Smart law firm buyers are looking for a firm that throws off a lot of cash, has a steady stream of new clients, and — this is big — will not suck up all their time and resources.
As an Owner, What Do You Want from Your Firm?
I always ask law firm owners the same question: “What do you want from your firm?” The answer has changed over the past decade. While I used to hear “more money,” “fewer hours in the office,” or “more freedom,” lately, I’ve been hearing, “I want to be able to sell in X years.”
I love this answer. Lawyers should be able to sell their firms and be financially rewarded for all the blood, sweat and tears they have put into their businesses. Unfortunately, however, not all firms are created equal, and they are not all equally attractive when it comes to selling.
What Matters Most to Law Firm Buyers?
If selling your law firm is your ultimate goal, focus on what makes your firm attractive to future buyers. Here are three things that matter most when negotiating a sale — and, coincidentally, increase the value of your firm.
1. Healthy Earnings, or SDE
SDE stands for Sellers Discretionary Earnings. SDE is your salary plus draws and all those personal expenses you run through the firm. I don’t care; everybody does it, and it is between you, the IRS, and your accountant. Basically, SDE is your total owner compensation: how much money you take out of your firm each year. (See “How Are Law Firm Owners Paid? Total Compensation vs. Salary.”)
The higher this number, the better. Why? This is how much the next owner will be able to take out. Remember that the next owner has to repay the loan they used to buy your firm. So, more than anything else, a buyer wants to make sure that if they buy a business, it will produce enough profit to support them plus service any debt used to buy it.
What kind of numbers are buyers looking for? At Cathcap, we believe in running firms according to the Rule of Thirds: 1/3 of revenue should go to the people doing the work, 1/3 to overhead expenses (including marketing), and 1/3 to profit. In this scenario, SDE should be at least one-third or higher because we assume the owner also draws a salary. (Read: The Best Compensation Plans Use the Rule of Thirds.)
2. A Well-Run Marketing Machine
Having a marketing machine that fills the pipeline—whether or not the owner is involved—is a huge boost to your firm’s value.
There is too much risk if all of your business comes from a single rainmaker, referral source or a single marketing channel like TikTok or Google. A buyer wants to see a firm that gets clients from multiple sources. No more than 20% of clients should come from a single channel, and 10% is preferable.
A buyer also wants to see marketing that does not involve the current owner’s name, image, voice or personality. A firm like that is tough, if not impossible, to transfer. If you are starting out, set up your firm with a trade name so that ownership can change without needing to change the name. If you are already in business, transition to a trade name immediately. Yes, there are still a few states where local ethics regulations impose restrictions on law firm names. So, before adopting a trade name, please check with your state bar and a legal ethics attorney.
3. Owner Dependence
This is the biggie. How much time, effort and attention does the firm require from the owner to operate daily? The higher the requirement from the current owner, the higher the requirement will be from the future owner.
Traditionally, firms are sold to internal buyers — younger partners in the firm. That is changing. The trend I am seeing, and expect to increase, is firms rolling up smaller firms as a growth strategy.
Buying and incorporating a firm into your existing firm is a great way to grow. However, it means the buyers already have a business to run. They cannot devote 100% of their time to running the firm they’re acquiring. Therefore, they are less likely to want to purchase a firm that requires 60, 50 or even 40 hours from the existing owner.
Frankly, they don’t have that many hours to invest in the new venture. A firm that operates smoothly and autonomously with systems and procedures makes an attractive acquisition. It’s also a pleasure for you to own.
What Does a Savvy Buyer Look For?
As I’ve said before, a savvy buyer is looking for the same things any attorney wants from the firm they own. They want a profitable firm that throws off a lot of cash, with a steady, dependable stream of new clients, that will not suck up all their time and resources.
Do You See a Trend?
If you’re thinking about your firm’s future, consider the strategies outlined above to enhance its value. Focusing on these key areas allows you to position your firm for a successful sale when the time is right. For more insights and guidance on preparing your firm for sale, explore additional resources on our website or connect with professionals specializing in law firm transitions.
If you don’t know where to start, my latest book, “Exit On Top,” is a step-by-step guide to help prepare firms like yours to sell – or own.
More Law Firm Financial Tips from Brooke Lively
For more tips on building a more profitable law firm, read:
Image © iStockPhoto.com.
Don’t miss out on our daily practice management tips. Subscribe to Attorney at Work’s free newsletter here >
