Tag Archives: law firm sales

A Tale of Two Sales

The merger and acquisition market of law firms in Australia appears to have gathered pace this calendar year. Already I have undertaken 11 valuations – with five of these being used as a starting point for negotiations for mergers, or to guide a deal where a firm is being acquired. In conjunction with the increased valuation activity, I have been engaged to find purchasers for three rather significant firms as well as finding merger partners for another two firms.

This role of law-firm matchmaker gives me a front row seat to understand what acquirers are looking for and what makes a sale or merger happen seamlessly. None of this will be a surprise to those reading this article – if you sat down with a pen and a piece of paper, you would probably soon come up with a fairly comprehensive list of desirable attributes a firm should have to be considered an attractive proposition.

When I sit down with partners who want to sell their firm, one of the first questions they ask me is how long the process is going to take. The answer to this question is: if you have all the information required for a due diligence to hand, and a sensible asking price, then we should have someone on the hook within three months, and a deal concluded within six months.

Once I have a confirmed sell mandate, I do two things before even thinking of approaching the market. First, I provide the firm with a checklist of likely due-diligence information that will be sought, and make sure that information is in a data room, ready to go. Nothing turns off a prospective purchaser more than very slow responses to reasonable requests for basic information. Second, I use this information to determine what I think the value of the practice is, and work with the partners to agree on the asking price and terms of the sale. From there, it is a matter of approaching the market and finalising the deal.

Contrasting Examples

In late 2018, I was engaged by two different firms to find buyers for their practices. On paper these firms appeared very similar, but in fact the ease of sale was vastly different. Revenue of both firms was about the same, all partners wanted to sell (there was no internal conflict about the desired outcome), both had specialisations that the market was seeking, and both were equally profitable. What could possibly go wrong?

In fact, in the case of the first firm, nothing did go wrong. The sale process was as smooth as could be, and they were the model client. At the first meeting, the partners spelled out their asking price and their (very reasonable) justification for it. On receiving my due-diligence checklist, they provided all the information within a week. By the time I had given them a target list of likely purchasers, we were all as confident as one could be. Of the five likely acquirers we approached, two were interested in exploring further, with one agreeing to the vendor’s sale price and proceeding to due diligence within three weeks of hearing of the opportunity. A Heads of Agreement was signed within two months and the whole deal concluded within five months. Quick, tidy and all parties were happy.

The process with the second firm could not have been more different. When I asked the partners for their sale price and terms, they said they wanted to see what the market would offer, based on a somewhat convoluted and subjective revenue-share model. When I pressed for a ball park they obfuscated and kept turning the conversation back to the revenue-share model. In a moment of weakness, or exhaustion, I went along with this.

When it came to due-diligence information, at the first meeting I was told this was already at hand as they had been contemplating a sale for some time. I accepted this, and went to the market with the opportunity. At this point the wheels fell off.

Meetings with interested acquirers became convoluted when they raised the question of price. Examination of the revenue-share model by some acquirers quickly fell apart when its lack of transparency was exposed. Any confidence in the vendor was further eroded when, pushed for a purchase price, they put forward a wildly optimistic number which could only be described as commercially insane.

A handful of potential acquirers that were prepared to talk further (once some sense around price had been accepted by the vendors) then sought the most basic due-diligence information. After waiting more than six weeks for information that should have been produceable within five minutes, these firms lost all confidence in anything that was put forward.

Now after almost eight months, we are really at the beginning of the process. The vendors have a reasonable price in mind and are open to terms. All due-diligence information is in a data room. My thinned out target list of potential acquirers provides some hope for success. However, I know that in future I will stick to my guns with a process that I know works, or I will walk away from the engagement.

Thought you might enjoy this story.

Edge Principal Sam Coupland is considered the foremost authority on law firm valuations in Australia, offering firms a robust valuation methodology to help them calculate accurate capitalization rates and assess the risk profile, cash flow and profitability of their firms. He is a frequent presenter on practice-management-related topics, delivering dynamic presentations to hundreds of lawyers every year in the areas of financial management, business development, succession planning, strategy, and people management.

Challenges in Selling a Legal Practice

Generational change in the legal profession of Australia and New Zealand has led to discussion around the value of a legal practice – is there any, or is it just a myth?

Well managed, profitable, organised businesses with repeat customers are worth real money. It is not uncommon for small, successful firms to be purchased and sold. Many firms have retained goodwill in their balance sheet, sell interests to incoming partners, and buy them from retiring or departing partners. So what are firms worth?

If any business is to be valuable it must be profitable, organised, able to achieve replicable results through quality systems and have some degree of inimitability. In many respects law firms are not that different. There are, however, some aspects of law firms that make a sale difficult.

1. Internal Sale

Selling an interest in the firm to current employees is usually the safest bet. In effect their employment with the firm has been one long due-diligence process so they know what they are getting into. Many of the challenges of an external sale will have been answered: What is the culture like? How robust are the systems? How sticky are the clients?

The financial mechanic for bringing an employee into equity can be more flexible, and may involve a lockstep or some form of vendor financing.

Of course there are challenges with an internal sale. The most common complaint I hear from an incoming partner who is asked to pay for goodwill is that they are just purchasing what they already produce as an employee. The counter argument to this is, ‘But that is what you were being paid to do.’

Incumbent partners are the other impediment for an internal sale. By admitting a current employee to partnership, the profit pool will be diluted. This is most stark in a small firm where an interest is being purchased from the incumbents; for example, if there were two partners who sold an equal share to an employee, the shareholdings go from 50% each to 33% each. In this case, the relative decrease in percentage is quite large.

A firm with ten partners that sells an equal interest to an employee will see each partner’s share drop from 10% to 9.1%, a change which is quite manageable.

In each instance the method of bringing an internal partner through will determine the severity or otherwise of the financial impact.

2. External Sale

There is a genuine appetite for firms to grow through acquisition with some payment occurring, though this market is fairly discrete. Large firms will rarely (if ever) pay to acquire a firm: The deal they offer is the potential for higher earnings / profit share when a practice or firm is tucked into their structure. It is at the smaller end where dollars change hands.

I have been in the middle of many merger or sale discussions where, at the outset, it appeared like a marriage made in heaven – only for things to unravel down the track. Many of the problems that arose could have been worked around, but often one of the parties dug in their heels, scuttling the deal. The most common challenges I have seen are:

Failure to get the partnership on board: The larger the firm, the more people who need to be convinced that this sale or merger is a good idea. Discussions can be stymied for any number of reasons.

  • For the acquiring firm, an acquisition will most likely benefit some practice areas over others. Partners in the practice groups which won’t benefit, but will be asked to foot the bill for the acquisition, may object to this – even if the profit-share arrangements in the firm mean that they will also share in the spoils.
  • Everybody in the profession has a view (one that is not necessarily accurate) of other practices. Differences in perceived prestige of firms can see partners baulk at a deal. Similarly, a tough experience with a target firm who were on the other side of a matter which turned sour can leave a lasting negative impression.

Debt levels and capital contributions: All firms have different levels and appetites when it comes to debt. Partners in a no-debt firm often struggle to sign up to a practice where they will be taking on a liability that was not of their making.

Profitability due to structure: Many smaller firms achieve high profits because they run on the smell of an oily rag. When their gross fees are absorbed into a larger firm with higher fixed overheads, the resultant profit is not as solid. I have seen this a number of times when the smaller firm is attracted to a larger practice and the name it has in the market, only to be turned off by the reduction in their profit share from what they were enjoying when they were on their own.

Orphaned practice areas or offices: Law firms grow organically and as a result have practice areas or office locations that suit the firm in its current operations. An acquiring firm may not have need for, or may be strategically opposed to, operating in some areas of law or particular locations. For a deal to occur, the acquired firm will have to jettison a practice group or location. Often personal loyalty wins out.

Some of the above situations are insurmountable, but in most cases a deal can be struck. I suspect we will be seeing a lot more merger and sale activity in the profession over the next couple of years.