When Selling a Practice, Measure Value Objectively

Published on: 
03/21/2011
It always strikes me as odd that prospective buyers of law practices think that the business of law is unique, that the process cannot be conducted as other businesses — professional, service and manufacturing — are conducted.

One perceived "difference" is that buyers seek to frame the price in terms of a percentage of revenue to be received in the year following the sale — the equivalent of a referral fee.

Buyers say that there is no way to know how much of the present revenue stream will stay with the new operation, that law is a personal-relationship business and many clients will go elsewhere.

Consequently, these lawyers are unwilling to offer a fixed price, unwilling to say the purchase price should be X dollars and the sum should be paid over Y years.

The same issues present themselves when discussing value billing. "Value" is ultimately determined by the client, but the attorney must educate the client about the meaning of the word.

Most clients are willing to pay a fair fee for value. What they do not want is to pay for inefficiencies or unnecessary services. To enhance the client's knowledge of value, attorneys must prepare a budget of events, time and costs for each matter and get the client to accept it. The bill for value thus measures achieving specific benchmarks.

Similarly, the purchaser of a law practice is often reluctant to agree to precise value measures. That attitude presupposes that the revenue stream of the seller will not continue, while ignoring the seller's needs: knowing what his legacy is worth; planning for the future with a nest egg intact; and being assured that he will not have to return to practice if the buyer defaults on the payment.

A buyer's fear might be addressed by the "excess earnings" model of law practice value. The calculation reflects the amount by which the five-year average earnings of the practice, less the fair return on physical assets, exceeds the fair compensation figure of a comparable attorney, capitalized as a function of the risk of retaining the clientele versus the competitiveness of the practice.

Essentially, that approach seeks to capitalize the net income stream expected by the buyer in the future.

That same approach is utilized by buyers of manufacturing and other businesses, and, as with law firms, buyers can lose their clients when smooth transitions do not occur and when the buyers fail to take care of their new customers.

Proper consideration of the interests of both buyer and seller is indispensible in a successful closing of a law practice sale. A fixed number and a short-duration payment plan are essential for the seller to retire with nest egg intact and the buyer to be able to grow the practice knowing that the growth will inure to his benefit, not to be shared with the seller.

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