Deal Structure for Law Firm Sales

Corporations 101

What are the mechanics of buying and selling a law firm? First, let’s go back to law school for a moment. For those of you who have never done transactional work during your career, law firm buyers purchase the firm’s equity or assets. In the former situation, the entity remains in place. In asset deals, buyers acquire assets that are then placed in the buyer’s existing entity.

Most buyers prefer asset deals and do not want to take the risk of assuming any liabilities of the seller’s law firm. Assets typically purchased include files, website, contact information, systems, and equipment. Asset deals occur most frequently when the seller is a solo practitioner, and the buyer is a larger, more established small firm.

Tax 101

Of course, Uncle Sam often plays a role in deciding how deals are structured. Generally speaking, sellers prefer equity deals because some of the amounts realized are taxed at a preferable capital gains rate. In asset deals, sellers receive money that is all or partially taxed as ordinary income. It’s above my pay grade to explain other tax consequences other than the maxim that what’s good for one party tax-wise will usually be bad for the other.

Other Factors Impacting Structure

From my experience, most sellers fall into two categories. The first category is those who want out ASAP. Sellers in the second category prefer to hang around for a few years and help the buyer as needed. The seller’s willingness to work for the successor can sometimes dictate a deal’s structure.

I Want Out Now!

When sellers want to ride off into retirement sunset sooner rather than later, the transaction, more frequently than not, is labeled a sale. Assets or stock are sold, and buyers hope their revenue stream will increase.

One downside of a sale is the need to comply with Rule 1.17 and its requirements. While that factor in and of itself rarely drives the decision of a transaction structure, it can tilt the balance.

Not So Fast! Going “Of Counsel”

Lawyers, especially solos, looking to hang around for a little with a buyer and slow down during the last years of a career, frequently go “of counsel” with the buying firm. In this scenario, the selling lawyers shut down their firm and then join the acquiring firm as full or part-time “of counsel” employees. The ABA has defined an “of counsel” relationship as a “close, regular, personal relationship” with the law firm. Many people label such arrangements as mergers. Whatever one calls it, as a practical matter, a law firm is “buying” a practice.

Should one go “of counsel,” the actual “sale” price is reflected in the compensation package negotiated with the successor firm. Buying firms tweak their compensation formula and pay the selling “of counsel” lawyer for work performed on seller-originated files. Sellers receive a percentage of the future gross revenue, much like an earn-out. But when you go “of counsel,” the percentage is known as origination, which is similarly in the 10 to 25% range. In this setting, signing bonuses replace the down payment often seen in formal sales.

In addition to the origination amount, packages may also include pay for your legal work.

Some firms will compensate non-billable time for transitioning clients and any necessary training and mentoring.

The Devil is in the Details

As with all business transactions, the details become more complicated when the parties finally negotiate all terms. But the details are usually very manageable, and the results are well worth the effort for both seller and buyer.

Feel free to reach out to me to discuss this further. You can reach me at 612-524-5837, or you can contact me online.