Law Firm Succession Planning - part four

Law Firm Succession - Part Four
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the implications for succession planning – the sole trader and partnership models have steadily declined and largely been replaced by the Limited Company.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.

Next, we come to property, security, and IT in your strategy: Can your new potential business partner now put a value on data security?

Part Four

Property

This is often overlooked when succession is being considered until it is almost too late and becomes a problem for the potential vendor and the acquirer.

Naturally, the property could be leased or owned. If it is leased, the remaining lease term is important. An acquirer does not want to be bound into an onerous lease, either in terms of length of the term, rent payable or other conditions: but on the flip side, the retiring party might consider that there is significant value in a long-term lease or one with unusually advantageous terms, such as a rent payable below current market rents. The retiring party will be the tenant and must make it sufficiently attractive to their successor to want to take over the lease. Otherwise, they will be stuck with the lease or may not be able to transfer the business at all. The expiry of the lease may itself be the trigger for retirement. The potential retiree must be aware of the lease issue and be ready to deal with this as part of the negotiations.

This situation is even more complicated if the premises are owned freehold by the retiring party(ies). They may well expect that the acquiring party will want to take over the premises. However, what if the firm has been using the premises rent-free? The retiring party, unless they are willing to sell the premises or are very generous, will expect to earn a rent. That will damage the profitability of the business and make it less attractive to any acquirer. In any event, the capital cost of acquiring the premises, alongside the value of the files, could well be prohibitive. And, in any event, in this age of open-plan and agile working, would the acquirer want those premises? They may be a millstone around the firm’s neck and preventing the firm from being as efficient as the best in the area. If the premises are to be sold, then the acquirer may ask for a discount on the capital cost of taking on the business, to reflect the increased rent that is likely to be payable once new premises have been found. All of this dents the potential pay-out to the retiring parties.

Once again, the main lesson is to plan ahead and have options available.

IT & Security issues

Anyone taking over the entire business will either continue to run it using the same hardware and software or, in a merger situation, will want to integrate it into their own IT.

In the former case, the only issues are to ensure that the purchaser acquires all the rights to use the IT, e.g. ensuring licences are transferred and do not remain in the name(s) of the retiring party(ies) and that the retiring party(ies) are locked out of the IT after retirement.

Where on succession, the business is being merged into another business, there is more work to do, in mapping all of the fields in the retiring party’s database into the acquiring party’s database. This is critically important to ensure a seamless transition for the firm(s) and clients and therefore, expert advice should be sought.

There are many potential IT issues, depending on how succession is facilitated and engaging help to ensure all issues are covered off will reduce the risks of things going wrong.

Logically can your prospective acquirer or merger partner now put a value on data security? Read on to find out…

Putting a value on security

Buyers and sellers need to be aware that cyber-security is playing an increasingly prominent role in the M&A space. Amongst corporates there is already a body of research that is showing correlations between security posture and valuations, as well as influencing the selection of one target over another and causing offers to be withdrawn altogether.

The law firm that can demonstrate rigorous data handling procedures, no GDPR infractions or future data breach-related liabilities, documented assessment of its IT supply chain and a generally robust approach to IT system management is going to have a clear edge over another prospective target firm that can offer no such assurances during the due diligence phase. It strengthens the negotiating hand and can certainly help seal a better deal, and getting on the front foot in this way should be best practice.

But what if the seller has reason to be less bullish and the security stance is more opaque? That’s where as a buyer you need your due diligence to kick in. And what you must understand is that you have far more tools at your disposal now to assess, in quite forensic detail, the security health of your target. Services exist that analyse all outside visible IT-related assets – basically it’s like getting a hacker’s eye view of an organisation but in a totally legal and legitimate way.

It’s all about understanding as much as possible about an organisation and its cyber security credentials before you part with your money – rather than walking blind into a closet full of skeletons. It’s a tangible part of the calculation of value, and beyond that business owners are increasingly aware that strong cyber security practices are critical to reputation, brand and revenue growth.

All of which means that an exiting owner needs to be aware that prospective buyers will be scrutinising more than the books and the business base. And if their security house is not in order, then they’re in for a tougher negotiation – or worse, no negotiation because there’s no more deal.

Next time…

In the last instalment of this comprehensive guide to succession planning for law firm owners we look at Finance and also whether to use a merger/acquisition specialist or not to help you with your match-making efforts.