If there is one question we are often asked it is what is my law firm worth. The simple answer is nothing and that seems so unfair until you consider a few points.
Investment
Most partners draw all the profit out and do not invest in the firm. Indeed there is not at lot to invest in which would bring value. Premises maybe and IT certainly but any firm looking to acquire your firm will most likely have different premises and IT. You can invest in staff, but they can leave so it is understandable why partners draw out all the profit.
I often use the analogy of a bakery. If a new baker sets up a bakery and builds it up to £2m turnover, with a factory and new ovens, mixing machines and conveyor belts, with long term clients and future contracts then when he comes to sell this has a real value of something like 3 or 4 times EBITDA. However a lawyer in the same situation has nothing structural to invest in and will not have any long term contracts and so it has no value. The upside is that he or she has drawn all the profits out along the way unlike the baker, the downside is that at the end of the day there is nothing to sell.
Insurance
The second point is insurance. In every market other than England & Wales, whichever insurer insured a firm in 2014 for instance is liable for any negligence in 2014. This seems fair, they took the premium they should have the liability. Not here though, the last insurer is left with liability and run-off. Lawyers complain about having to buy run off and it being 3 x premium, but look at it for the insurers point of view. The final insurer is obliged of give 6 years cover for 3 years premium. They don’t want it any more than you want to pay it and so as a partner gets to their end of their careers I see premiums going up as insurers “encourage” that firm to go elsewhere.
Run-off
Run-off is also only for 6 years and whilst the law society is looking at a number of insurance products to cover the rest of life, how do you price that? Currently 11% of claims are post run-off, so to be clear that is where a Solicitor has closed their firm, bought run off and retired, but at some point there was a conveyancing error, or a child was mid-advised and the resulting liability falls on that partner directly. He has not worked for a number of years and is in no place to fund the claims and more often than not the only option is an IVA. No one wants that, and the only cast-iron certain option is to find a firm to be successor practice. This saves run-off and a pound saved is a pound earned but most importantly protects the partner for life. Maybe Sleeping soundly and saving the 3 x premium is a fair value after all.
So is it really that bad? No, most of the deals we do are with good firms, well run but just where there is no succession in place. Local hero firms if you like, who have fulfilled a need for legal services in their community for a number of years and we act for a number of buyers of such firms. Generally the kind of deals are they will pay 1 x the average of past 3 years profits paid over 12 or 24 months and if done correctly can attract entrepreneurs relief at 10%. So if he or she is clever, a partner can draw profits throughout their career, hand the firm over without run-off cover and sleeping soundly in retirement plus get a series of cash payments at 10% tax over the first couple of years of their retirement. That’s not so bad after all.
The author of this article is Andrew Roberts of Ampersand Legal. Andrew can be contacted at andrew@ampersandlegal.co.uk or 07956 961404. Other members of ALFMA can be contacted here.