What is your law firm worth?
This question is paramount when the owners of a firm consider the possibilities related to a merger, a succession plan involving existing firm members, or the outright sale of an established practice.
There are variations by state as to what can and cannot be sold as part of transitioning of ownership of a law practice; and even given the existence of suggested formulas for valuation, when it comes to estimating the value of a given practice, there are often more questions than answers. But in order for a transition to be successful for all involved, it is essential to have a solid idea of what a firm is worth.
To this end, in our experience, here is where the conversation should begin.
Two Broad Considerations
In the typical law firm transition there are two separate areas of value, each of which represents distinct characteristics:
- Tangible assets – this is in many ways the easy part of the conversation. Examples include furniture, equipment, cash, investments, receivables, and work in process…; and then there is,
- Good will — this amounts to the equity of the law firm’s name that will be transferred to the new owners, and often represents the significantly more difficult (and typically most valuable) piece of the valuation process.
In the simplest terms, good will is the value associated with the firm’s ability, to generate future income under the newly constituted ownership. That future income generating capability absolutely has economic value; in many cases it may represent the most significant piece of the valuation puzzle.
Think about it. If you could purchase an investment — say an annuity that would guarantee a payment of $2,500 per year for 10 years, what would you pay? $15,000, $18,000 maybe $20,000? The same principle is true in the purchase of a business. The projected future income has value in the context of a present-day transaction.
Unfortunately, the future profits associated with a law firm are not as certain as a guaranteed annuity. Although a firm’s reputation may be outstanding, and the historical revenues may have generated an impressive level of profitability, the continuation of those profits depend on clients choosing to continue to be served by the new firm following a transition in ownership.
Notwithstanding the above uncertainty there are means of estimating future gross revenue and net profit associated with a firm that yield an approximation of the firm’s potential value. The use of revenue and profit multiples can provide a rough idea of value. That approximation requires further refinement in order to account for the risk associated with projections of future revenue associated with a particular practice.
For Your Consideration
What we are discussing here is what many in the marketplace refer to as the value of a law firm’s brand and the job of valuing that brand is clearly more art than science. There are more challenges associated with valuing a law firm than most other business types. But these challenges should not get in the way of a focused effort to approximate the value of a firm before beginning a process that will result in a transition to new owners.
What efforts have been made to estimate your firm’s value?