Law Firm Group Newsletter – Summer 2014

PUTTING A PRICE ON YOUR LAW FIRM

Joel Herman, CPA

Many situations can trigger the need for a law firm's appraisal, including insurance coverage, a partner's death or divorce, capital buy-ins of new partners, firm dissolution and mergers. There are specific ways that law firms create, or diminish, value. This blog discusses some of these "value drivers" and how the three most common business valuation methods are applied. But, as a Sidebar notes in regard to one divorce case, valuators often disagree about the same professional practice interest.

If you have never had your law firm appraised, it could only be a matter of time. Many situations can trigger the need for an appraisal, including insurance coverage, a partner's death or divorce, capital buy-ins of new partners, firm dissolution and mergers.

If you are contemplating a merger, sale or acquisition, a professional valuator should perform the appraisal to help ensure accuracy. But even when you leave valuation in an expert's hands, it is useful to understand how law firms create, or diminish, value.

Unique Factors

Valuation methods used for small businesses, such as multiple of earnings or discounted future cash flows, also apply to law practices. However, law firms must consider some unique factors. For example, the ABA's Code of Ethics generally prohibits law firms from buying and selling client lists. Although most states have adopted ABA Standing Committee on Ethics and Professional Responsibility Model Rule 1.17, which enables firms to sell client files and the associated goodwill firms generate, a few have not. Other "value drivers" that apply specifically to law firms include:

Financial Performance — Stable, sustainable, growing revenue streams and lean operating expenses are ideal. Appraisers evaluate balance sheet strength, including the transferability of work in progress (WIP) and collectability of receivables. Large firms may be more valuable, because they offer one-stop legal expertise and can spread fixed overhead expenses over a larger revenue base.

Type of Work — Does the firm provide services that match the needs of its local market? General practices may sell for less than specialty firms, such as patent or environmental law practices. If a firm handles only contingency fee cases, which generate varying annual revenues, valuing its future income streams can be challenging.

Reputation Firms add value with a strong brand, unique work and attorneys who are regarded as...