Are you preparing to buy or sell a law firm? If so, it is imperative that you have an accurate valuation of a legal practice. This raises an important question: How do you appraise a law firm? The short answer is that you must take a comprehensive approach that properly accounts for the practice’s hard assets, intangible value (goodwill), and liabilities.
At The Law Practice Exchange, LLC, we are leaders in the appraisal of legal practices. Our team of skilled professionals strongly believes in taking an individualized approach to law firm valuation. We want to make sure lawyers have the tools and knowledge that they need to protect their financial interests. In this article, you will find a comprehensive guide to appraising a legal practice.
An Appraisal is an Expert Valuation of a Law Firm
Every Business has a marketable value. A legal practice is no exception. The challenge with a business—especially a law firm—is that assigning a precise value is difficult. Law firms as business models vary by practice area, location, and ownership structure, and two firms that look similar on the outside can be very different once a valuation is done and all internal factors are considered. Professional support is a must. As defined by the Corporate Finance Institute (CFI), an appraisal is simply “an expert’s estimate of the value” of a particular asset. Anything can be appraised—from antiques to real estate to a legal practice. When a complex asset, such as a law firm, is being sold or otherwise transferred, a comprehensive and reliable appraisal is a must.
Owner’s Earnings are Often a Baseline in the Law Firm Valuation Process
There is not one specific method to value a law firm. Instead, the appraisal of a law firm is highly fact specific. All of the assets—including things like goodwill, brand value, and other intangible assets (client matters or cases, website, phone, etc)—must be considered. In addition, the liabilities of the legal practice should always be evaluated.
Most often, the net income or owner’s earnings of the law firm is used as the fundamental baseline to conduct the appraisal. A law firm’s value is often considered somewhere between two (2x) and three times (3x) of the average annual net income after some adjustments. That’s a wide range and some even go higher while some are lower, but it depends on many factors in the appraisal to determine where on that scale a law firm may land.
However, it is important to emphasize that there are exceptions as well which can break out of that range. As well, it is important to note that other valuation methods are utilized in addition to the net income. A legal practice that is being appraised must be carefully evaluated. In some cases, a practice may be worth more than net income would suggest. In other cases, a law firm’s net income may overstate its value.
Three Key Steps in the Legal Practice Appraisal Process
An appraisal of a law firm is a key component of any type of transition. You need a reliable and accurate valuation of a legal practice if you are preparing to buy a firm, sell a firm, or develop a succession plan. An appraisal should be comprehensive. Careful attention should always be paid to any unique value propositions offered by or drawbacks associated with a legal practice. The steps in the process may include the following:
- Discovery: The law firm appraisal process generally begins with discovery. Among other things, this aspect of the process typically entails an assessment of purpose, gathering of all relevant financial documents and records, and gathering all non-financial information about the history and operations of the firm. Only when an appraiser has comprehensive information will they be in a position to accurately value a legal practice.
- Analysis: An appraiser will conduct an in-depth, detail-driven analysis of all of the documents, records, and other business information that they collected. The analysis will provide a valuation for a legal practice based on several different factors, including revenues, net income, recent sales of comparable law firms, unique strengths and weaknesses of the legal practice, and other material issues.
- Appraisal: As a general matter, an appraisal is sought for a purpose; it could be a sale, a purchase, or a transition/succession plan. Regardless of that purpose, the appraisal of the law firm needs to be well-supported. That an expert assigned a particular legal practice is not going to do much unless you can support their assessment in negotiation or business planning. This is why you should always work with a professional who can provide a comprehensive law firm appraisal report.
The Law Practice Exchange is the Leader in the Valuation of Legal Practices
At The Law Practice Exchange, LLC, we are the experts in law firm brokerage services. Our team is built by lawyers for lawyers. The importance of an accurate law firm appraisal cannot be overstated. If you have any specific questions or concerns about the appraisal of legal practice, we are more than ready to help. Call us now or connect with us online to set up a fully confidential appointment. Our brokerage firm provides nationwide law firm appraisal services.