- Under what circumstances might I look to sell my firm?
- Can part of a law firm be sold?
- Can we sell a stake in the firm and continue the partnership?
- Who could we sell the firm to?
- Are there any external investors willing to buy a law firm?
- Are there any consolidator firms willing to buy?
- How do we work out the value of the firm?
- Do people still pay for goodwill when buying a law firm?
- What value is placed on work in progress when the firm is sold?
- What value is put on the tangible assets (eg the building)?
- How can we maximise the value of the firm?
- How can we minimise tax when we sell the firm?
- What do we need to do to make the firm sale-ready?
- Do I have to be a certain structure (like an ABS) to sell up?
- What is the process for selling the firm and how long will it take?
- What is the subtle difference between a sale and a merger?
- Other than price, what are the key terms we need to negotiate in the sale agreement?
- How do I start the sale process?
- How long will it take to sell the firm?
- What advisers or agents will we need and how much will they charge?
- What due diligence should I undertake as vendor?
- What due diligence might an acquirer undertake?
- How can we minimise disruption to employees and clients during the sale process?
- How do I keep the sale process discrete?
- Are there any regulatory concerns when we sell the firm?
- What are the implications if I need a quick sale?
- If I cannot find a buyer what are my alternatives?
- Will Covid affect law firm M&A?
Tom Blandford, legal sector partner at accountants Armstrong Watson, answers common questions about selling a law firm. The impact of Covid-19 is covered in FAQ 28. (Updated 16 September 2020)
1. Under what circumstances might I look to sell my firm?
The classic (but somewhat flippant) answer to this question is that you do not wish to be part of it anymore. This could be because you are seeking other challenges, it is time to retire or you have no one appropriate to hand over to. In the worst cases it could be a distressed sale brought about by sudden changes in the market or in personnel.
However, this is not the only answer. Many are seeking to grow their firm, the opportunities for the staff and their clients, and to create greater coverage (of types of law or of geography).
There is (or can be) value in law firms, so picking the right time to go to market is crucial. Holding on for one more year can be the difference between achieving a sensible consideration and having to walk away empty-handed.
2. Can part of a law firm be sold?
Yes. You might sell particular matters/work in progress (WIP), or a separately identifiable part of the firm (eg a particular office or department).
Sales of WIP are surprisingly common, especially in consumer law markets such as PI. Sales of an office or department are harder to achieve, as ‘carving’ out one part of a whole can be challenging, but it is by no means impossible.
3. Can we sell a stake in the firm and continue the partnership?
Possibly, but not exactly.
If you are bringing a new partner into the partnership, there is the chance that their capital contribution pays for the exit of others. This succession model is very common for internal promotion, where it is more understood that the incomer is ‘paying’ for the retirement of the outgoer (however indirect or notional that payment may be).
More commonly, where a stake is sold in the firm it is to an outside funder (eg a private equity house, or in an initial public offering). That being the case, the firm would have to be an ABS and would be very likely to be a limited company. So in that sense the firm and the partnership do continue, but under a different legal structure (which has its own complications and issues).
4. Who could we sell the firm to?
Many people will look to their immediate competitors as potential acquirers, given the obvious synergies. Equally, some deliberately avoid those and go further afield as they seek to become part of larger firms with more depth and breadth to their services.
Other external investors include venture capital and private equity houses. There are also several consolidators and so-called ‘succession solutions’ who are actively seeking to acquire multiple firms in short timescales.
5. Are there any external investors willing to buy a law firm?
Yes, absolutely. There are several venture capital and private equity houses who have bought/are looking to buy law firms. There are also several firms who have floated on the stock market.
To be attractive to external investors, it is important to have a very clear business model and business plan. The investor needs to see how they will get the return on their investment in the short/medium term and what makes your firm unique. This does not have to be a niche area of the law or a bespoke IT package. It could be as simple as a having a particular geographic presence or a decent reputation/brand.
6. Are there any consolidator firms willing to buy?
Yes. These tend to work by taking on your back office functions (eg marketing, finance, etc) which creates an instant increase in profitability by sharing fixed overheads over more work. This in turn leaves the lawyers (whether that is you or your successors) to get on with what they do best.
For the right firm it can be a neat solution to a problem, especially where the next generation are not willing or able to take over. However, some report that the centralised functions are spread very thin, and that over time it becomes unclear if they are value for money as they take the future profits for minimal involvement.
7. How do we work out the value of the firm?
There is no one answer and in this area it is crucial to take professional advice.
The textbook answer is a multiple of either maintainable earnings (ie profit with suitable adjustments made to it) or a multiple of turnover or assets (being careful to distinguish between the book value of assets in the accounts and what they could actually be sold for).
In practice, the value is only as much as a willing buyer and a willing seller can agree on (usually late at night over multiple coffees!). Having a sensible mediator to run these conversations is key.
8. Do people still pay for goodwill when buying a law firm?
Yes they do. However, not in every case and it does vary considerably based on the attributes of the firm.
Even where they do not, there are still some areas to discuss. These might include realising work in progress and partners’ current/capital accounts that might otherwise go unpaid, finding a good home for clients and staff, and avoiding potential closure liabilities such as redundancy, onerous leases and run-off cover.
9. What value is placed on work in progress when the firm is sold?
More than you may think and so this is important.
Accountancy rules (known by its old name of UITF40 but actually Financial Reporting Standard 102, Section 23) dictate that the book value of WIP is likely to be very low, as you have to be virtually certain of its recovery. This immediately excludes many matters, especially those at an early stage or on conditional fee arrangements. However, in a sale negotiation there is no obligation to follow UITF40 – though the acquirer may wish to!
Instead, it seems fair that work properly done under your regime should be reflected in the consideration that you receive, the difficulty being in valuing those items. How complete is ‘nearly finished’? Will the court find in your client’s favour? Will the client pay? Will some of the recorded time have to be written off?
This area becomes very complicated very quickly. It is often the subject of days of careful due diligence and investigation by specialist accountants to come to a ‘fair’ representation of the WIP’s true worth. One number it is very unlikely to be is the figure in the financial statements!
10. What value is put on the tangible assets (eg the building)?
Probably very little. The second-hand value for desks, chairs, etc is effectively nothing.
If you own (and many firms rent) the building then clearly it has a market value (easily obtained from a surveyor), but that does not mean the acquirer wants the building. Many a former law firm building has found itself turned into luxury flats or a boutique hotel.
That said, acquirers are always keen to maintain a status quo. Many clients do not know the name of their solicitor, but they do know the address or the telephone number. The acquirer needs to harness that brand awareness – one mechanism to do that is keeping the same premises, at least in the short term.
11. How can we maximise the value of the firm?
The ultimate answer here is to be good at what you do and to be profitable. Clearly there are a number of ways to achieve that. Some are obviously financial (eg control overheads), but others are much less tangible (eg are your staff well motivated and trained?).
Whichever route you take (and there are several), maximising value in an exit scenario is not something you should leave until you step into the negotiating room. Have a five-year plan so that you can exit the firm on a high point – when potential acquirers can perceive the value they are getting, as well as what they can add to take it to the next level.
12. How can we minimise tax when we sell the firm?
This need not be complicated, but it is important to get it right. There are many potential taxes that could affect a sale, including income tax, national insurance, capital gains and VAT. The interplay between all of them is too intricate to detail here.
The short answer is to take some pragmatic taxation advice and seek to maximise normal reliefs, without doing anything that is contentious or open to challenge by HMRC. For example, entrepreneurs’ relief is well documented and encouraged by the tax system. It can allow gains to be taxed at 10% which is clearly better than higher rate income tax at 45%, so taking advice as to what qualifies for that relief becomes key.
13. What do we need to do to make the firm sale-ready?
Much of this is about being profitable and successful, but I’m sure you were doing that already! The particular nuance when it comes to sale is making sure that the firm can survive without the principals.
This may mean widening client relationships early, so that clients are not affected by a transition of fee-earners. It may mean professionalising the management and support functions, so that the managing partner is no longer required to run the firm. Whatever the exact requirement of your circumstances, the acquirer needs to see how the firm will continue without you.
14. Do I have to be a certain structure (like an ABS) to sell up?
No, you do not. However, if you are looking for external investors then being an ABS would be a requirement.
15. What is the process for selling the firm and how long will it take?
The process should start years before in grooming the firm and making it ready. Thereafter the actual sale process starts by identifying potential suitors and approaching them if you have not already done so.
We always advocate an initial meeting over coffee to assess style/culture etc, with no specific conversations about valuation or mechanics. There are two reasons for this. Firstly, you are about to enter into a negotiation with them and it helps to see them as another human being. Secondly, you are likely to be working with them for some time – at least for a small handover period, but possibly in a fee-earner/consultant role for many years.
Thereafter, each process is slightly different. It usually involves some form of due diligence (which ranges from an hour or two of looking at files through to weeks of formal appraisal by specialist accountants), initial valuation and offer, negotiation of price and heads of terms, tax structuring, and ultimately a signed sale and purchase agreement.
16. What is the subtle difference between a sale and a merger?
This distinction is important as it can be emotive, so whilst you might think this is only terminology it hides an important cultural point.
In a so-called merger, one side will often perceive themselves as the bigger partner and thus as an acquirer that is effectively buying the other firm, whereas the other side may be thinking it is a merger of equals. If the transaction sets off on this footing, it can unravel over time as that cultural imbalance plays out.
It is important to establish early on if you are the bigger fish or the smaller one and to make sure you are comfortable with which way around the deal is going. A truly equal merger is very rare.
17. Other than price, what are the key terms we need to negotiate in the sale agreement?
There are many intangible features to consider – such as style, culture, ongoing support for staff, clients, etc. Some elements will be more important to you than others.
It is also worth noting the other variables within the consideration, in addition to price. These are ongoing employment (ie if you are being kept on for a considerable period, with what remuneration?) and deferral (ie if the consideration is to be paid over time, then on what basis?).
18. How do I start the sale process?
Get some professional advice from an adviser with suitable knowledge and experience of selling law firms.
Be aware that some law firm ‘brokers’ are more reputable than others.
19. How long will it take to sell the firm?
The fastest I have ever done it was six weeks. However, that was a distressed sale and a unique set of circumstances. Three to six months is more common.
20. What advisers or agents will we need and how much will they charge?
In theory, you could do it yourself. However, there is an old adage about having a fool for a client!
You are likely to want at least an accountant (for the valuation and tax structuring) and a corporate lawyer (for the drafting of the sale and purchase agreement). It is usually helpful to have someone (which might be the accountant or lawyer) as ‘lead advisor’ in a project management role and acting as ‘honest broker’ to all sides. This helps professionalise the process and remove some of the emotion.
21. What due diligence should I undertake as vendor?
Some believe the answer to this question is none! But remember that you are entrusting your clients and staff to them. Moreover, if the consideration is deferred then you will be a creditor of their business.
As a minimum, you want to check that the other side is financially sound and likely to be able to pay staff (and any deferred consideration) in the future.
22. What due diligence might an acquirer undertake?
Each one is different. This can range from a few hours ‘kicking the tyres’ to multiple days inspecting files, financials and quality of staff.
In either case, the basic premise is that they want access to certain matter files and to your financial data (such as accounts, ledgers and budgets/forecasts).
23. How can we minimise disruption to employees and clients during the sale process?
If done properly, there should be minimal disruption to begin with. That said, it is important to keep these stakeholders updated and communication flowing. Employees will likely fear the change and upheaval that comes with being part of a new organisation, so bringing them into the conversation as early as possible and with as much involvement as you can is key. I have seen “team on team” meetings early on to break the ice and pre-sale negotiations get down to very finite detail (literally in one case deciding whose coffee brand to use in the staff kitchen), all in an attempt to minimise change where possible.
For clients, they should primarily be reassured by knowing that their matter will continue where it left off, almost certainly with the same staff dealing with it. The usual approach is to write to them (or contact directly if a very important client) and explain what has happened. They are of course free to choose any legal representative they wish and it is not unheard of for some clients to pick this moment to change legal supplier; however, my experience is that this is caused by historic service issues/breakdown in relationship and the change in ownership is a useful excuse for a client who was already on their way out of the door.
24. How do I keep the sale process discrete?
Your accountant and solicitor should be capable of keeping the process confidential. Ultimately it will become public knowledge, but you should be able to control information to some extent using non-disclosure agreements etc.
25. Are there any regulatory concerns when we sell the firm?
From the SRA perspective, the most important issue is who is taking ownership of the client matters and ledgers and therefore who is deemed as the successor practice. This may not be straightforward, especially if some clients are remaining with the original firm.
Other issues that will need to be addressed in detail include the requirements of Companies House, Legal Aid Agency, HM Revenue & Customs and others.
26. What are the implications if I need a quick sale?
As any retailer will tell you, if ‘everything must go’ then the only way to do that is to slash prices. However, that need not be unreasonable. Even in quick and/or distressed circumstances, it is still possible to achieve some level of value, even if it is less than a more normal sale.
27. If I cannot find a buyer what are my alternatives?
Perhaps this would be the time to rethink internal succession options, perhaps recruiting an individual to fill that gap?
Ultimately you can always enter run-off cover with your PII broker, but that (together with any redundancies, lease obligations and so on) can be a costly exercise.
28. Will Covid-19 affect law firm M&A?
The impact of any Coronavirus-related recession and economic downturn is uncertain.
Generally, it is likely that we will see an increase in distressed sales. So healthy firms should ensure that their 'house is in order' before they come to market, to avoid any perception that it is a distressed sale. For acquisitive firms, it is likely to be a buyers’ market and a good opportunity to grow through acquisition rather than organically.
There is a useful June 2020 Armstrong Watson recorded webinar called What Law Firm Mergers Look Like in the New Normal (Andy Poole, Tom Blandford, Andrew Roberts and Mark Briegal in discussion).