Succession Planning: Buy Out at Retirement
Many baby boomer lawyers are approaching retirement and considering succession planning options. Owners of small law firms with a handful of non-equity partners or associates frequently wonder if it is a realistic expectation to get bought out by the other lawyers. If so, how do you then decide the amount and structure? Like many law firm valuation issues, there is no simple answer to either question. The answers depend upon a variety of factors.
Is a buy out a realistic succession planning option?
Perhaps the most important factor in deciding how realistic a buy out is as a succession planning option, is the nature of the practice. For those practices where there is likely to be future predictable revenue for the buying lawyers, a buy out can be very realistic. One example of a practice with likely future revenue is estate planning. Existing wills may need to be revised or an estate may need to be probated.
Also realistic are practices where the older lawyer nearing retirement has transferable client relationships. An example of that is a firm that provides general business advice to a few closely held corporations.
These types of practices also could be sold to outside third parties, providing the retiring lawyer with a Plan B if the retiring lawyer is unable to reach agreement with other firm lawyers. When these lawyers realize a third-party sale could jeopardize their futures, then they often become more interested in acquiring a future equity stake from the owner upon retirement.
Some practices can’t be sold at retirement
Many law practices have little-to-no value on the market. Extracting value as a succession planning goal is not going to happen. One good example is a law firm where the good will of the retiring lawyer is simply too personal.
A prominent criminal defense lawyer will probably have a hard time convincing the one or two lawyers who have worked at his firm to buy him out. Why? Once the lawyer retires, there likely will be little future business. Most people want to hire the reputation of the retiring lawyer, not the unknown lawyers who worked for him.
A family law practice, also, has little value due to the lack of a future revenue stream. Once a divorce is final, clients only occasionally make changes to the decree. Old files are not likely to lead to future business. Should the retiring family law attorney be prominent, the other lawyers in the firm run into the same problem as in a criminal defense practice. Without the reputation of the retiring lawyer, they are not likely to be hired by potential clients.
Should you buy out the owners?
Non-equity lawyers and associates should consider a buy out if the practice has the kind of value that would be saleable to a third party when the younger lawyers themselves are ready to retire. An equity stake enables the younger lawyers to invest in the firm in order to increase the firm’s future value. If it would not be saleable, they probably should not participate.
Determining buy out terms
Despite what some bean-counters say, there is no magic formula for determining terms. One key factor is always what the owner could realize from a sale to a third party.
For the younger lawyers, the question is how much an outside sale could jeopardize their futures. If the sale would jeopardize their careers, they should pay up. Alternatively, if the younger lawyers believe that they can make it on their own, why pay for an equity stake? It would be far more economical to simply create equity by starting their own firm.
Another factor to consider is what the younger lawyers can afford. There’s no point doing a deal if there is no reasonable way for the payments to be made. There are two ways to fund a buy out. First, the lawyer or lawyers could take out a loan from a bank or from the retiring lawyer. Alternatively, they can take less salary than they would normally receive during the term of the buy out.
Don’t get greedy at retirement
The most important factor in coming to terms is fairness. At times, retiring lawyers leave money on the table to demonstrate gratitude for colleagues’ past service.
Other owners are not so generous. Some even overplay their hand. They attempt to obtain value from the younger lawyers, when in reality there is little or no value. In this situation, the younger lawyers frequently walk. At times, however, they will agree to a buy out to show their appreciation for past employment.
On the other hand, there have been deals where the younger partners fail to fully appreciate the value of what is being offered to them. They come to the table with an entitlement mentality, expecting that their past years of toil mean they should pay virtually nothing for the equity.
I hate to break the news to these younger lawyers, but they don’t deserve anything for past work. Presumably, they were paid a market-rate salary for their work and are entitled to nothing more. Absent any promises that years of service would be specifically valued when owners retire, the slate is clean.
Succession planning has no playbook
As you can see, when it comes to succession planning, there are no hard and fast rules governing a buy out procedure for a small law firm owner or solo practitioner upon retirement. Market forces, business savvy and gratitude are all determinative.