewithal to pay you, even though the continuing practice may suffer some loss of business. Finally, you need to be sure of the character and ethics of the person to whom you are selling your life’s work. Forewarned is forearmed.
