So what do we know so far?
Law firms have a problem. There are too many owners that want to retire and too few people that are interested in taking over their business or share of their business and paying them out, so that they can do so. If you are a partner or owner looking to retire soon, then you need a plan to ensure that you have a successor or two ready, willing and able to take over the reins.
That all sounds very simple but if you drill deeper into the problem, there are many issues to address in passing on your business. Most owners focus upon the clients and the files. They are important – critically important. But there are many other areas around the business that can create difficulties for the retiring owner and are often overlooked when retirement beckons.
In Part One we looked at the changing sector structure and the implications for succession planning – the sole trader and partnership models have steadily declined and largely been replaced by the Limited Company. A focus was how to protect your core operating model – after all its not only lawyers who can retire after 20/30 years leaving a potentially huge knowledge gap.
The second instalment addressed the core issue of People – both to succeed you and protecting key relationships when staff move on. Oh, and the future of law looks Female according to the demographic data, have a look here!
Part Three addressed the important PPI dimension to succession planning. Love it or hate it no legal firm can exist without PII in place and it can pose fundamental problems for retirement and succession planning options. We talked about the importance of planning for property arrangements in any project plan in Part Four but also how security and IT now is influencing the due diligence process and valuations too.
In this final section we look briefly at the all-important subject of Finance. And, the merits of using an external party to assist you. Mergers and acquisitions for example can become an all-consuming process that may not reap any rewards until the ink is dry on the contract. Using an external expert is one way to protect the day to day running and value of your firm whilst looking for potential Succession opportunities in whatever form that takes for you.
Part Five – Finance and Conclusion
This is the ultimate issue. Buying into equity in a law firm is usually expensive. Over recent years, the values of capital accounts and undrawn profits left in firms to provide finance have increased. Values of well over £250,000 are common in multi-partnered firms. Sole traders can have smaller balances, depending on what is in their firm’s balance sheet. For example, if the premises are owned, held within and being sold with the business, the value of those premises will increase the capital to such an extent that it could make it almost impossible for a single person to acquire that firm.
To successfully transfer your business, you may need to split the part of the business that does the legal work, from any property-owning part. The property-owning part may need to be sold separately. That will make financing the legal part easier. Obviously, discussions will need to be had with your successor(s) about whether they would want to continue in the premises or move elsewhere.
A discussion with the bank about how to provide equity capital to the firm will usually be met positively but they will want to see things like business plans, cash flow projections, budgets and may want to discuss personal guarantees.
If you are selling, you can make the hand-over easier by introducing your successor as joint-equity owner first, taking a proportion of the equity: and then selling on the rest in stages or at a later date. Furthermore, staying as a consultant is a popular way of ensuring the goodwill in the firm is retained, notwithstanding that the equity has been transferred. Again, taxation and financial planning advice must be sought in these circumstances.
There is a sea change in the profession. It has been gathering pace over the last few years and because of the increase in regulation, fewer people wanting to take on equity, being risk-averse as regards being in business, combined with the demographic changes already underway, the profession will face more consolidation and probably a continued reduction in the number of firms, despite an increase in the number of solicitors with practising certificates. We will have fewer – but larger – firms.
Some of the smaller mergers in recent years have taken place with little due diligence and the issues outlined above have come back to bite the new owner of the equity. That may be through a very large increase in the PII premium, significant claims being suffered, difficulties in integrating the IT and accounting, problems monitoring quality across all files and loss of key personnel. Even worse, some owners have had to suffer the PII run-off premiums of – often – nearly three times the annual premium.
Finally, every succession issue is unique. There is no template.
This is why proper planning is important, both for the potential retiree/vendor and for the successor owner/firm. It is almost identical to ensuring a firm is ready for a merger. That means that the firm must be run well by continually addressing the issues above. A well-run firm will have more value than a poorly run one. So, there’s your incentive!