Reviewing Reasons to Acquire a Law Firm
The reasons for purchasing a law firm are as unique as the lawyers who want to do it. Some firms undertake mergers or acquisitions to expand a geographic reach or add new practice areas. Others look to consolidate in order to bolster their competitive strategies. Whatever the reason, there are some common motivations that come into play:
Expand geographic reach – growing a practice by acquiring a firm in another market is a common tactic. In this way, firms can increase their market share and revenue.
Add new areas of expertise – firms sometimes merge or acquire to add a new area of expertise to their capabilities. A tax practice, for instance , may want to better serve their clients by augmenting their existing capabilities with real estate expertise from a firm in town.
Bolster competitive strategies – a firm may want to bolster its competitive strategies through a merger or acquisition. Firms may be looking for a way to compete with larger law firms, or to broaden their expertise in a niche area. In any case, a merger or acquisition can boost their competitive strategies.
Existing client base and name recognition – many smaller firms looking to grow can benefit from an acquisition by gaining access to an established clientele. For example, if a tax lawyer has built a respected, small firm, they could merge with a larger firm that has, say, a well-known litigation team. The added value of their tax practice could make the whole firm more attractive to potential clients. They build their brand by leveraging their existing reputation and clientele.
Performing Extensive Due Diligence
Conducting thorough due diligence is critical to ensuring that the final purchase price is not inflated by undisclosed liabilities or faulty information. Typical areas of due diligence will include:
1- Financial Statements
All financial information is good – right? Well maybe not. The broker, the seller and your accountant all may have different views of what constitutes the real financial state of affairs. This is why you also want to get an accountant’s view if at all possible.
2- Trust account records
Lawyers have been cheating on their trust accounts for years. Even when best practices are followed, mistakes can still happen and lawyers can find themselves on the wrong side of the bar. Trust accounts must be thoroughly vetted, by you and your accountant.
3- Client lists
While client lists are usually pretty accurate, you need to verify the work performed and the billing history with each client.
4- Lawsuits
Any indication of past lawsuits must be dealt with during due diligence. It’s important to identify any lawsuits that are still pending, and to learn of any potential lawsuits (e.g. bankruptcy, license suspension, theft of client funds, etc.).
5- Financial obligations
Current debt from the practice, leases, vehicles, leases — they all need to be accounted for.
6- Seller’s professionalism
The law society and your accountant must have zero record of any concern about the conduct of the seller.
7- Corporate Information
Nothing worse than taking over a firm to find it wasn’t on solid ground from a corporate perspective. This can include the risk of outstanding or unfunded shareholder agreements with other partners.
Evaluating a Law Firm’s Worth
Valuation of a law firm is very complex, and for most buyers, the value of the practice or business being considered is often at the top of their list in importance. Your purchase decision, however, should not be based on the perceived value of the practice to you. An accurate valuation must consider many facets of the business with the emphasis on your needs.
In short, the valuation of a law firm is best done in the context of the full detail provided in a letter of intent. Although there is no business ‘dummy’ book on law firm valuation, follow the lead of the statutory guidelines on corporate valuation of either internal revenue or financial reporting:
- Identify the company being sold
- List the anticipated cash flows of the practice
- Identify and analyze the risk: of: 1) loss of client relationships; 2) potential aids and obstacles that might affect the practice
- Design a capital structure
- Discount the cash flow and determine the price of the practice.
The buyer should encourage the seller to identify the key value drivers and the risks associated with the retention of that value. A third party advisor can help develop risk management programs that will compensate for or minimize the risk.
The value of each practice location is determined on the basis of the practice’s size and its location. For example, a highly profitable practice of a particular size in a small market will typically have a lower value than a practice of the same size but located in a larger market where more potential clients are available.
Legal and Ethical Implications
When acquiring a law firm, there are a number of legal and ethical considerations the buyer must address. The most significant of these is preserving the attorney-client privilege for the firm’s clients. Unless the appropriate measures are taken, the privilege will be lost for communications made by the seller’s clients after the date of the sale. The consequences can be dire; if a former client decides to sue your law firm for legal malpractice, your privilege will be abrogated and the former client may have unlimited access to your organizations’ privileged communications with the seller as well as your own .
In order to properly preserve the attorney client privilege you must make appropriate and express provisions in the Purchase Agreement that: Without these provisions, the privilege may be lost, often with serious consequences for the buyer. Clients have the right to direct their files and correspondence to the seller’s law firm or attorney(s) of record, but cannot be required to do so by contract. Without appropriate provisions to retain client files, files may be surrendered to the seller and the new firm may not be able to obtain any notes, work product or other materials generated by the seller. In such cases, the seller’s clients may not appreciate their file being kept in storage indefinitely and may even want a complete copy of their file at the law firm’s expense, which can run into thousands of dollars per file.
Negotiating the Purchase Agreement
The initial negotiations regarding price and terms of the sale will begin the process of negotiating a letter of intent (LOI), which is followed by the actual preparation of a purchase agreement. An LOI, while not a legally binding agreement, lays out the general terms of the deal and the key components of the purchase agreement. This stage of the process may come before or after you determine valuation and price for the firm you are seeking to acquire.
Some of the key items to be included in the LOI and then detailed in the purchase agreement include:
Price: While any change in the purchase price will often prevent closing, other details about the price can be negotiated. For example, the amount of the down payment could be decided, as could some adjustment or hold back of purchase price or interest on unpaid portions of the purchase price. Providing minor incentives, such as dollar-for-dollar credits for new business generated in the first year of the agreement, may also be included.
Terms of the Sale: Will the buyer pay the purchase price and obtain the assets from the seller in exchange for an installment note? Will the buyer pay the price and acquire the assets directly, or would there be a stock purchase?
Transition: As with mergers, the buyer and seller need to agree to a transition period and discuss transitional support to be provided by both parties. This could include the seller working to assist in client retention by sending letters to clients on behalf of the new firm.
Sufficient Time: It is important to give yourself sufficient time to negotiate an agreement that meets your needs. You should not attempt negotiations in an area of unfamiliarity simply to avoid costs.
Facilitating a Smooth Transition
Once you have set a closing date, the real work begins. Your entire transition must be planned and communicated well ahead of time. It is not only important that your clients, staff and attorneys understand that a change has been made, but they must also understand what this change means for them. These are the last opportunities to quell potential fears and reduce anxiety. These are the times when soon-to-be-former clients will consider whether they want to be a former client or stay with the new firm. The same goes for the staff.
You will need to plan the details of who will communicate this change, when those communications will happen, and what resources will be provided to answer questions. Your accountant may be a resource to help the staff deal with the tax consequences of the transition. Announcements must follow a consistent and unconflicted message. You do not want conflicting information to come from both the seller’s and buyer’s firms. Information needs to be delivered with an air of authority and confidence. You do not want clients thinking the wheels are going to fall off your practice or the seller’s firm for that matter. One key element of this process is to make sure that you announce whom you will be bringing into the firm as well as whom you are letting go. No client wants to hear that someone is being let go but not who that someone is. Also, this announcement allows you to keep those you are letting go on the payroll until the transition is completed. This will help you prevent the loss of clients in the transition period between the announcement and the start date .
You also need to decide who, if anyone, you’ll leave behind. If you have purchased an existing firm, you’ll most likely want to have a smooth transition with the attorneys and staff so that they can assist the new firm through this process. As you approach, you should start having meetings with all the attorneys and staff to explain the reasons for the merger and why you have agreed to do this. You and your buyer need to agree exactly what is going to happen to the employees. Will they all become employees of your firm? Or just the employees you want to keep? Will they keep the client lists or will they not? Will you combine your firm’s infrastructure with the seller’s firm or keep both separate? How about overhead? Will you share office space now and move them to your offices later? All of these details must be discussed and agreed to before contracts are signed. Once you sign that contract, there is no turning back. You will need to document everything, even if it is just between the two of you. Make sure that all of your communications are spelled out in writing. Sometimes you will have to write some unpleasant things in those agreements. For example, if you will only be keeping one of the existing names for the combined firm, you will need to speak to all the employees, making it clear that some of them are going to lose their jobs. It is going to be hard, but necessary. If you didn’t think that through ahead of time and have not scheduled those meetings, you will not be ready for that revelation. Do them as soon as you finalize your agreements.