Law firms generally do not pay as much attention to their value as technology companies or public corporations, but a variety of circumstances can trigger the need for a firm valuation. Although attorneys may often deal with business valuations in the course of their work for clients, they might be surprised to learn how law firm valuations can differ.
When Do You Need a Valuation?
A firm valuation may be in order for:
- A partner buyout;
- Tax purposes;
- Partnership disputes;
- Divorces involving partners;
- Life insurance purposes;
- Buy-sell agreements;
- Financial reporting; or
- Bankruptcy proceedings.
One of the most common scenarios for a law firm valuation is the sale of the firm, even when the sale is not imminent. For solo practitioners or partners in smaller firms, for example, the sales price, as based on a valuation, could be an important part of retirement planning.
What Factors Affect Value?
Your firm's value will likely be based on its historical gross receipts which are used to project future income and its assets. The valuation will consider both tangible assets, such as real estate, furniture and equipment and intangible assets.
A law firm's most significant intangible asset is typically its goodwill, the value of which could even exceed the value of its tangible assets. Goodwill represents factors such as the practice's location, name, reputation, client base, staff, policies and procedures and other characteristics that are separate from the attributes of the firm's individual attorneys. This "practice goodwill" assumes clients would stay at the firm even if individual partners were to leave.
Which Valuation Method Applies?
Businesses are usually valued using one of three methods:
- Market Value
The market-based approach is less useful for law firms, as it can be difficult to find comparable guideline transactions.
- Asset Value
The asset approach computes the fair market value of a business based on its balance sheet assets and liabilities. Because law firms often use cash basis financial reporting, goodwill probably will not appear on the balance sheet, meaning the asset approach will not give any value to a firm's goodwill without additional calculations.
- Income Value
The income approach may prove most suitable for law firms. The valuator estimates the firm's future earnings and applies a risk-based multiplier, generally, between 0.5 and 3.0. Calculation of the multiplier considers factors like the current book of business, geographic location, number of clients, practice areas and potential for repeat business.
Turn to qualified valuators for accurate and reliable valuations or call us. Training, experience and familiarity with the industry, as well as the applicable standards and methods, are critical.
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.