Tom Lenfestey is an attorney, CPA and owner of The Law Firm Exchange. In this episode Tom explains how law firms are prepared for sale and sold.

See all episodes or subscribe to the Personal Injury Marketing Minute here: https://optimizemyfirm.com/podcasts/.

In this podcast Tom covers why attorneys sell their law firms, what is unique about personal injury law firms, ABA rules, increasing a firm’s value, how firms are priced, good will, how firms are marketed and what he does at The Law Firm Exchange. Tom also discusses what buyers are looking for when purchasing a law firm, such as taking over a practice or expanding their geographic coverage area.

Be sure to visit The Law Firm Exchange here if you have additional questions about buying or selling a law firm: https://thelawpracticeexchange.com/. You may also find them on Facebook here https://www.facebook.com/lawpracticeexchange/ and Tom may be reached at 919-789-1931.

Transcription:

Introduction

Lindsey:

Welcome to the Personal Injury Marketing Minute, where we quickly cover the hot topics in the legal marketing world. I’m your host, Lindsey Busfield. And today we’ll be discussing buying and selling law firms. Whether you are actively looking to expand your firm or considering selling your practice, or you are putting a contingency plan in place, it’s essential to understand the process and requirements to facilitate a smooth transition. Joining us today is Tom Lenfestey, the founder of the Law Practice Exchange. So thank you so much for joining us today, Tom.

Tom:

Yeah, thank you for having me.

About The Law Practice Exchange:

Lindsey:

So Tom, many lawyers aren’t actively thinking about selling their practice or buying one for that matter. So tell me a little bit about why you founded The Law Practice Exchange.

Tom:

Sure. I tell everybody that I think I get jealous of the other professions. So as a practicing attorney and CPA 10, 12 years ago, I was helping a lot of other professions. CPAs, dentists, doctors, on their succession planning. As a transactional attorney to sell their practices, to build in their succession plan, to sell to an associate doc within their practice. And as I was an attorney building my practice, had my associates and the revenues kept going up, which is a good thing. But really stopped to think about what is my plan as an owner of my law practice? And why was it that dentist, CPAs, doctors and others seemed to have figured out how to build value and then transfer it to the next generation as part of retirement, as part of just whatever their exit strategy was, but to really be able to do that successfully.

Tom:

So I did probably what any good lawyer would do or any good entrepreneur was. I looked around to see who was doing this, right? Who was helping lawyers with succession strategies, exit strategies, or brokerage because I really thought the nicest thing about dental and CPA was they were creating marketplaces to find buyers. To find successors. And I figured well, if I can find somebody that’s doing it, I’ll just look to see what they’re doing. Copy it, make it my own, all right.

Lindsey:

And do it better.

Tom:

Yeah, that’s right. But largely what I found was nobody was really doing it. And so close to 10 years ago now was when really the Law Practice Exchange started to take shape. First and foremost looking at how it can be done ethically and otherwise to sell a law firm, to build out continuation strategies for lawyers and law practices. And then really we started slowly and intentionally to test that model, educate attorneys. And really today we’re there, we have a proven model, we have proven success. And our goal is really to let every attorney out there know if you own a law practice, a law firm, that this may be an option you want to consider. It doesn’t have to be your option, but it’s an option that can be successful for you if you want to look at how it works and everything else.

Lindsey:

Interesting. So let’s rewind a little bit, and tell me what it means to actually sell a law firm.

What lawyers should know about selling a law firm:

Tom:

Sure. Yeah, a common question because I think a lot of people, especially if you look at some of the ethics opinions like ABA’s rule 1.17 or as each states adopted those. Selling a law firm to a lot of people is taking the keys, throwing them to the buyer and walking out the door, right? And to some extent, that’s how a lot of dental practices are sold, some other businesses are. It’s a very quick type of deal. But when we talk about selling, we’re really talking about a transition based ownership exchange. And what I mean by that is typically you’re going to stay on afterwards when the ownership maybe has shifted over to somebody else, and you’re going to work with them to make sure you can transfer the personal value, you have other things. But selling may mean actually selling ownership.

Tom:

It may mean that you’re going to join a firm as of counsel, and bring your practice over there. And you’re going to be able to monetize the value that you built through a compensation structure with them. You may end up taking your firm and merging it with another firm. And that all falls under that sell type of structure, but in the legal world, it’s really how to transfer the value that you’ve built to another for them to take over for the next generation benefit, and for the continuation of the clients and the work that you’ve been doing.

Reasons attorneys sell law firms:

Lindsey:

That’s interesting. So yeah, it’s definitely a different model than the other types of business sales, because of that continued involvement. So what are some reasons that attorneys would want to sell their firm or buy a firm to expand?

Tom:

Yeah, usually per sell, the number one reason that we actually get is retirement, right? Looking at retirement. And most of our attorneys, attorneys work longer. Retirement is not in every attorney’s vocabulary. And so that whole joke about attorneys, they die at their desk, right? So when we talk to our clients that are looking to sell their law firms, the number one reason they give us is usually not to spend more time with their kids. It’s to spend time with grandkids. They’ve built their firm. They’ve been financially, hopefully successful. Their kids are grown. They want to spend time with their grandkids or spend time with their spouse. A lot of times it’s that spouse that’s really encouraging retirement. The attorney would be happy working five, six days a week, but the spouse is saying no, I want a retirement together.

Tom:

And so that encouragement comes in, but most typical is retirement for selling. Others, definitely health issues come into play. And then we get some that just are looking for strategic sale merger, other structural options because they just see the landscape changing or they don’t enjoy the management aspects of it anymore. They really want to just practice law versus some other things. But definitely, retirement is probably the key element for the sell side for buying really proven revenues. Most of the time we’re dealing with lawyers and law firms that are looking at revenues and growth. And if they can see it and as it’s established in a history with a law firm, there’s a certain amount of clients, there’s maybe a certain marketing platform that’s been proven successful. Those different things, they’re willing to acquire and buy that.

Tom:

So there’s that element of acquisition of proven book of business or proven revenues. Another reason is adding different practice areas. So a lot of times is if their firm or them currently they kind of practice in these, it may make sense to look at a firm that has a practice area that they really see as a growth opportunity, but they need a mentor in that area. So that selling attorney can stay on and be that mentor, really helped transition, teach. Make sure the clients are taken care of, but also add a new practice area. So we saw a big bump, we’ll call it our COVID bump back in May. We had a bankruptcy listing in California, and we saw a tremendous amount of interest from certain firms. But did bankruptcy that were looking at another reason, geographical expansion, but also firms that were saying if we’re heading into a recession, I may want to add bankruptcy as a service to our potential clients, or as a diversified revenue.

Tom:

So diversified revenue, practice areas, geographic expansion. And then we deal with a lot of attorneys who may be within firms, maybe in-house counsel and they want to own a law practice. The opportunity may not be there for them in their current one, and they don’t want to start from scratch. And so for them to come over and be able to acquire a firm that’s producing good owners cash flows, good benefits, salary, everything else to them immediately works. And they’ve got some maturity, some financial stability and other things that really bring it all together where they can become an immediate owner of a good profitable revenue strong practice.

Lindsey:

Absolutely. And so they’re able to have additional value to purchasing a firm and in the long run, it’s a lot less expensive to buy that value as it already stands as opposed to starting from scratch and building it up without guarantee of getting to that point of success.

Tom:

Absolutely, and a lot of them from a buyer strategy, it’s to take a traditional firm and maybe take some of the things that you’re doing really well as a buyer. Maybe it’s your marketing platform that this other firm really hasn’t locked on to. And if you can take a undervalue or underperforming asset, a traditional practice and really supercharge it, you can essentially hopefully buy low and then really increase the overall value for you in net income and benefits, and future potential value as it comes to you.

Where do attorneys start who want to sell their firm?

Lindsey:

Absolutely. So talk to me a little bit about the process of buying and selling a firm. I’m sure that there are definitely some complexities to it, but for anybody who might be in a position where they are either thinking about acquiring another firm and leveraging that potential, or they are creating a contingency plan, or if they’re really at the point where they’re looking to sell their practice, where do you start?

Tom:

Yeah. Regardless of whether you’re a buyer or seller, I would tell anybody to start with what’s your goal, right? Or goals or expectations, anything else. So that’s really a soul searching for a buyer. Is it to add that practice area? Is it geographic expansion? We’ve got the hub, we need the spokes. We need to go to where our clients and our consumers are. So really looking at those goals. From the seller’s side, once you know hey, my goal is to retire. I’d love to continue to practice once I transfer ownership for another year, 18 months. What type of buyer is financials very important to you or is the buyer more important to you as a successor for your client care and everything else? Really going through those goals.

Tom:

And then from our seller’s side, we’re going to go through evaluation as part of our discovery and onboarding. How much is your firm worth? And then the other part is how much do you need? If your goal is to retire, our goal is to say, “Here’s what we think we can get in value in price for your firm. And upon these terms, does that give you enough to retire?” And I would tell you for most attorneys, most of our clients the answer is yes. A lot of them haven’t seen their firm as the value, but some of them do. They need to work a couple more years to do that, and so that may change the timing of their exit or overall their expectations because we really want to match well with what seller needs to what the market can produce.

Tom:

Whether that’s an internal associate that’s going to buy you out, or whether it’s another firm or another marketplace buyer, if they can’t offer enough for you to retire, no deal will ever get done. And so we go through evaluation and then we really, with our sellers, we’ll go through market strategy. So very similar to any attorney, if you’re looking at who could be your great next successor, what are you looking for in characteristics of a buyer that’s a firm or individual attorney? What will the client receive well, what kind of characteristics? Where should we look to marketing? Those different things. So we’ll go through a market prep before we really take them live to market, or take it into negotiations with any internal buyer, associate junior partner, those types of things.

Where attorneys start who want to buy a firm:

Tom:

On the buy side, once you know what your goals are, I tell everybody the next step is look at your own firm. Before you go and jump to say let’s go acquire this million dollar practice in a new market, it’s going to be great. I really try to encourage firms that if you find that your house is not in order, stop and get it in order. Sellers need to do the same thing before they go to market. But from the buy side, taking on a million dollars in revenue from a proven book of business sounds great until you realize you’ve got problems within your own system. If you’re marketing data, if you’re marketing plans and everything else are not in order and you haven’t supercharged that, then you’re going to not just have problems with what you have, but also with this newly acquired base.

Tom:

If you have issues with personnel or with different compensation models, so it’s really like make your firm strong before you go and acquire something else. I try to coach buyers that you want to feel that you’re better than the firm you’re acquiring, right? And that sounds weird and may sound conceited, but overall you want to feel that you have value to bring to this platform. Whether it’s you individually as an attorney, like you can come in and do great legal service, but also provide really good management for the firm. You’ve got plans to like I said, take it from a traditional to more of a modern law practice. Or for the clients, you can bring them more care, more service, more touch from your team approach, those different things. So if your house is falling apart, get that in order first, get your marketing, get your system, your personnel in order before you really jump to acquire a firm.

Tom:

But once you have that, then it’s really going through looking at why you want to do it, and going through the financial. I’m a big believer of getting pre-qualified with a lender, you don’t have to use lender financing, but just knowing what you can afford and how those payment may work for you. So then if you see that opportunity out there, you see that perfect firm that’s the geographic location you want, it’s the size you want. It’s everything else. Then you at least know with confidence that you can move forward under a financial framework and make it work. Make an offer.

How do you value a law firm?

Lindsey:

Those are some great points and some great advice. And it sounds like one of the big pieces to the start of it and throughout the process is evaluation of the firm. And so what makes up the value of a firm? How do you value a practice?

Tom:

Yeah, we take a multiple prong approach when we look at valuation. We look at revenues, we look at EBITDA or owner’s earnings. And then we look at market comparisons, if there’s a personal injury firm over here that does a million dollars in revenue, has this type of setup. Would that carry over to a similar firm? Is there a market comparison? And then we also look at what we call asset approach. So those four different methods. Revenues is pretty easy and quick to explain. If you’re doing a million dollars in revenue, the question is what would the value be? Is there a multiple, a factor? And usually that’s somewhere between 0.5 to 1.2 of your gross revenues of what the potential value of your firm would be. So if it’s a million and your valuation factor is 0.8 for revenues, then you’ve got a firm that’s maybe 800,000, right? The determination is really what is that valuation factor?

Tom:

Is it 0.8, is it 0.5, is at 1.2, which is really what we go through in discovery in evaluation side. But it gives you a range. On the earning side, we’re really looking at not the revenues that you have to transfer to somebody else, but what is the true benefit? Some people call this EBITDA, Earnings Before Interest, Taxes, Depreciation, and Amortization. But what is the true benefit to being an owner of this firm? So if you own a firm that does a million dollars in revenue and you make 400,000, which includes your salary that you pay yourself, your owner benefit, right? Meaning health insurance, maybe you’ve got a vehicle that’s paid for by the firm. Maybe the spouse is on payroll. We’re going to take all those and add those back, and essentially get you to that 400,000. Then it’s a question of okay, I can make $400,000 a year being the owner of this practice. And typically then we also look at a multiple to determine our valuation, and those multiples vary anywhere from 1.5 usually to 3.5.

Tom:

So again, if it’s 400,000, you’re looking at let’s just say a two, two and a half multiple. You’re looking at 800,000 to a million dollars for the total value of the firm. Asset approach, especially with personal injury. Personal injury, workers’ comp are key areas that we really look to asset approach, because we would say this is your case inventory. Depending on if you’re mass tort, don’t have that many cases, just have big cases or whether you are a personal injury practice with 1,000 personal injury that some of them may be $10,000 settlement cases. Some of them may be a few hundred thousand dollar litigation fee cases, but overall if we can determine an estimate of value of those cases, that’s collateral. It’s inventory on a shelf, it’s future revenues to be earned. It gives us a lot of security when we look at growth expansion, because if you’re a buyer that owns a personal injury firm, let’s say in South Carolina.

Tom:

And you want to expand in North Carolina, and you can go acquire a brand and everything else and a case inventory that already has … it does a million dollars in revenue a year, but it’s got a half a million dollars in case inventory. It gives you a good feeling that if I pay a million dollars for this firm, at least I know I got 500,000 in revenue already sitting-

Lindsey:

In the bank, yeah.

Tom:

Yeah, it’s sitting there, right? It’s just, I could liquidate, shut everything down and still earn 500. But the goal is of course, to nurture it, do the right things so that really, you see more of your value out of that. But that’s really our asset approach is to look at the assets that a firm has in cases, in reoccurring revenue. Most law firms if they don’t have case inventory, they don’t have that kind of billing structure their asset value is pretty low. It should be the floor for it, but overall in certain practice areas like personal injury, workers’ comp, sometimes immigration, some of these areas, they have a lot of inventory on the shelves so to speak, that we need to value. And already hit it on market approach. And we really look at those and depending on the practice type, the structure, everything else, we’ll weigh in one of those methods higher than the others. Typically, revenues and that earnings are the biggest weighted factors to determine what a firm may be worth.

How has COVID-19 affected sales of law firms?

Lindsey:

And I’m sure COVID has thrown a wrench into those valuation methods, especially when you have cases that aren’t necessarily closing because the courts are not necessarily taking those cases, or things are getting dragged out longer. So your 2020 revenues are not going to be looking quite like they did in 2019, and won’t be a reflection of their true value in 2021. Can you speak a little bit to how you’ve worked with that?

Tom:

Yeah, absolutely. So it’s been really interesting to see even firms of similar practice areas be hit differently based on COVID, based on delay and everything else. So there’s definitely for some, there’s been an impact, a COVID impact to revenues. And the question that really our buyers are asking and that we’re asking right now as we go through and look at those firms, as they’re starting to go to market in 2021 and we get them ready is, is it just the timing of revenues or is it actually there was an impact? Meaning there’s a lot of firms that traditional marketing was networking, coffees, associations, conferences, everything else and those aren’t happening. Right? So when will those happen is a question mark, but we had one deal that actually fell apart. It was a great estate planning firm and everything else, they were under contract moving forward. And really the buyer’s hesitation was due to COVID.

Tom:

They needed to go out and meet these clients in person. They needed to meet the referral sources. It was a lot of personal, what we’d call personal goodwill versus firm goodwill. And as part of that, they were just concerned when would that be able to happen? And so that really was August, September that it was, I don’t know when COVID is going to end, but it could be a substantial loss of value or it could just be time. And so really, we’ve tried to work with our sellers to be reasonable, to be understandable. It’s changed probably our payment structure on some deals as well to have a balancing sharing of risks. And it’s definitely impacted our due diligence timelines. Meaning our timeline in between an offer being accepted and closed, to make sure that the buyer feels very comfortable that the revenues are there or the value that they’re paying for is there, it hasn’t disappeared during COVID.

How to increase the value of a law firm:

Lindsey:

So as a law firm preparing to sell, what are some things that I can do that will increase the value of my firm?

Tom:

So first I would say, let’s talk about overall how we believe the law firm value comes about. One is your firm or what I just mentioned is your business goodwill, right? That would be your website. That would be your phone number. That would be your marketing platform and things that essentially drive the value of your firm. They drive clients to your firm, not to you necessarily individually. They’re not calling to speak with Tom because their buddy, Joe referred them to Tom. It’s not your personal network, it’s the value that you’ve built and you’ve directed to be part of your business assets. So what I would say is that really has a huge impact on overall value because as you can imagine, if you have a, for instance for you guys. If you have a solid marketing plan that produces 10 good leads a week. And of those 10, let’s say four convert to clients for a small firm. And you can show a buyer that look, this is what we do.

Tom:

We have a great website, we have this great marketing platform, everything else. We get 10 leads, here’s all the history, all the analytics. And we convert four of those, whatever else. To a buyer looking at that they say, “Well, I can take over the website. I can take over this.” That’s proven. If you tell them, “Well, I get referrals from the rotary club, and I get referrals from having coffee with these type of other professionals and they know me.” There’s a big question on will that personal value, what we call personal goodwill, will that transfer to a buyer, right? Because if you sit down and you’ve got some other attorney that refers cases to you and has been for 20 years, there’s no guarantee to the buyer that they’re going to accept the buyer. You can give the buyer the blessing, everything else, but there’s still that in the buyer’s mind, there’s that fear that that is not transferable value.

Tom:

So even if we can alter payment structures or anything else, that’s definitely a risk. So when we talk about value and we talk about maximizing value, anything you can do to maximize from goodwill or from value, meaning marketing for the firm. Those different platforms, systems, checklist, process, other elements are huge because those can transfer very easy to the next owner, the next manager versus the personal value investment. The investment into just you and your network or other things, which is the traditional way that most attorneys had built their practices. But there’s a lot of course, over in the last probably 15, 20 years that have invested in firm marketing. And that has a great impact on value and finding more buyers in the marketplace.

Digital marketing, SEO and leads affect price:

Lindsey:

I’m speaking to the website and digital presence for your digital marketing reputation. That is obviously an important factor that you hit on there, and it’s something that is transferable as opposed to the networking opportunities that have become a little more sparse in the COVID era. So that’s definitely an interesting point to having the different types of relationships being transferable, and not as transferable as you are looking at valuing the reputation of the company itself.

Tom:

Yeah, absolutely. And I’ve really talked of it’s not that you can’t transfer the other value, your personal network and everything else. We do a lot of those deals. We’re just a little bit more time involved. There’s a little bit more risk question mark to the buyer so the payment terms have to transfer. So when you’re talking maximizing value, it’s really building those firm systems, building the marketing that is attached to the business value versus you individual. But we as attorneys, we like to make ourselves big and that brand, and those can look to that aspect. The other thing I would tell everybody is I’m a big believer. If you want to look tomorrow at how to start building value within your practice and maximizing it is to start delegating. Even if you’re a small shop or anything else is if you’re trying to do everything, you’re trying to do all your marketing.

Tom:

You’re trying to do this much of the legal work but you have paralegals, if that’s that pyramid type of thing and you’re at top, see if you can level a little bit. Start delegating out, build a team of outsourced good providers, internal team. Make your employees truthfully assets versus just they report to you and everything else, because that’s a lot easier to transition and transfer as well. And it’s going to help you build those systems, right? So if you start delegating out certain work, you’re going to need checklists for people to follow. Or you’re going to have to customize certain software workflows or other things. So I’m a big believer if you want to help on value, delegate it out to those who can do it better and probably more efficient and usually at a lower cost than you can.

Mistakes attorneys make when preparing to sell a law firm:

Lindsey:

Well, and that hearkens back to your earlier point of making sure that your firm that you’re starting with is in order first, and making sure that you have those processes and workflows, and the right people working with you whether they’re procurement relationships or internal on your team. What we have always found is that the attorneys that we work with are great attorneys. They are not necessarily so great when it comes to their website or to pay-per-click advertising, or all of the other things that go into our sphere but they’re great attorneys. And that is what to start with. And from that, you can build out the rest of the pieces that go into creating a great offer on a stable law firm that’s ready to be a foundation for that growth. So what mistakes do you see that lawyers are making as they are either trying to buy or sell their practices?

Tom:

Yeah. I think one is understanding the financials, and that goes for both ways the sellers and the buyers is it is largely … it is a financial transaction. You can talk terms, you can say this is a great fit, everything else. But for our sellers, we go through I’ll call it an education process. That if you’re that owner of that law firm that does a million dollars in revenue, and you’re the only attorney. So you’re doing all of the attorney legal work and you’re looking to sell it to somebody else. And you say, “Well, they can make $400,000 a year on this.” Maybe. That other firm has to pay somebody to do the legal work that you were doing. So I’ve given you the good or bad example analogy in the past that when you look at law firms, it’s similar to factories in a machine … excuse me, machines in a factory in the fact that you’re producing. You’re just deliverable is you’re not printing something. You’re not making widgets.

Tom:

You’re producing legal deliverables. And if you remove that machine, if you remove you from that, you’re going to have a drop in production. And so anybody that takes over your practice either has to be that next machine to replace you, or they have to hire and they have to put somebody in place. So we try to educate sellers really on the side of projected cash flows for a buyer to make a deal work. So it brings the valuations down a little bit, but you have to understand there is a cost to you doing the legal work. That’s why you pay yourself, hopefully a reasonable salary from that approach. But you are one of those machines. Now we definitely have some firms, some big personal injury firms that we’ve worked with and otherwise that the ownership doesn’t provide any legal work. And so they don’t have a replacement cost like maybe at another smaller firm or otherwise. And then to the buy side, it would be the same thing. Understand your financials.

Tom:

If you’re going to take on a million dollars in revenue and you’ve got some deal term costs to that, the next question is what are your costs that are going to be applied to that million dollars, and does the deal still make sense? So what does your IT cost? What does your marketing costs for that million dollars, right? It’s really go through a comparative analysis to make sure that the deal still works for you. And there is still excess cashflow to make it a benefit, right? So financials are definitely one. The other is if you can bring in other advisors, the best of it is just like we were talking about with marketing and everything else, like attorneys like to do it all. But if you can bring in an accountant, a CPA or somebody that’s gone through this before to help you, you will get much farther along on a much better platform than trying to do everything yourself and run your own law firm, and take care of your clients.

Tom:

And so that whole delegation factor really comes into play in this spot as well, because a lot of times as we are an intermediary or broker, some of the things we do is just an accountability check. It’s accountability to the seller’s side. Hey, you need to make a decision here. You need to produce these financials. So the buyer’s side you need to go through the financials. You need to decide what kind of offer you’d want to do. So really don’t be afraid to ask for help. This is not something, because we know it’s a young marketplace. It’s not something that everybody goes through every day. So if you can find good outside resource or if you have it within your firm, tag them in, you will get much farther along.

How to contact The Law Practice Exchange:

Lindsey:

Speaking of asking for help and finding great outside resources, Tom, where can people get in touch with you if they want to learn more?

Tom:

Sure, thelawpracticeexchange.com. You can find us on the web, you can find us of course, on LinkedIn or find me on LinkedIn Tom Lenfestey. Also, we’ve started a Facebook group buying and selling law firms on Facebook. Be happy to have you there where we’ve tried to really take the education first attitude. A lot of these things are new to attorneys, right? Buying, selling, successions, structures. So we’ve tried to figure out a way to get the most resource out there. And in today’s day and time, social media, short video, everything else seems to be a good spot to do that. You can also email me tom@thelawpracticeexchange.com or give us a call (919) 789-1931.

Lindsey:

Great. Well, thank you so much for joining us today, Tom. That was very helpful, and we look forward to speaking with you again soon. And I encourage anybody to reach out to Tom if they have further questions. So thank you all. Have a great day.