United States: Law Firm Group Newsletter – Summer 2014

Last Updated: September 17 2014
Article by Joel Herman and Steve Lewis

PUTTING A PRICE ON YOUR LAW FIRM

Joel Herman, CPA

Many situations can trigger the need for a law firm's appraisal, including insurance coverage, a partner's death or divorce, capital buy-ins of new partners, firm dissolution and mergers. There are specific ways that law firms create, or diminish, value. This blog discusses some of these "value drivers" and how the three most common business valuation methods are applied. But, as a Sidebar notes in regard to one divorce case, valuators often disagree about the same professional practice interest.

If you have never had your law firm appraised, it could only be a matter of time. Many situations can trigger the need for an appraisal, including insurance coverage, a partner's death or divorce, capital buy-ins of new partners, firm dissolution and mergers.

If you are contemplating a merger, sale or acquisition, a professional valuator should perform the appraisal to help ensure accuracy. But even when you leave valuation in an expert's hands, it is useful to understand how law firms create, or diminish, value.

Unique Factors

Valuation methods used for small businesses, such as multiple of earnings or discounted future cash flows, also apply to law practices. However, law firms must consider some unique factors. For example, the ABA's Code of Ethics generally prohibits law firms from buying and selling client lists. Although most states have adopted ABA Standing Committee on Ethics and Professional Responsibility Model Rule 1.17, which enables firms to sell client files and the associated goodwill firms generate, a few have not. Other "value drivers" that apply specifically to law firms include:

Financial Performance Stable, sustainable, growing revenue streams and lean operating expenses are ideal. Appraisers evaluate balance sheet strength, including the transferability of work in progress (WIP) and collectability of receivables. Large firms may be more valuable, because they offer one-stop legal expertise and can spread fixed overhead expenses over a larger revenue base.

Type of Work Does the firm provide services that match the needs of its local market? General practices may sell for less than specialty firms, such as patent or environmental law practices. If a firm handles only contingency fee cases, which generate varying annual revenues, valuing its future income streams can be challenging.

Reputation Firms add value with a strong brand, unique work and attorneys who are regarded as experts in their field. Firms also can boost value by speaking at conferences, publishing articles in professional journals and participating in community service.

Concentration Risks Value is diminished when one attorney or client generates a significant portion of the firm's business. Significant could be defined as low as 10%. The loss of this rainmaker or major client could cause financial distress.

Staff A firm's assembled workforce of paralegal, IT, marketing and secretarial professionals is important, too. In addition to the quality and depth of your staff, valuators consider your employees' average years of experience and retention rates.

Valuation Methods

In general, there are three business valuation methods. Here is how they might apply to your law firm:

  1. Cost A valuator adjusts your balance sheet to current market values. Your most valuable tangible assets include receivables (such as unbilled work in process and client costs), computer equipment and furniture, and real estate. Favorable or unfavorable lease terms can also affect value. Your firm's net tangible value is the difference between your hard assets and liabilities.
  2. Market If your firm is being appraised for sale, private transaction databases can be used to derive a range of pricing multiples of earnings or gross revenues. Where your firm falls within that range depends on its value drivers.
  3. Income This approach determines value based on discounted net cash flow or capitalization of earnings. More valuable firms have higher expected cash flows and lower discount rates.

Goodwill Hunting

Goodwill is likely to be your firm's most valuable asset — and the most difficult to measure. Appraisers typically value goodwill by subtracting the net tangible value derived from the cost approach from the values derived under the market or income approaches.

Goodwill can be further split into two components: Business and professional. Business goodwill is associated with the firm as an operating entity and includes such items as client lists, name recognition and an assembled workforce. Personal goodwill cannot be separated from individual lawyers, except over time with carefully planned transitions of client relationships. Employment contracts, non-compete agreements and earnouts can facilitate the transfer of personal goodwill in the event of a merger.

A Valuation Specialist

Whether your firm is contemplating a merger or have other reasons to obtain an appraisal, be sure to work with an expert who has experience valuing law firms. Valuators must employ standard appraisal methods, as well as consider ABA rules and other unique value drivers.

TWO-TRACK MIND: MULTIPLE PARTNERSHIP MODELS & THEIR BENEFITS TO FIRMS AND LAWYERS ALIKE

Steve Lewis, CPA

Firms that hire and retain only partnership-track associates may be turning away profitable legal talent. Many skilled lawyers do not want the long hours and ownership responsibilities of equity partnership — and, for those who do, the organizational structure that once supported this goal has become less viable in the 21st century. This article explains why a two-tier system — of equity and non-equity partners — may be the solution.

Historically, the legal profession has been one of the most demanding, requiring long hours and high performance levels — particularly for those who hope to become a partner in a private firm. So it is not surprising that many of today's lawyers are "opting out," eschewing the partnership track for a better work/life balance.

If your firm hires only partnership-track associates and adheres to the old "up or out" rule whereby associates who do not make the grade are expected to leave, you may be turning away profitable legal talent. A two-tier system — of equity and non-equity partners — may be the solution.

Popular for a Reason

The two-tier concept has spread like wildfire in the past decade. According to the American Bar Association, more than 60% of larger firms now offer equity and non-equity partnerships. Several industry shifts have made this system attractive:

Smaller Pies With fewer equity partners, each individual can take a bigger slice. As law firms get squeezed by rising costs, intense competition and budget-minded clients, limiting the number of profit-sharers may keep current equity partners satisfied and engaged.

Lateral Movers Hiring midcareer lawyers is increasingly common. But despite having high expectations for such lateral movers, firms are often wary of offering untried attorneys full equity partnership.

Changing Values Many younger attorneys are rejecting the idea that their job is their life and refusing the late nights, frequent travel and mental pressure generally associated with equity partnership tracks. Similarly, some lawyers simply want to practice law, not generate new business or assume management responsibilities.

Oversupply It is no secret that there are more law-school grads than plum, partnership-track positions. Not every lawyer is owner material, but many are, nevertheless, capable of making significant legal and financial contributions.

A Better Offer

Some firms have reacted to such cultural changes by creating "permanent associate" programs, placing non-partnership-track attorneys in satellite offices with lower-profile, less-challenging work. Unfortunately, this can create a demoralizing "second class citizen" environment that discourages them from producing their best work.

Non-equity partnerships offer an alternative for attracting and retaining talent. Lawyers in this tier enjoy the title of "partner" but typically are compensated with a combination of salary and performance bonuses, not profit shares. In fact, one of the advantages of adding non-equity partners is the flexibility to determine the best means of their compensation.

Non-equity partners do not make capital contributions to the firm or assume personal liability for debts. But they may be granted limited voting rights and participate in partner meetings where strategic decisions are made.

Qualified Candidates

Such positions should not be used to dispose of underperforming lawyers who traditionally would be asked to move on. Instead, reserve them for individuals such as:

  • High-billing senior associates who desire a 9-to-5 workday;
  • Older equity partners whose business development activities have slowed;
  • Experienced lawyers with valuable niche knowledge, but no desire to be an owner; and
  • Unproven lateral hires.

Some of these attorneys may eventually become equity partners. But it is important to make your non-equity track a respected and professionally challenging alternative to equity partnership so that good lawyers will remain loyal to your firm.

Eye on the Prize

For most ambitious young attorneys in private practice, equity partnership remains the ultimate prize. But the organizational structure that once supported this goal has become less viable in the 21st century. Although some research has suggested that single-tier firms enjoy higher per-partner profits, most firms that want to remain competitive need to explore alternatives to the traditional equity partnership model.

Transitioning to a two-tier partnership system can be complicated.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Joel Herman
Steve Lewis
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions