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If you are considering selling your law firm, you have two basic options. They are:
- Have an existing associate or associates (if you have associates) buy you out , or
- Transition to a third party (sell to or go “of counsel” with another firm)
Let’s take a look at the considerations for each.
Buyout By Insiders
If you have any associate attorneys working for you, you should always first consider whether they can succeed you as the owner of the practice. Selling to your associate rewards their loyalty, puts cash in your pocket, and provides uninterrupted service to your clients.
Many small firm owners wrongly assume that finding a third-party buyer is more lucrative than an internal deal with an associate. That is often not the case.
Let’s challenge this and other assumptions law firm owners make when comparing their options for selling.
My associates lack the “right stuff” to successfully take over the practice.
Yes, you are correct. Your internal successors are not as good as you. They probably would have left you years ago and started their own firm if they were.
Using the standard of “Are they as good as me?” is unrealistic, and unnecessary. For an internal transition to succeed, good may be good enough. Further, assess whether they have the potential to get closer to being as “good as you.” The emphasis is “closer.” Assess their capability to grow into an ownership role. Give them the benefit of the doubt.
A third party will pay me more.
Don’t be so sure. It’s the rare deal, internal or external, where the buyer pays a fixed price. Most are structured as earnouts. That is, sellers receive payments based on the future performance of the law firm. Thus, an earnout structure does not provide an sale to a third party with any advantages, price-wise, over a sale to an associate.
In addition, I’m unaware of any data supporting the notion that a third party will pay more. My experience as a consultant over the last two decades does not support it. The marketplace for law firms remains too immature and underdeveloped to assume anything.
Why Internal Deals Can Be Preferable
Here are the advantages to an internal deal with an associate.
They are more predictable.
I believe in the adage that it is better to work with “the devil you know than the devil you don’t.” You know your associates, warts and all. Face it: you have little to no idea how a third party will perform. It’s a crapshoot. You can plan how to handle the warts. With a third party, you must make it up as you go along.
Your brand may be lost otherwise.
Sometimes, the best buyers are successful firms in your geographical location or practice area and already have a well-established brand. Typically, they have no interest in yours, including the firm’s name. Sure, they will want things such as your client list, website content, staff, etc., But that intangible value of the firm’s brand will be lost in a sale to an outsider.
Contrast that with insiders. They will have every reason to keep some portion of the firm’s name and benefit from that recognition. However you attempt to monetize that, insiders will want to capture its value.
Third-party buyers may not be so easy to find.
At times, buyers are not as easy to find as hoped. I’ve had countless clients tell me their firm is perfect for this type of lawyer or law firm. I usually agree but then feel compelled to inform the client that, yes, your firm would be ideal for an attorney who fits that profile, but I’ll be damned if I know how to target that ideal purchaser.
For example, your firm may be perfect for an unhappy Big Law associate or a big-city lawyer looking for a better work/life balance. Now, tell me how to locate that lawyer other than directly contacting every lawyer in a particular market or practice area who might fit that profile. There is no central clearinghouse for law firms like other small businesses. You can’t just place your firm up for sale on eBay, knowing that thousands of eager searchers will see it. The marketplace for law firms is too underdeveloped, and will remain that way for quite some time.
In short, don’t automatically reject the possibility of an internal deal, assuming that you can easily find a willing and capable buyer. That assumption may be wrong.
Be realistic.
The marketplace for law firms is fickle. Yes, I know your potential inside purchasers are not perfect, but don’t forget the adage, “don’t let perfect be the enemy of the good.”
Third-Party Sales
The other exit strategy involves selling your practice to an outside buyer. There are two ways to approach the sale of your firm.
One method is to sell your stock to keep the firm’s entity intact. Under this scenario, the parties agree to a fixed price for the shares of equity; in essence, the value of the entire firm. After the sale, the buyer will own the firm’s assets and non-excluded liabilities.
Alternatively, the buyer may prefer to acquire the firm’s assets. The law firm buys the files, website, contact information, etc. In this scenario, sellers are often paid via an earnout based upon an agreed percentage of future gross revenue over an agreed-upon time period.
What should the percentage of revenue be? It’s usually in the range of 10 to 25 percent. If it’s less than 10 percent, getting your entire payout will probably take forever. Anything above 25 percent will probably leave little or no profit for the new owners.
Buyers usually prefer an earnout option because their risk is considerably less than a fixed price. They also favor asset purchases since they also avoid unknown liabilities.
As is the case with all business deals, there’s risk involved. When there’s an agreed-upon fixed price, the buyer may pay something for nothing if the hoped-for future revenue does not materialize. With an earnout, the buyer assumes no risk of losing money other than a negotiated down payment. The buyer pays the seller nothing more if there's no future revenue. In exchange for this, however, the buyer assumes a different risk. Should future revenues exceed the anticipated amount, the buyer pays more.
The two approaches have significant differences in tax consequences for both seller and buyer. It’s therefore critical that you discuss the options with your accountant.
Other Methods of Doing a “Sale”
“Of Counsel” Relationship
There is an alternative to outright selling a practice to a third party where the selling lawyer shuts down its firm and then joins the acquiring firm in an “of counsel” role. Some think of such arrangements as mergers.
The ABA has defined an “of counsel” relationship as a “close, regular, personal relationship” with the law firm. The “of counsel” alternative can be a very attractive means to structure a succession arrangement for those retiring lawyers who still want to practice on a limited basis during their last years.
Whatever the label, as a practical matter, the law firm is “buying” a practice. Unlike a sale, where there would typically be a set price or earnout, the retiring/selling lawyer in an “of counsel” arrangement gets paid for the practice via the law firm’s compensation structure. Most firms will usually tweak their existing formula and compensate the “of counsel” selling lawyer for seller-originated files. Signing bonuses replace the down payment that you often see in fixed-priced deals. Some firms will also compensate nonbillable time for transitioning clients and any necessary training and mentoring.
How to Choose
There is no one right option—only the best one for your unique circumstances. Admittedly, the decision can be a difficult one to make on one’s own, which keeps many attorneys stuck.
The trouble is that you don’t know what you don’t know, and it is often helpful to review your options with someone who has experience with all of these options. If you have any questions about whether to sell your law firm to an associate, seek a third-party buyer, or go “of counsel” with another firm, contact Roy Ginsburg to schedule a consultation and get the knowledgeable help you need to move forward.
