Law Firm Succession Planning - part five

Law Firm Succession - Part Five
A roadmap for success

A note for today – the Law Firm Succession Series

The extract below is written as a knowledge piece. It is written with the medium to long-term issues facing the profession in mind.

In that context it does not – directly – take account of the issues raised by the current Covid-19 outbreak. The outbreak is undoubtedly damaging business and law firms are no exception. Certain areas of law will be hit harder than others, but undoubtedly, businesses will be dealing with the effect of this for potentially many years to come.

However, this only emphasises the issues raised in this article series and the resulting White Paper and accelerates the need for Law Firms to address the challenges.

We hope you appreciate the ideas within the Succession White Paper and look forward to helping you with those challenges, whether in the current emergency or once some version of normality has returned.

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the implications for succession planning – the sole trader and partnership models have steadily declined and largely been replaced by the Limited Company.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

Finance

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.

Save your energy

Deal advisors such as accountants don’t just have their respective expertise to bring to proceedings – they also have plenty of experience with a catalogue of ‘Lessons learned’ that they’ll only be too willing to share. Take this one: don’t take your foot off the gas at the critical moment. The basic premise here is that both sides expend so much energy in getting the deal over the line that they then collapse in that post-event euphoria, the adrenalin seeps away and tiredness and relief replace focus and momentum.

To be fair, most people are aware that the hard work begins after the ink is dry – after all, the business case that prompted the deal is just numbers and projections on a page, it needs the new entity to come together to actually deliver them. And those first weeks are critical, it’s no time to sit back. There are the obvious projects, from the integration of IT and finance systems, to the communications to staff, stakeholders and clients; but this is also a crucial time to lock in the next tier down.

Take the regional law firm whose ownership hinted to its next tier that there was possibly a buy-out opportunity for them as they themselves sought an exit. The three individuals in that next tier duly took some professional advice, advised the ownership of their interest and then….nothing. The first they knew about their future was when the firm’s owners announced their merger with Firm B some weeks later; they had not been consulted or been given any chance to move forward with their own offer. Being presented with a fait accompli was bad enough but then there was no effort in the immediate aftermath of the deal either to sit down with them, sort things out and lock them into the new partnership.

Less than three months in, they left and moved together to another firm, taking with them a client base large enough to take the shine off the projections – and striking an early and heavy blow to the prestige and standing of the merged organisation.

The takeaway here is to use your advisors, consultants and service providers so that they can take some of the weight off; let them do the detail, the heavy lifting, so you get to a good place with the numbers and the contracts and the project plans, and carry that impetus through to the execution post-signing. That way you leave yourself with the time and energy and perspective needed to look after your key people, ensuring not just a smooth transition but a firm foundation for future success.

Conclusion

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!