Preparing For A Law Firm Sale – What Documentation Do You Need?
Though long and satisfying, a career in law also has its sunset years. You will have to think about what to do with the law firm you have built for years through blood and sweat at some point. You will want the best for your law firm as you’ve done for many years. One decision that most law firm owners consider is selling the law firm. It’s not an easy decision, but it’s a rewarding one that ensures you get some compensation for the years of work put into the firm.
Like a case, you should have a plan, follow jurisdiction rules and ask for assistance when necessary to ensure you get the valuation and sale of the firm right. You will also need several documents, as highlighted below.
A Written Notice
Most law firm sale structures require a written notice to your active clients. Depending on your state rules and the sale structure you choose this notice may contain information about the proposed sale and the client’s right to retain other counsel or take possession of the file is one of the initial documents you will need as per the ABA Model Rule 1.17, adopted in 1990. However, if you are merging your practice, joining another practice or selling with a plan to continue for some time this notice requirement may be a bit different than under 1.17 and should be used to inform clients, referral sources, community and others of your continuation plan and introduction of the successor.
Before selling your practice, you should check your state’s rules. Some states have adopted Rule 1.17, and others have variants of this rule. And remember, your sale structure matters when looking at the ethical requirements.
Pricing is a vital factor in the process of selling a law firm. Like other businesses, there’s more to the firm’s value than meets the eye. Start by hiring a CPA or consultant to help set the firm’s price.
Although physical assets like furniture are a part of the sale price, they are not the initial focus of evaluating the cost of the law practice. Buyers are more interested in the firm’s goodwill or adding practice areas.
The CPA or consultant you select will value the fixed assets and goodwill of the firm. While assets are much easier to value, goodwill is slightly different. For goodwill, the consult will evaluate:
- The firm’s net tangible assets on an accrual basis
- Add back benefits and compensation to reconstruct the net income and subtract a reasonable compensation package
- Calculate the average of the reconstructed net income for three to five years
- Multiply the net tangible assets from the reconstructed net income average by a reasonable return date
- Subtract the reasonable return from average reconstructed net income (Excess net income)
- Capitalize on the excess net income to arrive at goodwill.
The goodwill and firm asset valuation determine the price tag to attach to the sale of the law firm. It’s crucial to remember that according to the ABA Rule 1.17, the fees may not be raised because of the firm’s sale.
An Offer-to-purchase Agreement
After the valuation process, you will set out to find a buyer. Considering this is your lifelong work, you want to find a buyer with a good reputation, ample experience and education to run the firm profitable. Potential buyers can include attorneys looking to expand, lawyers, coming out of Biglaw or even a lawyer currently working in your practice.
Once you identify the right buyer and there’s serious interest in the firm, you will need an offer-to-purchase document. This is a legally binding contract containing the details of the sale. Some of these details include:
- Purchase price – This is the price you have agreed with the buyer to purchase the law firm. Some OTPs will also include additional terms like an expiry date for you to accept the offer on the purchase price or make a counteroffer.
- Conditions of sale – This is possibly the most essential aspect of the sale agreement. It details the conditions of the sale, usually agreed upon by both parties.
- Occupation date – It’s prudent for the Offer-to-Purchase to have an occupation date for a smooth transition. By the occupation date, you should have removed all personal effects and other items not part of the sale from the premises and have it ready for occupation by the new owners. You can also have a transition period set out so the new owners can come in and learn the ropes of how things run at your law firm.
The terms of the sale contract can be extensive depending on your wishes and desires and the running conditions of the firm.
A Note on Seller Financing
The buyer has multiple financing options when purchasing the law firm. Seller financing is one of the fastest and most convenient methods, especially in a shrinking credit market.
In this case, you take on the role of the lender. You and the buyer will sign a promissory note containing the financing terms and record a deed of trust (in some states) with the local public records authority.
This approach applies if the buyer cannot afford to purchase the firm outright and would rather pay installments.
Current and Past Financial Statements
Any shrewd buyer will want to understand the law firm’s financial health. The easiest and most practical way to do this is by requesting that you provide current and past financial statements of the business, usually up to three years. This allows them to verify that the firm is profitable and has been growing.
A Statement of Seller’s Discretionary Earnings
A statement of the Seller’s Discretionary Earnings (SDE) calculates the financial benefits that you have derived from a business on an annual basis. Some buyers may also present this as an adjusted cash flow request.
This statement gives the buyer insight into how clean the business’s financial details are. The leaner or more practical your SDE statement is, the more likely you will sell the firm at the best price and terms.
Cash Flow Statement
As the buyer shows more interest in the firm, they will request a cash flow statement. The statement has detailed information about the business’s cash flow, indicating how much money the business is making and spending. The cash flow is vital in several ways:
- It gives the buyer insight into the spending activities of the firm
- It gives the buyer ideas on how to increase cash flow in the firm, potentially
- Provides a basis for a working capital analysis
- Improved knowledge of cash balance
- Insight into potential crisis management planning for firms in financial constraints
Contact The Law Firm Brokerage Experts
Although this is meant to be a baseline of what you may need to sell your law firm, buyers can and often do request additional documentation depending on the details and complexity of the firm’s sale. It’s highly recommended to engage experts at every corner to get the most value out of the sale and the firm’s best terms with the new owners.
Selling your law firm is a complex process and with the right team on your side, you can maximize your firm’s value and reduce your stress throughout the process. Contact our team here at The Law Practice Exchange today for a confidential, no-obligation consultation and find out more about selling your firm.