New Opportunities for Buying and Selling Law Practices

By Edward Poll
Published in Los Angeles Lawyer

Table of contents

Introduction

Selling a law practice has been prohibited for decades. Times are changing! California has permitted such sales since 1989. The American Bar Association altered its opposition in 1991. Since then, other states have changed their prohibitions. The legal profession is taking one more step toward recognizing the economic realities of modern professional life.

Some attorneys in larger firms have bemoaned the commercialization of the legal profession. Yet, these very same attorneys have always had mechanisms in place that provided them and their heirs with funding for the value of their interests in the larger firm. Allowing small firms and sole practitioners, and their heirs, the opportunity to reap the rewards of years of effort in building a valued reputation from delivery of quality legal services levels the economic playing field in considerations for retirement and estate planning. Now that all attorneys can sell their practices, the true value of the practice, by reference to the marketplace, can be determined.

Slowly, the mechanisms for selling the law practice from one attorney to another attorney are developing. Larger firms are accustomed to the process of buying and selling a practice. The process is called "merger" or "retirement" or "breakup," among other headings. An increasing number of sole practitioners and small firm partners are thinking about getting out of the practice of law and doing something else. What else? That is less clear. But, many attorneys have left the practice of law, just closing their office doors one day and never returning. By doing this, the attorney forsakes "cashing in" on a valuable asset that has taken many years to build. That no longer has to happen.

And, what about the situation where the attorney dies suddenly and leaves his/her spouse to "mop up." Is there anything of value that can be sold? Yes, there are the books in the library, the used computer equipment, the office furniture and the like. There are also accounts receivable. But, there are also client files and goodwill. This goodwill and the clients' files have value. And that value can now be recognized as a result of the change in the Rules of Professional Conduct.

Value vs. Price

The right and ability to sell a practice says nothing about the value or price to be paid/received for the sale of the practice. These are separate issues. An attorney should realize that his/her practice is valuable and that the value (not the practice) can be passed on to the heirs of the attorney at time of death or otherwise become part of the attorney's estate if the practice is sold before death.

Is every practice saleable? Maybe not. Some practices are so small and so personal in nature that without a continuing involvement of the first attorney, a second attorney would not succeed in keeping the clients. However, even the smallest and most personal practices might be saleable for the right price and under the right terms. If the buying attorney were assured that he/she would receive that which was negotiated ... a law practice of a certain volume of revenue or a certain client base that remained with the buying attorney for a designated period of time ... a sale would be highly likely even for the smallest firm.

Then, the question every attorney wants answered is: "How much can I get for my practice?" At this point, "valuation" issues are out the door and the "bottom line" question is asked. The price to be paid may be estimated by reference to financial data and certain market place guidelines. But, no amount of analysis will determine the precise price a willing buyer and a willing seller will accept. That figure is subject to many different factors including terms of payment, geography, nature of the practice, history of client retention by the selling firm and size of the practice. But, whatever the price, a key issue for the buyer is whether the buyer will retain the practice being sold. In order to assure the buyer, an earn-out or pay-out based on collections may be created. This will assure the buyer that payments will be made only for designated revenues received. The selling attorney then has an incentive to help the buying attorney in his/her efforts to keep the clients of the practice.

Additional information on how to value a law practice and specific tips concerning the negotiation of the price to be paid may be obtained from Selling Your Law Practice: The Profitable Exit Strategy (pub. 2005).

Who Would Buy A Practice?

We can imagine the seller, the attorney who has been in practice for a number of years and wants to retire, the attorney whose dreams of what the practice might be like just haven't been fulfilled, the attorney who has been elected or appointed to a judgeship, the attorney whose family has decided to relocate to another geographic area, etc.

But, who's buying law practices? First there are the lawyers practicing in larger firms who want to go out on their own. Some law firms have grown so large that the individual lawyer feels lost or out of step with the new culture of the large firm. Operating your own practice is a way of retrieving the personal touch and total involvement in the practice of law. Another segment of potential buyers is the larger firms' faithful servants who fail to make the grade on the "partner track." Another group of prospective buyers is attorneys who failed to develop a personal client following and were terminated. As more attorneys find the partnership track in larger firms unattractive or unattainable, as larger firms "down-size" or "right-size," the importance of law firm acquisition choices grows. Sole and small firm practitioners make excellent buyer-candidates.

Yet another group of potential law practice buyers is law school graduates, especially those in the bottom 90 percent of their class who are finding that jobs are not so easy to find as in the 1980s. After spending three or more years in law school and many thousands of dollars on an education, frequently with large student loans to repay, these new lawyers are not willing to shift careers without a gallant effort to succeed on their own. They are going to hang out the shingle one way or another and succeed by sheer determination. While the number of prospective buyers in this category remains small, the number is growing. Stories appear more frequently in the legal press about one success story after another of recent entrants to the practice buying an existing practice. We have many successful examples in other professions. Why should the legal profession be different?

Many lawyers are ready -- either by themselves or with others -- to start their own practices. Many are opting to do what is common in other professions: Buy an existing practice rather than start a practice "from scratch."

How do you let it be known you want to buy/sell a law practice? Business opportunities brokers, law firm management consultants, accountants, valuation firms and appraisers are excellent resources to spread the word that you are looking to buy a law firm practice or that you are looking to sell a practice. Another source, not yet used for this purpose, but not to be discounted, is the Internet and law-related Web sites. In the future, electronic means of spreading the word may be the most effective and least expensive method of communicating this information.

Rules of Professional Conduct

In business, it frequently is easier to buy an ongoing operation rather than start a new one. In an existing business, there is a history of sales, of revenue, that can be counted on as a continuing base. Customers tend to continue their purchasing habits if they like the product or service in spite of new ownership. Costs of operations are known, merely by looking at previous records; little or no guessing is necessary. The buyer can visualize where savings can be implemented by making changes.

The same rationale applies to the purchase and sale of a law practice. The differences between other business enterprises and a law practice are primarily in the areas of:

The Rules of Professional Conduct set forth requirements for transferring one's interest in a law firm. For example, fees charged clients cannot be increased solely because of the sale and the selling attorney must give written notice to clients no less than ninety days before the transfer that clients have the right to their files and to retain other counsel. In other industries, the transfer of ownership is seldom announced en masse because of the desire not to disturb existing relationships. The State Bar has gone overboard to assure clients have the knowledge that they can leave for new counsel. Despite this, however, most clients remain with the new attorney, especially where the selling attorney participates in the transition and assures clients that the new attorney is very well-qualified. The Rules of Professional Conduct raise additional issues that can be answered only by reference to the Rules of each jurisdiction. For example:

  1. Can an attorney break off and sell or buy only a portion of a practice? Assume a rural or suburban sole practitioner who has a general practice and who has developed a sub-specialty in pensions and profit-sharing; the attorney now wants to retire and sell the practice. It may be impossible to find a single buyer who would be willing to come into the community and practice general law and who is also competent to handle the technical pension and profit-sharing work. Can the practice be split?

  2. Does client confidentiality prevent discussion about specific clients or their matters? If not, how can a buyer know the nature of the practice without some disclosures? Would a buyer be willing to purchase something, sight unseen?

  3. Is the sale of a law practice equivalent to a referral for a fee, something that is not allowed in many jurisdictions?

  4. Does an attorney's existing errors and omissions insurance policy cover the new cases acquired from the selling attorney?

  5. Does an attorney's existing errors and omissions insurance policy cover the selling attorney for allegations of negligence made after the transfer of the case and matter files? What about the client who doesn't realize until after the transfer that the alleged negligence occurred? Is the selling attorney protected when the claim for the alleged negligence is filed after the expiration of the policy in effect at the time of the transfer? The alleged malpractice might come from the attorney's own negligence that occurred before the sale of the law practice, but not known to the client until after the sale, or the alleged negligence might have been committed by the buying attorney and the client is trying to use a large net to ensnare anyone who might have "deep pockets." What protection is there for the selling attorney? What are his/her choices?

Conflicts of Interest

The conflicts check will be the last element before the actual transfer. In smaller communities, the possibility of conflicts of interest increases substantially. Has a conflicts check been done by both attorneys? The parties may want to consider, in advance, whether they want to negotiate a modification in the price or terms in the event a conflict of interest does arise in one or more matters that would prevent the buying attorney from taking on that/those matters.

The ethics issues can be resolved. State and local bar associations are becoming more sensitive to the needs and economic realities facing sole and small firm practitioners that do not face larger firm attorneys. Balancing these realities against the legitimate concerns for client protection can result in benefit for both clients and attorneys (and the estates of deceased attorneys).

Some Negotiating Issues

Who should do the negotiating? Would you negotiate the purchase or sale of your own residence? Probably not. Traditionally, buyers and sellers of real estate act through agents, or real estate brokers. Would you negotiate the purchase of a new car? Probably. What is the difference? One difference is the size of the transaction. Another difference is the personal stake in the outcome. If we can't buy the car we want because the seller is obstinate, we'll walk away, not having our ego bruised. But, if we can't get the house we want, our vision of the future and our stature in the community is somehow impacted. To reduce the possibility of this happening, we retain an independent third party to help us. Another difference is that sellers often talk themselves out of a transaction after the deal has been negotiated, but before the papers have been finalized. To reduce the chances of this occurrence, third party experts are engaged.

The nature of the practice of law is very personal. The lawyers must know that their respective "cultures" or approach to the practice are complementary and not too dissimilar. But, until the financial aspects of the transaction are agreed upon, at least in their broad parameters, it is advisable to keep the principals' contact with one another to a minimum. The attorneys will not be practicing together; one will be the buyer and one will be the seller. Therefore, as in the residence example, the less contact between the two, the less the egos of either will become involved.

Conclusion

The practice of law is an honorable profession. The practice of law is also a business. And the efforts and hard work of attorneys over years of toil does have value and can be transferred to the benefit of all concerned.

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