As a small law firm owner with lawyers working for you, if you are thinking about retirement, you are likely looking to one of them as a potential successor. This is an option most law firm owns contemplating retirement should consider first. Doing so rewards your associate’s loyalty, puts cash in your pocket, and provides uninterrupted service to your clients. Even so, many small firm owners reject the buyout option too quickly, thinking the grass will be greener with a third-party buyer. At times, that can be a mistake.
This post will outline some questions and perspectives to help you evaluate your associate more accurately and make a more informed decision.
Let's first debunk some assumptions owners make when comparing the two options.
Assumption #1: My Associate Lacks the "Right Stuff" to Be My Successor
Yes, you are correct. Your internal successors are not as good as you. If they were, they would probably have left you years ago and started their own firm. The standard of "Are they as good as me?" is unrealistic and unhelpful. After all, even you probably weren’t as good as you are now ten, twenty, or thirty years ago.
Do your associates have the talent and skills to succeed? Just because an associate handles files well doesn't necessarily mean they can successfully operate a law firm. The skill set required to be an effective law firm owner differs from that of an excellent practicing lawyer. Here are the most essential skill sets to consider when vetting any successor, be they current associate, or third party.
Business Acumen: Can they run the law firm as a profitable business? Do they know the difference between revenues and profits? Can they screen clients effectively? Will they manage office expenses carefully? Will they send bills promptly? Do they know what to do to collect unpaid bills?
Marketing Savvy: Do they recognize the importance of marketing? Do they have a basic understanding of marketing? Are they quick to learn? Getting the phone to ring or attracting clients to your website doesn't just happen. Your successor will need to develop the business. Will they be able to do that?
Many owners reject the buyout option if there are too many "maybes." That could be a mistake. For an internal transition to succeed, good may be good enough. Big picture, assess whether they have the potential to get closer to being as "good as you." The emphasis is "closer." Assess their capability to grow into an ownership role. Give them the benefit of the doubt. Remember that people can learn and grow. So, even if they're 85% as skilled as you, they could eventually fill your shoes with time, experience, and some training. Don't let perfect be the enemy of good.
Assumption #2: A Third Party Will Pay Me More
When it comes to the sale of law firms, I'm not so sure. It's a rare deal, internal or external, where the buyer pays a fixed price. Most are structured as earnouts. That is, sellers receive payments based on the future performance of the law firm. Thus, an earnout structure does not provide an external deal with any advantages, price-wise, compared to an internal deal.
In addition, I'm unaware of any data supporting the notion that a third party will pay more. My experience as a consultant over the last twenty-plus years does not support it. The marketplace for law firms remains too immature and underdeveloped to assume anything.
Why Internal Deals May Be Preferable
They Are More Predictable
Internal deals can often be more predictable. Working with "the devil you know" means understanding your associates' strengths and weaknesses. You can plan how to handle any issues that arise. With a third party, you enter into unknown territory, which adds an element of risk.
You Preserve Your Brand
An internal successor is more likely to preserve the firm's brand. Third-party buyers, especially those from firms larger than yours, might not value your brand, opting to integrate your firm into their existing structure instead. This could result in losing your firm's identity, which you have spent years building. An internal successor will likely maintain the firm's name and reputation, benefiting from the established brand recognition.
Avoid the Challenge of Finding a Third-Party Buyer
Finding a third-party buyer can be more challenging than anticipated. Despite your firm's potential attractiveness, locating a buyer who fits your firm's profile and values is not easy. Unlike other small professional service businesses (think dental and accounting), there is no central marketplace for law firms. The market is extremely fickle and uncertain.
Opening Up Your Books
Yes, you will have to do it. There is no way around it. Buyers want to know the financial condition of what they are buying as part of their due diligence. I know what you're thinking. How will I defend the amount of money I've made over the years compared to what they've earned? You simply say they will now have the opportunity to earn that much, if not more, as an owner.
Hopefully, after reading this post, you will have more clarity and direction. If you'd like professional advice on your situation, feel free to reach out to me. I've helped over 200 firms with their exit strategy, and I would be happy to discuss this further. You can reach me at 612-524-5837 or you can contact me online.
