Selling a Law Practice: Prospects and Pitfalls

[Ed. Note: The author is now putting finishing touches on a timely new book-with-CD publication, tentatively titled How to Buy, Sell, Merge or Close a Law Practice. In this forthcoming guide, Poll has updated his 1996 "toolkit" for buying and selling a law firm (see www.lawbiz.com) while also adding how-to chapters on firm mergers and closings. Although the related article below focuses on the sale of small practices, readers from large firms may take more than passing interest in Poll's observation that buyers of small firms are often attorneys who are leaving large firms.]

Large firms have long had well-defined methods for transferring ownership interests in a practice via “mergers,” “retirements,” “breakups,” etc. Attorneys in larger firms have also always had mechanisms in place that provided them and their heirs with funding for the value of their individual interests in the firm.

By contrast, the outright “sale” of a law practice from one attorney to another was prohibited for decades. In 1991, however, the ABA dropped its opposition. California had already permitted such sales since 1989, and more states have now followed suit; so the mechanisms for selling a practice have been developing, albeit slowly.

These changes are economically vital for small-firm and sole practitioners. Many of these attorneys tend to conclude their law practice without any transfer of ownership, by just closing their office doors one day and never returning. By doing so, an attorney forgoes “cashing in” on a valuable asset that has taken many years to build. That no longer has to happen. Like their counterparts in large firms, sole and small-firm practitioners ' and their heirs ' can now reap the rewards of years of effort. This levels the economic playing field for retirement and estate planning.

While the sale of a practice is now widely permissible, the unique market and negotiation factors for selling and buying a firm are not widely understood.

How Sale of a Law Firm Differs

In business generally, it frequently is easier to buy an ongoing operation rather than start a new one. An existing business has a history of sales and revenue that can be counted on as a continuing base: if they like a product or service, customers tend to continue their purchasing habits regardless of new ownership. Costs of operations are knowable from previous records; little or no guessing is necessary. This availability of baseline data helps the buyer visualize how changes would lead to savings.

While this generic rationale for buying an existing operation applies to the purchase and sale of a law practice, notable differences are evident, primarily in the following areas:

• Ethics ' legal clients require special protections in the transition process.
• Benefit of the bargain ' compared to buyers of other enterprises, buyers of law firms usually want more secure assurance that they'll receive what they bargained for.
• Negotiations ' attorneys tend to negotiate their own deals rather than involve third party experts such as brokers. (As suggested below, overcoming this tendency would help many deals proceed more smoothly.)

Who's Selling?

One scenario leading to the sale of a practice is that increasing numbers of sole practitioners and small firm partners are thinking about getting out of the practice of law and doing “something” else.

Other types of sellers that buyers are likely to encounter include the attorney…

• Who simply wants to retire.
• Who has been elected or appointed to a judgeship.
• Whose dreams of what the practice might be like just haven't been fulfilled.
• Whose family desires to relocate to another geographic area.

Finally, a potential sale situation arises when an attorney dies suddenly, leaving a spouse who must “mop up.” Is there anything of value that can be sold? Yes, there are the books in the library, the computer equipment, the office furniture and the like. There are also accounts receivable.

But there is also value in the firm's goodwill. Thanks to many states' changes in the Rules of Professional Conduct, that value can now be recognized.

Every attorney should realize, therefore, that his or her practice is valuable and that selling the practice may be feasible. Alternatively, if the practice is not sold, then its value (not the practice itself) can be inherited by the attorney's heirs.

Is every practice actually salable? Some practices are so small and so personal in nature that without a continuing involvement of the first attorney, a second attorney would probably not succeed in keeping the clients. Negotiating the right price and terms, however, should make almost any practice salable. Specifically, if the buyer can be assured of receiving a certain volume of revenue, or a client base that remains with the practice for a designated period of time, then a sale is highly likely even for the smallest and most personal practice.

Who's Buying?

First, there are 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 firm. Operating your own practice is a way of regaining total involvement and the personal touch in your practice of law.

Other buyer candidates coming from larger firms include lawyers who do not make the grade on the “partner track,” or who fail to develop a personal client following and are terminated, or who for personal reasons choose not to seek partnership status in the larger firm. As more attorneys find the partnership track in larger firms unattractive or unattainable, and as larger firms downsize or right-size, the ability to acquire a law firm will continue to grow in importance as a lifestyle option.

Sole and small firm practitioners also make excellent buyer-candidates.

Yet another group of potential law practice buyers is law school graduates, especially those in the bottom 90% 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 their education ' and frequently with large student loans to repay ' these new lawyers are unwilling to shift careers without a gallant effort to succeed on their own. They are going to hang out their shingle one way or another and succeed by sheer determination. While the number of buyers in this category is small, success stories in the legal press suggest that the number is growing – a trend perhaps inspired by many successful examples from other professions.

In sum, many lawyers desire to run their own practice, either by themselves or with others. And many of these lawyers are opting to do what is common in other professions: buy an existing practice rather than start a practice “from scratch.”

How Sellers and Buyers Connect

How do you let it be known that you want to buy or 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.

Also not to be discounted, though still little used for this purpose, are law-related Web sites and other Internet resources. In the future, electronic means of spreading the word may be the most effective and least expensive method of communicating this information.

Protecting Client Interests

The Rules of Professional Conduct set forth requirements for transferring one's interest in a law firm. Many of these rules are for the benefit of the law firm's clients. For example, fees charged to clients cannot be increased solely because of the sale.

State Bars have also gone overboard to assure that clients know they can leave for new counsel: in California, for example, 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.

Nevertheless, most clients remain with the new attorney, especially if the selling attorney participates in the transition and assures clients that the new attorney is very well qualified.

Complications, Conflicts and Downstream Hazards

The Rules of Professional Conduct raise additional issues that can be answered only by reference to the rules of each jurisdiction. For example:

• Can an attorney sell or buy only a portion of a practice? Consider a rural or suburban sole practitioner who has a general practice with 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 to practice general law and who also is competent to handle the technical pension and profit-sharing work. Can the practice be split? (The ABA in 2002 modified Rule 1.17 to permit the sale of part of a practice. Each jurisdiction, however, must be consulted to determine that state's current position.)
• Does client confidentiality preclude discussion of specific clients or their matters? How can a buyer know the nature of the practice without some disclosures? Consult the rule in your respective jurisdiction to assure that the negotiation process does not violate confidentiality.
• Is the sale of a law practice equivalent to a referral for a fee? Referral fees are not allowed in many jurisdictions.

A conflicts check will be the last element before the actual transfer. In smaller communities, the possibility of conflicts of interest increases substantially. Both attorneys must perform a conflicts check, and the parties should decide in advance whether they will negotiate a modification in the price or terms if a conflict prevents the buyer attorney from taking on the affected matter(s).

In any sale of a business, downstream risks need to be evaluated and, to the extent feasible, controlled. In the sale of a law practice, a significant hazard is future malpractice claims. The following questions merit careful examination of both parties' errors-and-omissions insurance policies as well as close attention to state and local rules and their court interpretations if any:

• Does the buyer attorney's existing E&O policy cover new cases acquired from the selling attorney?
• Does the selling attorney's existing E&O policy cover him or her 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? Can the selling attorney be charged with “negligent referral” as a result of the sale? If the selling attorney is at risk from post-sale malpractice claims, the selling attorney may want to consider “tail” coverage.

Dynamics of Negotiating the Sale

Having the right and ability to sell a practice says nothing about the value of the practice or the sale price obtainable for it.

How much can I get for my practice? That's, of course, the question every attorney wants answered. 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 marketplace guidelines. But no amount of analysis can predict the precise price a willing buyer and willing seller will both accept. That figure is subject to many different factors, including terms of payment, geography, and the offered firm's nature, size and history of client retention.

Whatever the price, a key issue for the buyer is whether the buyer will retain the practice being sold. One way to assure the buyer is to design an earn-out or pay-out based on revenues actually collected. The selling attorney then has an incentive to help the buying attorney keep clients in the practice.

Who should do the negotiating? Would you personally 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 yes. 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.

A concern for the law firm buyer 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 can be engaged.

Law practice in small firms is very personal. The seller and buyer must therefore know that their respective approaches to the practice are complementary and not too dissimilar. Nevertheless, 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. As in the residence example, the less contact between the buyer and seller, the less the egos of either will become involved.

Conclusion

State and local bar associations are becoming more sensitive to the needs and economic realities facing sole and small firm practitioners. The efforts of attorneys over years of toil have value, which to the benefit of all concerned can now be more easily transferred. The sale of a law firm poses practical and ethical challenges, but ordinarily these can be resolved.

[Ed. Note: The author is now putting finishing touches on a timely new book-with-CD publication, tentatively titled How to Buy, Sell, Merge or Close a Law Practice. In this forthcoming guide, Poll has updated his 1996 "toolkit" for buying and selling a law firm (see www.lawbiz.com) while also adding how-to chapters on firm mergers and closings. Although the related article below focuses on the sale of small practices, readers from large firms may take more than passing interest in Poll's observation that buyers of small firms are often attorneys who are leaving large firms.]

Large firms have long had well-defined methods for transferring ownership interests in a practice via “mergers,” “retirements,” “breakups,” etc. Attorneys in larger firms have also always had mechanisms in place that provided them and their heirs with funding for the value of their individual interests in the firm.

By contrast, the outright “sale” of a law practice from one attorney to another was prohibited for decades. In 1991, however, the ABA dropped its opposition. California had already permitted such sales since 1989, and more states have now followed suit; so the mechanisms for selling a practice have been developing, albeit slowly.

These changes are economically vital for small-firm and sole practitioners. Many of these attorneys tend to conclude their law practice without any transfer of ownership, by just closing their office doors one day and never returning. By doing so, an attorney forgoes “cashing in” on a valuable asset that has taken many years to build. That no longer has to happen. Like their counterparts in large firms, sole and small-firm practitioners ' and their heirs ' can now reap the rewards of years of effort. This levels the economic playing field for retirement and estate planning.

While the sale of a practice is now widely permissible, the unique market and negotiation factors for selling and buying a firm are not widely understood.

How Sale of a Law Firm Differs

In business generally, it frequently is easier to buy an ongoing operation rather than start a new one. An existing business has a history of sales and revenue that can be counted on as a continuing base: if they like a product or service, customers tend to continue their purchasing habits regardless of new ownership. Costs of operations are knowable from previous records; little or no guessing is necessary. This availability of baseline data helps the buyer visualize how changes would lead to savings.

While this generic rationale for buying an existing operation applies to the purchase and sale of a law practice, notable differences are evident, primarily in the following areas:

• Ethics ' legal clients require special protections in the transition process.
• Benefit of the bargain ' compared to buyers of other enterprises, buyers of law firms usually want more secure assurance that they'll receive what they bargained for.
• Negotiations ' attorneys tend to negotiate their own deals rather than involve third party experts such as brokers. (As suggested below, overcoming this tendency would help many deals proceed more smoothly.)

Who's Selling?

One scenario leading to the sale of a practice is that increasing numbers of sole practitioners and small firm partners are thinking about getting out of the practice of law and doing “something” else.

Other types of sellers that buyers are likely to encounter include the attorney…

• Who simply wants to retire.
• Who has been elected or appointed to a judgeship.
• Whose dreams of what the practice might be like just haven't been fulfilled.
• Whose family desires to relocate to another geographic area.

Finally, a potential sale situation arises when an attorney dies suddenly, leaving a spouse who must “mop up.” Is there anything of value that can be sold? Yes, there are the books in the library, the computer equipment, the office furniture and the like. There are also accounts receivable.

But there is also value in the firm's goodwill. Thanks to many states' changes in the Rules of Professional Conduct, that value can now be recognized.

Every attorney should realize, therefore, that his or her practice is valuable and that selling the practice may be feasible. Alternatively, if the practice is not sold, then its value (not the practice itself) can be inherited by the attorney's heirs.

Is every practice actually salable? Some practices are so small and so personal in nature that without a continuing involvement of the first attorney, a second attorney would probably not succeed in keeping the clients. Negotiating the right price and terms, however, should make almost any practice salable. Specifically, if the buyer can be assured of receiving a certain volume of revenue, or a client base that remains with the practice for a designated period of time, then a sale is highly likely even for the smallest and most personal practice.

Who's Buying?

First, there are 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 firm. Operating your own practice is a way of regaining total involvement and the personal touch in your practice of law.

Other buyer candidates coming from larger firms include lawyers who do not make the grade on the “partner track,” or who fail to develop a personal client following and are terminated, or who for personal reasons choose not to seek partnership status in the larger firm. As more attorneys find the partnership track in larger firms unattractive or unattainable, and as larger firms downsize or right-size, the ability to acquire a law firm will continue to grow in importance as a lifestyle option.

Sole and small firm practitioners also make excellent buyer-candidates.

Yet another group of potential law practice buyers is law school graduates, especially those in the bottom 90% 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 their education ' and frequently with large student loans to repay ' these new lawyers are unwilling to shift careers without a gallant effort to succeed on their own. They are going to hang out their shingle one way or another and succeed by sheer determination. While the number of buyers in this category is small, success stories in the legal press suggest that the number is growing – a trend perhaps inspired by many successful examples from other professions.

In sum, many lawyers desire to run their own practice, either by themselves or with others. And many of these lawyers are opting to do what is common in other professions: buy an existing practice rather than start a practice “from scratch.”

How Sellers and Buyers Connect

How do you let it be known that you want to buy or 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.

Also not to be discounted, though still little used for this purpose, are law-related Web sites and other Internet resources. In the future, electronic means of spreading the word may be the most effective and least expensive method of communicating this information.

Protecting Client Interests

The Rules of Professional Conduct set forth requirements for transferring one's interest in a law firm. Many of these rules are for the benefit of the law firm's clients. For example, fees charged to clients cannot be increased solely because of the sale.

State Bars have also gone overboard to assure that clients know they can leave for new counsel: in California, for example, 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.

Nevertheless, most clients remain with the new attorney, especially if the selling attorney participates in the transition and assures clients that the new attorney is very well qualified.

Complications, Conflicts and Downstream Hazards

The Rules of Professional Conduct raise additional issues that can be answered only by reference to the rules of each jurisdiction. For example:

• Can an attorney sell or buy only a portion of a practice? Consider a rural or suburban sole practitioner who has a general practice with 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 to practice general law and who also is competent to handle the technical pension and profit-sharing work. Can the practice be split? (The ABA in 2002 modified Rule 1.17 to permit the sale of part of a practice. Each jurisdiction, however, must be consulted to determine that state's current position.)
• Does client confidentiality preclude discussion of specific clients or their matters? How can a buyer know the nature of the practice without some disclosures? Consult the rule in your respective jurisdiction to assure that the negotiation process does not violate confidentiality.
• Is the sale of a law practice equivalent to a referral for a fee? Referral fees are not allowed in many jurisdictions.

A conflicts check will be the last element before the actual transfer. In smaller communities, the possibility of conflicts of interest increases substantially. Both attorneys must perform a conflicts check, and the parties should decide in advance whether they will negotiate a modification in the price or terms if a conflict prevents the buyer attorney from taking on the affected matter(s).

In any sale of a business, downstream risks need to be evaluated and, to the extent feasible, controlled. In the sale of a law practice, a significant hazard is future malpractice claims. The following questions merit careful examination of both parties' errors-and-omissions insurance policies as well as close attention to state and local rules and their court interpretations if any:

• Does the buyer attorney's existing E&O policy cover new cases acquired from the selling attorney?
• Does the selling attorney's existing E&O policy cover him or her 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? Can the selling attorney be charged with “negligent referral” as a result of the sale? If the selling attorney is at risk from post-sale malpractice claims, the selling attorney may want to consider “tail” coverage.

Dynamics of Negotiating the Sale

Having the right and ability to sell a practice says nothing about the value of the practice or the sale price obtainable for it.

How much can I get for my practice? That's, of course, the question every attorney wants answered. 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 marketplace guidelines. But no amount of analysis can predict the precise price a willing buyer and willing seller will both accept. That figure is subject to many different factors, including terms of payment, geography, and the offered firm's nature, size and history of client retention.

Whatever the price, a key issue for the buyer is whether the buyer will retain the practice being sold. One way to assure the buyer is to design an earn-out or pay-out based on revenues actually collected. The selling attorney then has an incentive to help the buying attorney keep clients in the practice.

Who should do the negotiating? Would you personally 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 yes. 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.

A concern for the law firm buyer 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 can be engaged.

Law practice in small firms is very personal. The seller and buyer must therefore know that their respective approaches to the practice are complementary and not too dissimilar. Nevertheless, 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. As in the residence example, the less contact between the buyer and seller, the less the egos of either will become involved.

Conclusion

State and local bar associations are becoming more sensitive to the needs and economic realities facing sole and small firm practitioners. The efforts of attorneys over years of toil have value, which to the benefit of all concerned can now be more easily transferred. The sale of a law firm poses practical and ethical challenges, but ordinarily these can be resolved.