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Practice Management: Preparing to sell

Every Issue

Cite as: Jan/Feb 2015 89 (1/2) LIJ, p.79

It is important to understand value when getting ready to sell your law firm.

You have decided to sell your small or medium-sized legal practice. There are many reasons for a sale. Maybe it is your choice after new year reflections, a business strategy or maybe it’s forced on you due to poor health, business results or partner relationships.

Generally it is better to plan in advance for a sale as part of your exit strategy for the business (and yourself). The sale process is likely to be a roller coaster: emotional, time-consuming and stressful, especially if a new experience. The more investment you make in understanding value and what buyers may value, the more likely it will be a better experience.

Like many small and medium business owners new to a sale, you will be asking questions such as what is the value of my legal practice? What happens in a sale? Who would buy my business? Do I need an adviser?

What is its value?

The value of your law firm will depend on a number of factors including its size and buyer.

Traditionally, for a larger legal business, it is likely that the expert valuation will be financially based and address future cash flow or “goodwill”, adjusted by a risk factor. Methods include future maintainable earnings based on discounted cashflow and net profitability less commercial salaries to owners.

Occasionally accountants also assess the net value of assets. For example work in progress, debtors, equipment less creditors, loans and employee entitlements. This can be confusing as it may be used to allocate price after the overall deal.

Calculation of the risk factor (also called capitalisation rate) is more challenging. It assesses how much a buyer is willing to pay based on the risks and rewards of the economy, legal industry and your particular legal practice. For legal businesses, a rough rule of thumb is one to three times the future cashflow with the smaller the business, the lower the multiple.

For smaller businesses, it’s usually all about meeting key performance indicators (KPIs). That is, owners are required to transition by remaining as employees in the business with payment on success in meeting KPIs with “perhaps a little upfront”.

In addition, be aware that each potential buyer will value your business differently. If you gave 10 potential buyers the same information about your business and each put in an offer, each would put a different dollar value and deal terms. This is because the buyers all have unique business and personal needs. Say there are two genuine buyers. Buyer 1 needs to sell their existing business first. Buyer 2 has just lost their job, has a payout and needs to generate an income rather than spend their capital. Buyer 2 will be far less likely to negotiate the price down. Buyer 1 would be happy to put in a low offer and wait.

Who will buy?

The conventional – and arguably tried and tested – process for small and medium business sales is to advertise widely using media and websites. Steps include getting valuation/s, writing an information memorandum and undertaking internal due diligence, followed by large scale advertising and marketing to potential buyers. Then qualifying buyers, handling inquiries, assessing offers, negotiating final offers and coordinating legal requirements.

This “bait and wait” approach may not always work well for legal practices. It’s a one way mindset of selling the business to the buyer. It favours the buyer as the seller gives out commercially sensitive information, negotiates down on price and is led by advisers seeking fees. It tends to ignore hidden costs of time, reputational risk and stress.

As an alternative, consider targeting the “natural owners” as potential buyers of your law firm. Natural owners are people with a good understanding of your industry although they are rarely actively looking.

Finding the natural owners requires a new mindset. Start to engage now. Research and identify potential buyers from your staff, suppliers, long standing customers, competitors and supporters. You tend to know who’s who and you can access specialists such as head-hunters. Next aim to understand the opportunities (financial and non-financial) your business can bring to potential buyers with their different needs. Summarise your key business information. Actively target and contact buyers who could be interested, ask questions to establish credentials and find out needs, motivations and strategy. Be creative about advertising, for example, using an expression of interest process to attract buyers prepared to put in the effort of an offer.

For law firms, the most likely buyers are your employees. Also consider competitors such as firms looking to expand their customer base, service areas or geography, or lawyers seeking to set up on their own.

Need an adviser?

It will nearly always be worthwhile using professional advisers as it is difficult to be objective about your own business. However if your business is worth less than $100,000, it may not be economic. Pick your advisers well. Make sure they understand the legal profession, have strong experience in business sales, can project manage and can deliver. Use an expert for financial valuation. Use a broker for the sale. Be clear about what you want when briefing your advisers.

Tips

Understand that you will be on a roller coaster ride during the sale process. To help keep strong, pick trustworthy advisers, understand your acceptable outcomes for a sale, accept that potential buyers will come and go, and ensure you have a backup plan.

Summary

When you sell your small or medium-sized legal practice, while you have an expert financial valuation of your business, remember that each potential buyer will value your business differently according to their needs. Understand the sales process and how to find the best price and buyer. Use professional advisers. With time and understanding on your side, prepare your legal practice to build and improve its value.


JUDITH BENNETT is a lawyer, LIV Practice Support Committee member, university lecturer and management consultant for law firms at www.Business4Group.com.

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