Question:

I am the sole owner of a five lawyer business transactional law firm in Cincinnati, Ohio. I  am sixty-seven and hoping to retire in the next three to five years. Besides myself there are two non-equity partners and two associates in the firm. I have not properly saved for my retirement and I am hoping to sell my practice to the two non-equity partners in the firm for a substantial sum. I founded the firm thirty years ago and believe that I have invested substantial sweat-equity in building the firm up to where it is today. I am not sure where to start and whether my expectations are realistic. Your suggestions and recommendations are most welcomed.

Response:

Years ago when interviewing non-equity partners or associates in a law firm I would never have asked them if they were interested in equity ownership or partnership since the answer would have been yes. Today, this is another story. Many non-equity partners and associates today do not want to own a law firm as sole owners or even have equity in a equity partnership. Don’t assume that your attorneys even have an interest.

So your first step will be to talk with each of them and determine their level of interest.

Your next step will be to determine the value of the firm and what you hope to ask for and how you want to be paid. Some firms have substantial goodwill value and others have little goodwill value at all. Firms that have little value are those where all the business is originated by the owner and he or she controls the referral sources. In these firms when the owner leaves there may be little to no future business.

In the final analysis the value of the practice is what an outside buyer or an attorney working for the firm will pay for (or invest) the practice. A balance often has to be struck between valuation and affordability. The valuation process is simply a tool to use to help you begin discussions and get to this point.

You also have to keep in mind that many of your competitor law firms are offering equity partnership with no buy-in at all.

I believe that firm value has to be balanced with affordability and a prospective equity member’s ability to pay for the shares. It all comes down to compensation. Generally, I find that a prospective equity member or partner must be able to see a significant compensation increase with a breakeven/payback period of around three years – no more than five. I also believe that when shares are seller financed the period should be no longer than five years. Many firms do not sell shares based on formal valuation – other methods are used.

Questions that equity member candidates usually raise:

1. Is the breakeven/payback from the investment in say three years as a result of the compensation gap?
2. How much more will he or she earn as an equity member?
3. Can he or she earn enough as an equity member to justify the investment?
4. Can he or she earn more as a partner somewhere else with as large investment, a smaller investment, or even with no buy-in at all?
5. Can he or she earn more somewhere else as an associate or non-equity partner?

In many law firms’ compensation is based upon performance and contribution and ownership shares have little or no bearing on member or partner compensation. Their primary goal is to acquire and retain talent.

Your expectations may be realistic if the clients and referral sources stay with the firm when you are no longer there and if your non-equity partners care about equity and owning a law firm and are willing to make the investment and take the risk.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

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