As baby boomers age and start to think about retirement, these lawyers begin to think about selling their legal practices. At the same time, younger lawyers are looking for ways to expand or diversify their practices. They are also thinking about buying a law practice.
Buying a law practice is a strategy that offers sellers and buyers alike significant gain with minimal risk.
Even though the risk is small, it is enough to scare off some potential buyers. Lawyers, after all, are blessed with ultra-cautious DNA. For many, the term “risk” is not part of their vocabulary.
Perhaps the following hypothetical example will persuade skeptical buyers by demonstrating the small risk and potential high reward of a law practice sell/buy arrangement.
Conventional wisdom has it that there is value in an estate planning practice. Most estate planning lawyers should have drafted many wills for clients over the course of a career. In theory, these should lead to future business when a will needs updating or an estate is probated. Anyone who buys this practice is buying this future business.
While there is no guarantee that this business will materialize, it is reasonable to assume that at least some of these former clients will seek out the buyer when they are in need of future legal services. By selling a practice to this particular buyer, a retiring lawyer is actually recommending the purchaser. While some clients may certainly look elsewhere, others will not.
Let’s assume that our hypothetical selling estate planning lawyer has consistently netted about $100,000 in annual revenue. Let’s further assume that the lawyer has created 1,500 wills during his years of practice.
We can probably assume that, over the next five years, 50 clients will contact the purchaser of the practice to have their wills updated (at $1,000 per will) and 20 more will need to have an estate probated (at $5,000 per probate). The purchaser has gained an additional $150,000 in total revenue. These are relatively conservative assumptions.
Using the “rule-of-thumb” method to calculate value, bean counters assign a variable (also known as a multiple). They multiply the net revenue by this variable to derive a value. Although there is little science to support one multiple over another, most experts put the number somewhere between .3 and 1.0.
So, for the purpose of our hypothetical, let’s assume a conservative multiple of .5. The value of the practice for sale is .5 of $100,000 or $50,000. It makes a lot of sense to spend $50,000 for a practice that is likely to earn $150,000 in the next five years.
An alternative method of calculating value dispenses with the arbitrary variable. Using this method, the buyer pays the seller an “earn-out” – a percentage of future revenue for a fixed period of time. If the buyer pays one-third (a typical ratio) of the $150,000 revenue over the next five years, the seller receives the same $50,000. Here again, the buyer is tripling the return on his $50,000 investment.
Many risk-averse potential buyers prefer the earn-out method, because there is absolutely no risk of losing money other than a negotiated down-payment. If there’s no future revenue, the buyer pays the seller nothing more.
In exchange for this, however, the buyer does assume a different kind of risk. Should future revenues exceed $150,000, the buyer pays more than he or she would under the rule of thumb fixed price.
Lawyers can grow or diversify their practices by strategically purchasing the practices of other lawyers. Don’t be afraid. Just do the numbers. Tested financial methods let you understand the advantages and minimize the risks – conquering your skepticism and giving you the fortitude to proceed with such a transaction.
Originally posted on www.lawyerist.com.