Best Practice: 2-phase approach catching on for law firm successions
Asked and Answered
By John W. Olmstead, MBA, Ph.D, CMC
Q. I am the solo owner of a five-attorney estate planning firm in Los Angeles consisting of myself and four associates. I am approaching retirement and looking at my exit options. Since there are no heirs apparent in the firm, I am looking to sell the practice. However, the potential buyer that I have been speaking with is nervous and concerned about client defections, proper transition, etc. Also, I would like to continue to practice for a few years and don't want to run afoul of the rules of professional conduct. I would appreciate your thoughts.
A. You might want to consider a two-phased approach. Merge with the other firm, continue to work for a few years, work on transitioning relationships, retire and sell your interests, and continue to work as an Of Counsel after that if you so desire.
For Example: A sole proprietor was generating $500,000 in annual revenues with one full-time senior attorney, a full-time paralegal, and a clerical person while netting 40%, including perks and benefits. This owner wanted to work three more years full time and several more years in a part-time role thereafter. The firm interested in acquiring the practice was a three-partner firm generating $2.2 million a year working with similar clients, under a similar culture and fee range.
Phase One consisted of a merger with the retiring owner agreeing to retire in three years and sell his ownership interests for an agreed amount. At its inception, the two practices were combined. The successor firm provided the practice with the same amount of labor required in the past through a combination of retaining and replacing staff, as both were deemed necessary by the parties. The successor firm took over most of the administration, and the deal was announced to the public as a merger.
The transitioning owner was able to come and go reasonably as he saw fit, run his practice through the successor firm’s infrastructure, and retain significant autonomy and control. Because he historically generated a 40% margin, the successor firm agreed to assume all the operating costs of the practice and pay 40% of gross collections from the transitioning owner’s original clients as compensation. Phase One was set to terminate on the first of the following events: (1) the end of three years; (2) the death or disability of the transitioning owner; or (3) the election of the transitioning owner.
Phase Two was the buyout of the retiring partner's ownership interest, and it was set up in a traditional fashion. Phase Two kicked in at the end of Phase One. By deferring the buyout until the full-time compensation ceased, the transitioning owner could extend the period for his full-time compensation, and the successor wasn’t being asked to pay for the practice and full-time compensation at the same time."
Many firms have taken this approach and we have found that it increases the likelihood of successful client transitions, reduces the risk of client defections, and increases the value for the retiring owner.
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John W. Olmstead, MBA, Ph.D, CMC,(www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics. For more information on law office management please direct questions to the ISBA listserver, which John and other committee members review, or view archived copies of The Bottom Line Newsletters. Contact John at jolmstead@olmsteadassoc.com.