Cashing Out
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For the estimated 400,000 lawyers who will enter retirement age over the next nine years, selling a law practice is a way to produce an income stream and free up time for pursuing other interests.
But whatever the motivation to sell, experts agree that planning is fundamental.
“Like a client who refuses to sign a will for fear it will accelerate death or the acceptance of death,” concludes attorney and CPA Jay Foonberg of Beverly Hills, Calif., “lawyers often wait for a crisis to decide to sell.” Obviously, the more urgent the seller’s circumstances, the less favorable the financial outcome.
Edward Poll, principal at LawBiz Management in Venice, Calif., a one-stop shop for selling law practices, conservatively calculates “a seller should figure on at least nine months before handing over the key, and that presumes on day one you find the buyer. And that doesn’t happen.”
Just as lawyers advise clients to plan for the unexpected, so should they. As Foonberg notes, “Lawyers do not anticipate late in life marriages and second marriages with a 50-year-old father and a 35-year-old mother and a newborn waiting to be educated who will be in high school when the father is on Social Security with no way to pay for college.”
Indeed, if 2008 taught us anything, it should be that $300,000 of equity in a house is not a retirement plan.
IT’S (MOSTLY) LEGAL
Only four states prohibit the sale of a law practice, poll says. The current version of ABA Model Rule 1.17 provides that a lawyer can sell a practice or an area of a law practice.
“Generally, at least 90 days’ notice to clients in advance of the transfer is required,” he says. “Also, lawyers are prohibited from selling files.” Clients are the seller’s crown jewels. “In effect, what a lawyer is doing is selling goodwill,” Poll adds.
For advisers who are unfamiliar with the law firm model, goodwill becomes difficult to quantify. Guiding most accountants will be court and administrative decisions in tax, probate and dissolution fights. This is problematic, Foonberg says, because “there is no willing buyer or no willing seller in these types of cases, but rather the opinion of some third party reached after acrimonious fighting.
“Fair market value assumes a willing seller with full knowledge of all the facts and under no compulsion to sell, and a willing buyer with full knowledge of all the facts under no compulsion to buy,” he says. As with most products or services, the less urgent a seller is to sell a practice, the greater the likelihood of attaining a reasonable price.
“The highest and best price will be paid by someone already in the firm who knows the clients, the work being done, the staff, etc.,” Foonberg says. “They will typically pay a figure dependent in large part on future receipts from the clients of the firm at the time of sale, with possible inclusion or exclusion of referrals from those clients.
“There will normally be a starting price, which is an estimate of a certain number of years’ multiple of cash receipts over the prior three to five years, with an adjustment up or down over a period of three to five years depending on what in fact happens.”
A firm with a drop in revenue due to the recession may see reduced valuation depending on the type of practice and how fast it can return to normalcy, according to Shannon Pratt, chairman and CEO of Shannon Pratt Valuations in Portland, Ore. “For contingency firms, historical recovery on contingent billing is important and could result in contingent receivables being discounted for probable collection.”
And ignore financial planners who determine the sales price at a “lifestyle price.” This is the number designed to ensure that a financial planner’s client may achieve a particular standard of living during retirement. “For objective valuation purposes, the seller’s ‘lifestyle price’ and the actual fair market value are unrelated,” Poll says.
When hiring professional assistance, fees vary from flat rates to contingency fees up to 45 percent of the first year’s compensation.
SALE STRUCTURE
Be cautious of structuring the buyer’s payment based on revenue collected. “This could be viewed by some as akin to selling files,” Poll says. “The better method is developing a purchase price, then arranging for a progress payment, but not based on revenue collected.”
Foonberg also suggests sellers and buyers both need to look at the reason for buying or selling. For example, a lawyer retiring for health reasons may be willing to sell at a lower price.
Importantly, the method for determining the value of the law practice may pave the way for financing. Sellers need to be mindful that bank loans are traditionally a potential purchaser’s first option. Lenders analyze the borrower, the business and whether the asking price is realistic. Consequently, inflated valuations can sabotage a deal.
For sellers needing an income stream who have buyers unable to secure favorable lending terms, seller financing or the “of counsel” relationship are alternatives. For example, a buyer pays 40 percent down with the seller providing the remaining 60 percent, and the buyer pays the seller a monthly payment with interest.
However, Poll cautions, “if you’re dealing with a buyer who cannot obtain bank financing, you may be better off to collect on your own accounts receivable than gamble with a buyer who already has a tenuous financial condition and could go bankrupt.”
Allowing a smooth transition, the of-counsel route “is the only one good solution to setting a price which maximizes value to both the selling lawyer and the buying firm,” Foonberg asserts. “It is the best solution.”
For those hesitant about selling because of client care concerns, Poll suggests self-reflection and self-evaluation.
“It’s likely you’ll be passing the practice off to someone who will provide just as good, if not better, service to clients when a purchaser is younger with more energy and the desire to stay more attuned to changes in the law.
“You’ll be helping your clients go further with the hand-off than you may have the desire to do at this stage of your life.”
Susan A. Berson is a partner with the Banking & Tax Law Group of Leawood, Kan. She is the author of The Modern Rules of Personal Finance for Professionals. She can be reached at .(JavaScript must be enabled to view this email address).
