Putting a value on legal practices
Andrew Roberts considers how firms can prepare for potential mergers and avoid the mistakes and unrealistic expectations of others
The legal profession seems to have recently realised that there will soon be consolidation within the profession, the likes of which has never been seen before.
The 10,000 or so legal practices that contain four partners or less have just become aware for the need for succession planning and exit strategies - a little late for many firms. The average age of an equity partner in a law firm is 63 and, as averages suggest, many are in their sixties and seventies, still practising with little hope
of exit.What value could be placed on these practices and what value could they bring to the table in merger discussions?
Many accountants and brokers still cling to age-old methods of valuing a law practice, which regretfully has raised the expectations of many partnerships and sole practitioners to unrealistic levels.
This raises the question: does goodwill actually exist in a legal practice in the current climate?
The legal profession, unlike other professions, is conducted virtually exclusively on a transactional basis, and very little emphasis has been placed on the lifetime value of the client. Which raises yet another question: do law firms have clients or customers? Customers shop around for services and products and will go to several suppliers to find the one that offers the best deal - whether that is in terms of service, price, or quality.
Preparing your practice for a potential merger or outside investment in the future will result in a greater value being placed on your practice. This will mean driving your costs downwards and, by using technology to improve processes, your firm will have greater value.
The fundamental challenge facing these 10,000 or so practices is the lack of younger potential partners prepared to become equity partners. The traditional method of exit for many senior partners in the past has completely disappeared in the current environment.
Many new entrants are reluctant to take on further debt and become equity partners. Who can blame them? Why would any younger fee earner or salaried partner want that sort of responsibility when the profession has to consolidate?
As an example, I was
recently approached by two thirtysomething salaried partners in a three-equity-partner practice, with a turnover of around £2m, making marginal profits. It is a full-service law firm, with 25 per cent of its turnover coming from conveyancing. They had been negotiating purchasing equity for the past two years, with the three existing equities (all in their mid-sixties) making unrealistic demands for both their investment and time. The support staff in the practice had been with the firm for many years and, with its conveyancing income dropping by 65 per cent this year, the firm would be making losses in the current financial year.
They have subsequently discussed the situation with the three equity partners and decided not to take up their offer.
This is a typical example of what is happening and I suspect the two salaried partners will leave in due course. What then happens to the existing practice and the three equity partners in their mid-sixties with no succession or exit plan? Will they look to merge with another practice and what value would they anticipate receiving?
Law firm value
Merger and acquisition discussions are currently at levels never seen before and most partners need an urgent reality check to consider the true value of their practice to any potential merger candidate or even a potential acquirer. Partners that try to negotiate on their own soon find the potential transaction falls apart, predominately due to unrealistic expectations on the part of the firm eager to merge.
Many accountants and brokers have informed law practices that their goodwill can be valued on the basis that they own their existing work in progress and debtors and they can reasonably expect a third of their current turnover as a valuation for their practice. I have yet to see that valuation being met by any prospective purchaser or merger, and have seen many potential mergers failing because of intransigence on the part of the partners.