How Do You Value a Law Firm?

The legal industry is competitive. The American Bar Association (ABA) reports that there are approximately 1.3 million licensed attorneys in the United States. Those attorneys work across more than 400,000 law firms—with the overwhelming majority being small law firms having nine or fewer attorneys on staff. Given the numbers of these law firms, it begs the question of how these law businesses are continued as ownership changes over time. In many ways, a law firm is similar to other businesses. One of these is that it can be bought or sold. 

The first step in buying or selling is always to look at what’s the value of the business. However, there is an inherent challenge that comes with valuing a law firm for when considering an exit planning, sale, or purchase. Whether you are considering selling your law firm, buying a more significant stake in your current practice, or buying a separate law firm, it is imperative that you know how much it is worth as a benchmark to set other details in place. In this article, you will find a comprehensive overview of the key things to know about how to value a law firm. 

Every Firm has a Marketable Value—But It Can Be Difficult to Determine a Precise Number

Every law firm in the United States has a marketable value. It is worth something to somebody. The core challenge of buying, transferring, or selling a law firm is that it can be challenging to put a precise dollar figure on the value. A law firm’s “goodwill”—an intangible asset that encompasses its reputational value—plays a big role in the valuation of a law firm. 

An Overview of Methods to Value a Law Firm

There is no “one” correct way to value a law firm. There are several different common methods that are used to determine how much a law firm is worth. What makes the most sense for your situation depends on the specific factors. Some methods that are used to value a law firm include: 

  • Rule of Thumb Approach (Revenue): Known by the short-hand “rule of thumb” method, this law firm valuation approach looks at revenue. The law firm’s value is presumed a multiple—usually one or less—of a single year’s total revenue.  
  • Asset-Based Approach: With the asset-based approach, value is assigned to the tangible and intangible assets held by the firm. The approach can be useful for law firms that own significant tangible assets, such as receivables, cases in progress, or other non-goodwill assets. 
  • Market Comparison Approach: The market comparison approach looks at similar sales that have occurred in recent months or years. A comparator law firm can help to provide a baseline. 

It should be noted that law firm valuation methods are not “either/or.” In most cases, it makes sense to consider multiple different valuation approaches to determine the proper valuation for a law firm and when a true valuation analysis is done more approaches are utilized and typically weighted by how applicable they may be to the subject law firm. 

Many Factors Affect the Valuation of a Law Firm

A law firm should always be valued on a fact-specific basis that considers all methods, but also the non-financial aspects of the firm that may make it unique and push the value up (or down). A careful assessment is needed of the law firm’s prior, current, and future financial position along with these other factors. There is a wide range of different things that will impact the core value of a law firm. Specific factors that can impact the valuation of a law firm include: 

  • Revenue (both historical and year-to-date)
  • Size of practice (number of attorneys and staff)
  • The value of hard assets
  • Ongoing financial liabilities, including debts 
  • Historical and current-year profitability
  • Type of practice area
  • Location of the practice
  • Involvement of the owner-attorney in legal work
  • Marketing and brand
  • Demand for practice area
  • And many more.

Law Firm Valuation Tip: Documentation is key. Whether you are buying or selling a law firm, it is crucial that you thoroughly review all of the firm’s financial documents and records. This includes everything from annual financial statements to business tax returns to appraisals of hard assets. To determine the true financial picture of a law firm a comparison and new model of the financials are usually built to show the true normalized financials.

Both Buyers and Sellers Need to Get the Valuation Right 

Price matters. A seller of a law firm that undervalues their business is getting less than they deserve. An enormous amount of time and effort goes into building a successful law firm. Along the same lines, a buyer that pays more for a law firm than it is actually worth will be in a challenging financial position. It may be difficult to make out well on the investment. 

The Bottom Line: A law firm is inherently difficult to value, but market value metrics and experts are available to help more now than ever before. A wide range of different unique factors must be considered to determine how much it is actually worth and a skilled professional who has experience with law firm valuation can help you determine the value. 

The Law Practice Exchange is a Leader in the Valuation, Buying, and Selling of Law Firms 

At The Law Practice Exchange, LLC, we were built by lawyers for lawyers. If you have any specific questions or concerns about how to value a law firm, we are here as a professional resource. Contact us today to set up your fully confidential initial appointment. We are also proud to be the nationwide leader in law firm brokerage services

Buyer Financial Pre-Qualification – What, Why and How?

You’ve decided that it’s finally time to take the step and move forward in exploring a purchase of a law firm. You have located one or a few potential law firm listings that you think may be the right choice for you or your law firm’s needs and you are ready to get things moving. However, there is one thing you should do before diving into a review of the law firms, financials, calls, and meetings to see if one is the right opportunity for you –  you should get pre-qualified for the purchase of a law firm.

What Is Pre-Qualification?

If you’ve ever gotten a home mortgage before, you may already be familiar with the process of pre-qualification. Pre-qualification is a preliminary commitment from a lender to give you a set amount of money that you can use to fund the purchase. The lender will supply you with a pre-qualification letter or document that you can present to brokers or to sellers when you reach out expressing interest in the law firm(s).

Why Get Pre-Qualified?

If you are going to require financing for any portion of the purchase of the law firm, it is crucial to get pre-qualified before you take any further steps. Even if your needs are only for working capital and not related to the acquisition price of a firm you would still want to make sure that key piece to the equation can be fulfilled. Doing so at the beginning of your search will provide a number of benefits:

Saving Time – By applying for pre-qualification, you’ll know up front whether or not you’ll even be able to obtain a loan of the type, the amount or for the purpose needed. In the event that you can’t obtain pre-qualification with your current lender due to that lender’s industry focus, you’ll have time to connect with a lender which is focused on law firms and move things forward for you as needed.

More Focused Search – Your pre-qualification will let you know precisely how much you can spend on the purchase of a law firm and what works for your goals, needs and overall financial risks.  As a result, you’ll be able to focus on the law firm that you can afford. The improved focus will make for a more streamlined search process and help you find the perfect law firm to buy much faster.

Expanded Options – Some prospective law firm buyers are pleasantly surprised by their pre-qualifications and find out they will be able to afford a different scale of law firm than they anticipated. Once you know how much you will be able to borrow, you may be able to expand your search to more profitable or larger law firms that may be better fits for you or your firm in the long run.

Credibility – Having a pre-qualification letter from a lender will show sellers that you’re the real thing. By establishing financial credibility from the start, you’ll be in a better position to negotiate. When sellers take you seriously, they’ll be more cooperative and eager to work with you.

How to Get Pre-Qualified?

To get pre-qualified, you’ll need to approach lenders and complete an application. Lenders may want to see proof of income, bank statements or tax returns, so it’s helpful to have those documents together.

If you’re looking for assistance with pre-qualification or want to line up your next steps so that you can begin searching as soon as you have your qualification paperwork, The Law Practice Exchange can help! Contact us today and we can provide law firm marketplace lenders and other resources to help you expedite this process.