For personal injury law firm owners thinking about leaving practice, there’s good news and bad news regarding selling a personal injury law firm.
Personal Injury Firms
First, the good news. Unlike most practices, personal injury practices have a real monetary value and a relatively easy manner to determine that value, even if the owner decides to shut the firm down. At times, this value can be significant and easy to monetize.
What am I talking about? The firm’s case inventory. Owners of a personal injury practice can refer out the inventory and agree to a split of the ultimate settlement or verdict proceeds, depending on what stage the case is in at the time of the transition. Few practice areas have comparable case inventories that can so readily be turned into cash.
Unique Financing Challenges
Now, the bad news. Selling a personal injury practice has unique capital requirements and cash flow issues that, as a practical matter, scare away many prospective buyers. As such, the pool of potential buyers can be very small.
Why the Challenge?
Here’s a hypothetical situation demonstrating this state of affairs. Let’s say a personal injury practice usually grosses around two million dollars a year, and its owner would love to sell the firm to a trusted associate. And to keep this example simple, the parties agree that the firm’s goodwill value is one million dollars, with most of the payments in the future via an earn-out. In other words, the purchase is essentially financed from the firm’s future revenue to make this affordable for the associate. So far, so good.
The firm’s monthly overhead expenses are around $200K, and the owner likes to keep $500K in the firm’s operating account. The firm usually funds individual case expenses to the tune of $50-100K per month. Finally, the parties agree on a formula to divide the proceeds of the firm’s inventory as the cases settle. As a practical matter, this means that for the first six months, most settlement proceeds will go to the firm’s previous owner since those cases were opened up and largely worked on when the seller owned the firm.
Thus, on day one of a transition, the new owner (the former associate) has to come up with at least half a million dollars for the operating account and to make sure he has at least an additional $100K on hand to fund the expenses of existing and new cases. And to add insult to injury, most revenues that come in the door during the early months after the sale will be from the inventory and, therefore, primarily go to the former owner, not the new one.
In short, at a minimum, the new owner will probably need to find at least another half to three-quarters of a million dollars for the operating account (which includes money for his salary) and expenses to keep the lights on. And don’t forget, the buyer still needs to make payments on the firm’s one million dollar agreed-upon value.
Will it be difficult to obtain the funding? Not as hard as you think. The owner or a bank (especially an SBA loan, which is more available than one may think) may be willing to finance this. The real problem is that most lawyers don’t have the appetite to take on that amount of risk. Imagine the conversation when the associate goes home and asks the spouse whether it’s okay to take out a second mortgage or an SBA loan for which a personal guarantee is needed. It’s easy to see why most deals die at the dinner table.
Limited Pool of Buyers
Now, don’t get me wrong. The firm can be sold. However, the likely buyers are probably only a larger personal injury firm that rarely flinches when assuming risk. Insiders and smaller firm owners, not so much. Understanding the reasons why will help you to have more realistic expectations about selling your law practice, and less frustration.
Feel free to reach out to me to discuss this further. You can reach me at 612-524-5837, or contact me online.
