Many small firm owners wrongly assume that finding a third-party buyer hoping for a more lucrative deal is preferable to making an internal deal with an associate. At times, that is true, but more often than not, it is not.
Owners should be more receptive to the exit strategy of selling to associates. Let’s first debunk some assumptions owners make when comparing the two options.
My associates lack the “right stuff” to succeed as a successor.
Yes, you are correct. Your internal successors are not as good as you. They probably would have left you years ago and started their own firm if they were. Using the standard of “are they as good as me?” is unrealistic. For an internal transition to succeed, good may be good enough. Further, 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.
A third party will pay me more.
Don’t be so sure. It’s the 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, pricewise, 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 fifteen-plus years does not support it. The marketplace for law firms remains too immature and underdeveloped to assume anything.
Why Internal Deals Can Be Preferable
Here are the advantages to an internal deal with an associate.
They are more predictable.
I believe in the adage that it is better to work with “the devil you know than the devil you don’t.” You know your associates, warts and all. Face it: you have little to no idea how a third party will perform. It’s a crapshoot. You can plan how to handle the warts. With a third party, you must make it up as you go along.
Your brand may be lost.
Sometimes, the best buyers are successful firms in your geographical location or practice area and already have well-established brand. Typically, they have no interest in yours, including the firm’s name. Sure, they will want things such as your client list, website content, staff, etc., But that intangible value of the firm’s brand will be lost with most third parties and your ability to monetize it.
Contrast that with insiders. They will have every reason to keep some portion of the firm’s name and benefit from that recognition. However you attempt to monetize that, insiders will capture its value.
Third-party buyers may not be so easy to find.
At times, buyers are not as easy to find as one would hope. I’ve had countless clients tell me their firm is perfect for this type of lawyer or law firm. I usually agree but then feel compelled to inform the client that, yes, your firm would be ideal for this so-and-so type, but I’ll be damned if I know how to find that lawyer type. For example, your firm may be perfect for an unhappy big law associate or a big city lawyer looking for a better work/life balance.
Now, tell me how to locate that lawyer other than directly contacting pretty much every lawyer in a particular market or practice area that might fit that profile. There is no central clearinghouse for law firms like other small businesses. You can’t just place your firm up for sale on Amazon or eBay, knowing that thousands will see it. The marketplace is too underdeveloped.
In short, don’t automatically reject the possibility of an internal deal, assuming that it would be no problem finding a willing and capable buyer. That assumption may prove not to be true.
The marketplace for law firms is fickle. Yes, I know your insiders are not perfect, but remember, don’t let perfect be the enemy of good.