Buying a Law Practice Makes Sense

As baby boomers age and start to think about retirement, these lawyers begin to think about selling their legal practices. At the same time, younger lawyers are looking for ways to expand or diversify their practices. They are also thinking about buying a law practice.

Buying a law practice is a strategy that offers sellers and buyers alike significant gain with minimal risk.

Don’t be a Skeptic

Even though the risk is small, it is enough to scare off some potential buyers. Lawyers, after all, are blessed with ultra-cautious DNA. For many, the term “risk” is not part of their vocabulary.

Perhaps the following hypothetical example will persuade skeptical buyers by demonstrating the small risk and potential high reward of a law practice sell/buy arrangement.

Estate Practice for Sale

Conventional wisdom has it that there is value in an estate planning practice. Most estate planning lawyers should have drafted many wills for clients over the course of a career. In theory, these should lead to future business when a will needs updating or an estate is probated. Anyone who buys this practice is buying this future business.

While there is no guarantee that this business will materialize, it is reasonable to assume that at least some of these former clients will seek out the buyer when they are in need of future legal services. By selling a practice to this particular buyer, a retiring lawyer is actually recommending the purchaser. While some clients may certainly look elsewhere, others will not.

Time to Talk Numbers

Let’s assume that our hypothetical selling estate planning lawyer has consistently netted about $100,000 in annual revenue. Let’s further assume that the lawyer has created 1,500 wills during his years of practice.

We can probably assume that, over the next five years, 50 clients will contact the purchaser of the practice to have their wills updated (at $1,000 per will) and 20 more will need to have an estate probated (at $5,000 per probate). The purchaser has gained an additional $150,000 in total revenue. These are relatively conservative assumptions.

Rule-of-Thumb Method

Using the “rule-of-thumb” method to calculate value, bean counters assign a variable (also known as a multiple). They multiply the net revenue by this variable to derive a value. Although there is little science to support one multiple over another, most experts put the number somewhere between .3 and 1.0.

So, for the purpose of our hypothetical, let’s assume a conservative multiple of .5. The value of the practice for sale is .5 of $100,000 or $50,000.  It makes a lot of sense to spend $50,000 for a practice that is likely to earn $150,000 in the next five years.

Earn-Out Method

An alternative method of calculating value dispenses with the arbitrary variable. Using this method, the buyer pays the seller an “earn-out” – a percentage of future revenue for a fixed period of time. If the buyer pays one-third (a typical ratio) of the $150,000 revenue over the next five years, the seller receives the same $50,000. Here again, the buyer is tripling the return on his $50,000 investment.

Many risk-averse potential buyers prefer the earn-out method, because there is absolutely no risk of losing money other than a negotiated down-payment. If there’s no future revenue, the buyer pays the seller nothing more.

In exchange for this, however, the buyer does assume a different kind of risk. Should future revenues exceed $150,000, the buyer pays more than he or she would under the rule of thumb fixed price.

Buying a Practice is Not That Risky

Lawyers can grow or diversify their practices by strategically purchasing the practices of other lawyers. Don’t be afraid. Just do the numbers. Tested financial methods let you understand the advantages and minimize the risks – conquering your skepticism and giving you the fortitude to proceed with such a transaction.

(photo: http://www.flickr.com/photos/wongjunhao/2706075264/)

Legal Careers, Starting a Law Firm

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  • Tom Seeley

    I have been negotiating with older attorney for two years for a buyout. He is averse to the earn-out method and wants flat fee buyout but wants to base that on 1.5x earnings of himself and a former partner.

    My concern about rule-of-thumb method is getting burned if none of his clients come back. Assuming I did go with rule of thumb valuation, any suggestions as to a protection against enormous drop in revenue due to retirement? I have heard horror stories of this happening

    • http://www.royginsburg.com Roy Ginsburg

      Your concern is very legitimate. In most these deals, sellers want a fixed fee. I don’t know the type of practice, but 1.5x sounds high. As for protection, I am assuming that you would pay the fixed fee over time. You could try to make some of the future payments contingent upon certain revenue goals. Good luck to you.

  • Tom Seeley

    Thanks. That is what I’ve tried and been stonewalled. Hate to give up opportunity of his referrals, but at the same time, can’t see paying for promise of referrals.

  • Jeremy

    I am currently in a deal with an “experienced” member of the bar to take over his practice. I clerked for a local judge then joined a previously solo. The big advantage for me is he was a family friend from long before I went to law school (he tried to talk me out of that!) so we have a very open and trusting relationship. It is a really good opportunity although I will warn that the generational gap and differential in tech-ability can be difficult at times.

  • Dutch

    Roy,

    What resources are there to come up with a down payment? I am looking to buy a practice after having been away from my home state for a few years. While we have been aggressive in paying off student loans, we don’t have much in the way of cash on-hand. Any suggestions?

    Thanks,

    Dutch

  • Nick Kosmas

    When you are calculating the purchase price, are you factoring in your salary? If a practice nets $150,000, is that after the practitioner has paid himself a reasonable salary? If not – aren’t you just paying for a job? In most other fields, the owner’s salary is taken out of the net.

    Let’s assume the answer is no, and your $50,000 investment gets you $150k over 5 years, or $30k/year. What about the hours you have to put in to earn that $30k? Plus, you have spent $10k/ year to earn that $30k, so you are netting only $20k/year.

    If I factor in 20 hours per probate and 4 hours per will (assuming a fee of $250/hour), I am now working 600 hours for $20k, or $33/hour. Could using the $50,000 to market your own practice make better sense?

    It would seem to me that a better plan would be to buy into a partnership with the attorney, where you can get a portion of his profits, plus still make your own. Over time, his share of the profits can be reduced, and you get the benefit of his name, reputation, and client base. Eventually your ‘partner’ can retire and you keep the firm going.