Four elements of a Law Firm valuation
“How much is my firm worth?”
This is the question that we are most frequently asked when dealing with small firms where partners are looking to retire – i.e: an acquisition. At the heart of this query is how to go about a law firm valuation. This is never a question with a true merger because with these deals the partners tend to stay on, each set of partners will own their firm’s pre-merger assets and it is essentially a paper transaction. However, when retiring, how to value their law firm is at the front of everyone’s minds.
The stock answer is that firms are not worth anything but I think this is too general. If you have a good firm then it does have a value and you should expect a return, but you need to be flexible and commercial about getting it. There are 4 elements which will add up to a proper return.
Whatever you think about the mad system (and England & Wales seem to be the only jurisdiction in Europe with it – not even Scotland or Northern Ireland do) a pound saved is a pound earned and so at the most basic level if you can find a firm to take your firm over and become successor practice you have already made a return. For example, if you run a general practice turning over £300,000 with a fair amount of conveyancing and a good claims record, your PII is likely to be around £15,000 pa. To close, your run-off will be in the region of £45,000 meaning that with a takeover you have saved £45,000.
This is the same in real terms as being paid £45,000 for your firm, a 15% return on turnover or, on normal metrics, a £300,000 firm might produce a profit of £130,000 and so the seller is “paid” 35% of profit which is not a bad return. This is a saving and so is tax-free of course.
The above is the basic starting point we always use, and then we can add to it. In the above example, upon takeover, the seller would expect to work for 12 months as a consultant to hand the clients over and bed in the new firm. This might not need to be full time, but would probably start full time and then diminish towards the end. Some deals we advise on have a 24-month period, but in our experience, 12 months is enough and the second 12 months is a little like having Banquo’s ghost sitting at a desk.
It would be reasonable in this 12-month period to split the profit with the acquirer so that the deal largely pays for itself, and maybe the seller might earn £65,000 and the buyer £65,000 for this 12 months. Depending on how the contract is structured the seller could earn most of their £65,000 at a very low tax rate (c10%) which is the equivalent of earning c£90,000 before.
Therefore, on this arrangement, the seller has safely moved over his or her clients to the new firm, has protected staff, has avoided the costs and disruption of closure and earned £135,000 in real net terms.
Further, what we often see is that the seller will remain as a consultant to the firm, attending events as needed and referring clients across being paid on an ad hoc basis. Most Partners are attached to their firms and are not ready to cut the ties and an arrangement like this should benefit both parties.
There is often a real benefit to a new entrant taking over an existing firm. We have recently been advising a firm that has been in it’s premises on a high street opposite the station for 30 years. They are a known and trusted firm and many local people see them as “their solicitor” so the firm or individual taking them over will benefit from this history. There is no formula for working a value out, but an extra payment to acknowledge this history, maybe £20,000 in the above example, might prove to be a lot cheaper than starting up from scratch and a sensible investment.
Often the retiring partner will own the offices, or have them in a pension scheme. If the firm were to close they would need to be re-let so an additional benefit might be to agree a 5-year lease with the new owners. If this was, say, £10,000 pa then this is an extra £50,000 that the seller has made from the deal.
Therefore, when it comes to a law firm valuation, the stock answer that no-one will pay for goodwill is probably correct. But, in the above example, by being flexible and sensible, the seller has actually made £205,000 from the transaction at very attractive tax rates and can retire elegantly.