Personal injury law firms are different from other types of firms in terms of practical economics. Here are three reasons why.

• Part of the firm’s value is relatively easy to determine and find buyers for;
• Insider deals for these firms can be problematic; and
• Outside investors are a new pool of potential buyers

Let’s take a closer look at these factors.

Unique opportunity: Easy to Cash Out

The simplest way to understand the value of a personal injury law is to divide it into two components. First, there is the goodwill value. Reasonable people will always disagree about that, since it is so intangible and, at times, very personal to the selling owner. Even if you do find a buyer, reaching agreement on the value of that goodwill is likely to be a sticking point when it comes to price.

However, there is a second component of law firm value that:

• Has real, significant monetary value that is not theoretical;
• Is usually relatively easy to quantify without hiring any fancy or pricey appraiser; and
• Is usually relatively easy to find buyers for

I am talking about a personal injury firm’s case inventory. Whether sold to an insider, a third party, or, if the firm is shut down, the entire inventory is referred out, the inventory can always be monetized. Simply reach an agreement to share the final settlement or verdicts with the buyer.

Most should be willing to accept a typical “third of a third” or a variation thereof, a well-known and accepted custom in the personal injury world. It may take a few years to get all the proceeds, but the cases will eventually provide cash in your pocket.

Case Inventory Example

Let’s say that the inventory is worth one million dollars in attorney fees, assuming total recoveries of three million dollars and a 33% contingent attorney fee agreement. Chances are very good that, over time, the buying law firm will pay you a few hundred thousand dollars. $333,333 to be exact, if you agree to a third of a third. That number could, of course, be lower or higher if you and the buyer agree to a different percentage. Very few practice areas have comparable, valuable assets that can be monetized so easily.

Unique Challenge: Insiders May Be Unwilling to Buy

However, selling a personal injury practice presents unique financing and cash flow challenges that, in practice, can deter many prospective buyers, especially insiders. This hypothetical demonstrates the predicament.

John’s practice typically grosses $3 million a year, and he strongly prefers to sell the firm to two of his trusted associates. Let’s further assume that the parties agree that the firm’s goodwill value is $2 million, with half paid at closing and the other half paid in the future via an earn-out or seller financing. In other words, the purchase of goodwill is largely financed by the firm’s future revenue, making the purchase far more affordable. So far, so good.

Now let’s take a closer look at expenses.

The firm’s monthly overhead expenses are $300K;

• John likes to keep $500K in the firm’s operating account;
• Individual case costs run $100K per month; and
• The parties agree on a formula for dividing the proceeds from the firm’s inventory as the cases settle.
• Goodwill payments

Thus, on day one of the transition, the new owners (the former associates) collectively have to come up with $500K as partial payment for goodwill, plus $500K for the operating account, plus an additional ongoing monthly $100K to fund the expenses of existing and new cases. And to make matters worse, most of the revenue that comes in during the first year will be from the previously seller-owned inventory, and therefore, a significant portion will go to John, the seller. Not to mention, there are also the earn-out or financing payments for the goodwill purchase that need to be made. Cash flow will be a very big problem.

In short, the buyers will need more than $1 million at closing. They will likely need even more financing in years 1 and 2 if they still want to earn a decent salary, because revenues will be insufficient with so much money going out the door for inventory settlements, goodwill earn-out, and financing payments.

Will it be difficult to obtain the funds? Not really. The owner or a bank (especially an SBA loan, which is more available than one may think) may be willing to finance this. Further, it may even be possible for the buyers to take out a second mortgage for some of it. That’s not the problem.

The real problem is that many lawyers don’t have the appetite to take on that amount of risk, especially an insider who is accustomed to being an employee. Most lawyers who work for other lawyers in the PI world usually have little risk DNA. If they did, they probably would have left the firm years ago and started their own.

Imagine the conversation when the potential buyer goes home and asks their spouse whether it’s okay to take out a second mortgage or a six-figure SBA loan that requires a personal guarantee. It’s easy to see why insider deals can die at the dinner table.

Owners should still consider selling to insiders as the first option. But they should be aware that going down that road may cause formidable cash flow issues for intended buyers.

Who Then Buys Personal Injury Firms?

Now, don’t get me wrong. Even if your insiders say no or your firm has no viable insiders to consider, you can still sell it. Instead, buyers will be local or regional personal-injury firms that rarely flinch at assuming risk. In other words, your sale will likely be to friendly (or not-so-friendly) competitors. But for some owners, selling to competitors feels like betraying their soul.

However, recent developments in the law firm ecosystem have significantly increased the pool of buyers. Enter private equity (PE). They’re now investors who use a workaround to Rule 5.4 that prohibits non-lawyer ownership of law firms. That workaround is the Management Services Organization (MSO). Borrowing from a model long used in medical, dental, and accounting, PE investors create a separate entity to handle all back-office functions (e.g., HR, accounting, IT). Remaining lawyers still retain ownership of the firm itself and control the actual legal work. PE earns revenue from the services it provides to the law firm.

Get Help Selling a Personal Injury Law Firm

Personal injury law firm owners who hope to sell to loyal employees face real and substantial financing challenges that are very difficult to overcome. That’s the bad news. The good news is that there is now an entirely new pool of possible buyers who are not even lawyers. That should enhance the market value of all personal injury firms due to the increase in demand.

Have questions about selling your personal injury law firm? You don’t have to figure it out alone. Feel free to reach out to me with your questions. You can reach me at 612-524-5837, or contact me online.