So what’s my law practice worth?
How’s this for an answer? “Whatever someone is willing to pay”? If you need a more precise answer, consider this: the literature, written primarily by CPAs, describes a wide range of valuation methods. Many are difficult to comprehend unless you have a strong finance background. Even then, the formulas typically have little or no bearing on what is actually paid for a law practice.
Why don't the usual appraisal methods used by CPAs work for law firms?
Primarily because law firm revenues are relatively unpredictable. Other professional service businesses that are frequently bought and sold, like accounting practices and medical or dental practices, have fairly predictable books of business. The transferability of an attorney’s book of business is much harder to predict. In large part, this is because many services that lawyers perform are one-time or, at best, sporadic. In addition, certain client relationships may not be as easy to transfer as the seller and buyer hope.
Can't you use a multiple of revenue (aka the Rule of Thumb)?
Many lawyers try to apply the “Rule of Thumb” valuation method because of its simplicity. Under this method, a firm’s value is expressed as a multiple of revenues—usually gross revenues. In most other industries, you can derive the multiple statistically from the sales of many businesses of the same type.
So why not use the Rule of Thumb?
First, the marketplace for law practices is very immature. There is no meaningful database due to the low number of deals occurring in the industry.
Second, and even more problematic, is the fact that most lawyers complete deals confidentially—no one but the lawyers themselves know the terms.
Finally, even if a sufficient base of knowable transactions existed, you would be hard-pressed to find a worthwhile multiple due to incomparable data—practice areas are too different. For example, comparing a one million dollar family law practice to a one million dollar estate planning practice is like comparing apples to oranges. They are two fundamentally different businesses. They only thing in common is that their owners are licensed attorneys.
What about working with a CPA who regularly appraises law practices when an attorney gets divorced?
A divorce setting is very different from a selling setting. Remember, the key to appraising a practice is predicting future revenue. In a divorce situation, an appraiser can usually reasonably assume that revenues from a divorcing attorney pre-divorce should be very similar to revenues post-divorce. In this setting, appraisal formulas make sense. The same cannot be said in the sales situation. For many practice areas, it is not so easy to predict how much revenue a successor will be able to bring in. It will largely depend upon the practice area and many CPAs are simply clueless about those nuances.
What then is Roy's appraisal method?
To get a sense of Roy's method, go through this little exercise:
Imagine it is a Friday afternoon. After years of hard work, you’re ready to ride off into the retirement sunset. When Monday morning comes, will existing clients or prospective clients still contact you and agree to work with your successor?
If your answer is “no,” your practice is probably worth little to nothing. If your answer is “yes,” you’ll need to ask two more questions.
Will I get referral fees if I sell?
No. But thinking about future predictable revenue in the context of referral fees is a concept that lawyers can wrap their heads around.
So how does Roy determine the right number?
He appraises practices by taking a percentage of predictable revenue over a timeframe. For many deals, Roy’s appraisal methodology is an excellent starting point for negotiations. Depending upon the circumstances surrounding the transaction, however, it may not be the ending point.
If you’d like more information on other market realities, as well as a more comprehensive discussion of Roy’s appraisal method, consider reading Roy’s eBook, Exit Strategies for Lawyers. It’s only about 40 pages long and it will tell you everything you’ve ever wanted to know about how to value a law practice and a lot more!
Roy Ginsburg, attorney coach and law firm succession consultant, can provide you with the valuation insight you need to prepare your practice for sale. Call him today at (612) 524-5837 or contact him by email.