Understanding the Financial Aspects of Impending Retirement

As an estimated 400,000 lawyers from the Baby Boom era will reach the traditional retirement age in the upcoming decade, it is increasingly emphasized that there are significant ethical consequences for failing to plan a practice's future by transitioning client matters to a successor lawyer or firm. But a lesser publicized truth is equally certain: There are significant penalties in store for any lawyer who does not make a financial plan for succession into retirement. Certainly there are more caveats to this than there were just a few years ago as the lingering effects of the Great Recession make some lawyers fear that they cannot afford to retire. The truth remains, however, that no lawyer is immortal, and planning to practice until death or disability strikes is not planning at all.

The financial aspects of a potential retirement are different for lawyers working for big firms versus those in small or solo practices. The one constant is that the issues involved cannot and should not be ignored, as lawyers tend to do. Even transactional lawyers typically are not known for personal financial foresightedness, as they ' like most of their peers ' focus much more on practice matters at hand than on financial matters in the future. Lawyers who do this are cheating both themselves and their heirs. At minimum, whether in a large or small firm, lawyers nearing retirement age have some important financial issues that must be considered, the sooner the better.

Big Firm Issues

De-equitization

De-equitized lawyers, a phenomenon of the Great Recession, have likely earned good money during their time with the firm, but the lifetime “tenure” that they counted on in order to glide into emeritus status is a thing of the past. Today all lawyers at large firms can and should ask hard personal finance questions about how to cope with a potential dismissal. Did they save enough to afford retirement, or did their standard of living increase over the years to match their income? Will they be able to get any equity at all out of their firms, and if so, how fair will be the price set by their former partners who are casting them away? Did they continue to service major clients effectively, positioning themselves as indispensable counselors that the firm dismisses at its peril? If not, de-equitized big firm partners may have no alternative but to sue their firms alleging that they were merely “employees” who were thus covered by age discrimination laws. They may be right ' but that's not an ideal end to a professional career.

Partnership Agreement

Too few lawyers understand their partnership agreement, having leapt at the chance to become partner, but not thinking the decision through or even reading the agreement itself. Lawyers nearing retirement age at any large firm should be able to answer these questions about their partnership agreement and what they mean for the financial future:

• How much did you actually pay to join the firm?
• Would you have to pay if you left voluntarily?
• Do you receive severance and your share of your receivables if you leave involuntarily?
• Does the firm consider if there is goodwill for interests in your firm?
• Are you a personal signatory to the firm's line of credit or lease?
• Is the management system one vote per lawyer, or one vote per pro rata share?
• Can you get your full investment back only if you leave at certain times of the year?

The partner who can't answer such questions is committing personal financial negligence.

Collections

Big firm partners nearing retirement have one valuable financial asset that can be used as a bargaining chip if a forced exit looms ' client receivables. Every partner should take care to understand what are his or her amounts in receivables, and be personally involved in bringing in those receivables. Ensure that there are incentives in your interest to collect the receivable before any potential departure. These are some factors to address for this issue:

• Ensure that time sheets are current.
• Send billings to clients immediately, even if the totals are off or need adjustments later.
• Monitor payment history of the client, and exert special follow-up effort on unpaid invoices.
• Have a peer review key client files to confirm that no ethical issues would forestall payment.
• Communicate with the client if payment is not received promptly.

Small/Solo Firm Issues

Estate Plan

It should go without saying that life insurance, plus a disability policy, is a prudent step for any sole or small-firm practitioner. There must be reasonable expectations for the kind of policy chosen ' a desire to maintain the family's lifestyle unchanged if the lawyer were unable to practice may be outweighed by the cost of such a policy's premiums. Other elements needed include a will and an estate plan that make legitimate application of all the advantages allowed under law. The plan can estimate and minimize estate tax liability exposure, create trusts to conserve assets and minimize tax impact, provide financially for all the expenses necessary to close a practice, and properly value the practice for estate tax purposes.

Valuation Concerns

The process for effectively securing such protection begins with a list of assets and liabilities. The valuation of a practice (intended to support retirement) is often based on a “rule-of-thumb” method after valuing physical or identifiable assets. The “rule of thumb” method is based on a multiplier in the range of 50% to 300% of annual gross receipts, depending on the nature of the practice, the transferability of the clients and how much repeat business is expected. Another valuation method is based on the present value of the practice's stream of income. There is no one way to value a law firm that is generally accepted; and these are only two of the possibilities. And some say that there is no goodwill in a law practice. Those who do accept goodwill may use the “excess earnings” model in which goodwill is defined to be a differential advantage resulting from the individual lawyer's skill, reputation and special talent.

Negotiating Strategies

In the sale of most business opportunities, the seller normally enters into a consulting agreement for a period of time after the closing of the transaction. Further, the seller normally enters into a covenant not-to-compete agreement with the buyer. No buyer wants to pay “good money” for the assets of a business only to find the seller starting up again right across the street. Under Rule 1.17 adopted by the American Bar Association in 2002, lawyers can sell a practice area and still remain in practice, although not in the area sold. However, even in some states that have adopted this rule, bar associations may hold that the sale of the entire practice is required without allowing for a transition involvement to occur. In other words, when an escrow for the sale closes after notice is given to clients in accord with the rule, the lawyer must stop practicing, period, without a transition period to help the buyer consolidate his/her relationship with the existing clientele.

Resolving this issue can involve negotiating the length of escrow, focusing on minimum notice of sale to be given to the clients. An extended escrow could encompass one year or some other time constraint desired by the buyer and agreeable to the seller. If this is not possible, however, the parties can combine a merger with a buy-sell agreement. Such a situation creates partners who can enforce an agreement of separation (sale of a partner interest). And, with Rule 1.17 now allowing the sale of a practice area, it will be possible to sell part of the practice at a higher price (to address the real worth of the full practice), the balance of the practice being transferred at a later time when the lawyer wants to terminate his work regimen entirely, but at a lower price. The combination of the two would represent the actual full purchase price for the firm.

Concluding Thoughts

This discussion is not intended to be an exhaustive review of financial aspects of retirement or the valuation of law practices. Practice realities and retirement needs are different for every lawyer. What is common to all lawyers is that these realities and needs must be faced. Lawyers who fail do so, in effect, are throwing away the value of their practices, in the process relinquishing their life's work without getting anything in return. Lawyers should not ignore perhaps the largest asset in their estate, their practice. The value is there. After investing years of hard work and financial resources in growing the practice, effective planning allows any lawyer to reap the benefits of that value and the extensive investment of time and effort that created it.

Ed Poll, J.D., M.B.A., CMC, principal, LawBiz Management, helps law firms increase profitability, coaching them on issues of internal operations, practice development, and financial matters. He practiced law for 25 years, has coached lawyers for 20 years, and is the author of 13 books. Poll is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a board-certified Coach to the Legal Profession, a charter member of the Million Dollar Consulting' Hall of Fame and Recipient of a Lifetime Achievement Award, State Bar of California (LPMT Section). He can be reached at 800-837-5880, www.lawbiz.com, www.lawbizblog.com, and www.lawbizforum.com.

As an estimated 400,000 lawyers from the Baby Boom era will reach the traditional retirement age in the upcoming decade, it is increasingly emphasized that there are significant ethical consequences for failing to plan a practice's future by transitioning client matters to a successor lawyer or firm. But a lesser publicized truth is equally certain: There are significant penalties in store for any lawyer who does not make a financial plan for succession into retirement. Certainly there are more caveats to this than there were just a few years ago as the lingering effects of the Great Recession make some lawyers fear that they cannot afford to retire. The truth remains, however, that no lawyer is immortal, and planning to practice until death or disability strikes is not planning at all.

The financial aspects of a potential retirement are different for lawyers working for big firms versus those in small or solo practices. The one constant is that the issues involved cannot and should not be ignored, as lawyers tend to do. Even transactional lawyers typically are not known for personal financial foresightedness, as they ' like most of their peers ' focus much more on practice matters at hand than on financial matters in the future. Lawyers who do this are cheating both themselves and their heirs. At minimum, whether in a large or small firm, lawyers nearing retirement age have some important financial issues that must be considered, the sooner the better.

Big Firm Issues

De-equitization

De-equitized lawyers, a phenomenon of the Great Recession, have likely earned good money during their time with the firm, but the lifetime “tenure” that they counted on in order to glide into emeritus status is a thing of the past. Today all lawyers at large firms can and should ask hard personal finance questions about how to cope with a potential dismissal. Did they save enough to afford retirement, or did their standard of living increase over the years to match their income? Will they be able to get any equity at all out of their firms, and if so, how fair will be the price set by their former partners who are casting them away? Did they continue to service major clients effectively, positioning themselves as indispensable counselors that the firm dismisses at its peril? If not, de-equitized big firm partners may have no alternative but to sue their firms alleging that they were merely “employees” who were thus covered by age discrimination laws. They may be right ' but that's not an ideal end to a professional career.

Partnership Agreement

Too few lawyers understand their partnership agreement, having leapt at the chance to become partner, but not thinking the decision through or even reading the agreement itself. Lawyers nearing retirement age at any large firm should be able to answer these questions about their partnership agreement and what they mean for the financial future:

• How much did you actually pay to join the firm?
• Would you have to pay if you left voluntarily?
• Do you receive severance and your share of your receivables if you leave involuntarily?
• Does the firm consider if there is goodwill for interests in your firm?
• Are you a personal signatory to the firm's line of credit or lease?
• Is the management system one vote per lawyer, or one vote per pro rata share?
• Can you get your full investment back only if you leave at certain times of the year?

The partner who can't answer such questions is committing personal financial negligence.

Collections

Big firm partners nearing retirement have one valuable financial asset that can be used as a bargaining chip if a forced exit looms ' client receivables. Every partner should take care to understand what are his or her amounts in receivables, and be personally involved in bringing in those receivables. Ensure that there are incentives in your interest to collect the receivable before any potential departure. These are some factors to address for this issue:

• Ensure that time sheets are current.
• Send billings to clients immediately, even if the totals are off or need adjustments later.
• Monitor payment history of the client, and exert special follow-up effort on unpaid invoices.
• Have a peer review key client files to confirm that no ethical issues would forestall payment.
• Communicate with the client if payment is not received promptly.

Small/Solo Firm Issues

Estate Plan

It should go without saying that life insurance, plus a disability policy, is a prudent step for any sole or small-firm practitioner. There must be reasonable expectations for the kind of policy chosen ' a desire to maintain the family's lifestyle unchanged if the lawyer were unable to practice may be outweighed by the cost of such a policy's premiums. Other elements needed include a will and an estate plan that make legitimate application of all the advantages allowed under law. The plan can estimate and minimize estate tax liability exposure, create trusts to conserve assets and minimize tax impact, provide financially for all the expenses necessary to close a practice, and properly value the practice for estate tax purposes.

Valuation Concerns

The process for effectively securing such protection begins with a list of assets and liabilities. The valuation of a practice (intended to support retirement) is often based on a “rule-of-thumb” method after valuing physical or identifiable assets. The “rule of thumb” method is based on a multiplier in the range of 50% to 300% of annual gross receipts, depending on the nature of the practice, the transferability of the clients and how much repeat business is expected. Another valuation method is based on the present value of the practice's stream of income. There is no one way to value a law firm that is generally accepted; and these are only two of the possibilities. And some say that there is no goodwill in a law practice. Those who do accept goodwill may use the “excess earnings” model in which goodwill is defined to be a differential advantage resulting from the individual lawyer's skill, reputation and special talent.

Negotiating Strategies

In the sale of most business opportunities, the seller normally enters into a consulting agreement for a period of time after the closing of the transaction. Further, the seller normally enters into a covenant not-to-compete agreement with the buyer. No buyer wants to pay “good money” for the assets of a business only to find the seller starting up again right across the street. Under Rule 1.17 adopted by the American Bar Association in 2002, lawyers can sell a practice area and still remain in practice, although not in the area sold. However, even in some states that have adopted this rule, bar associations may hold that the sale of the entire practice is required without allowing for a transition involvement to occur. In other words, when an escrow for the sale closes after notice is given to clients in accord with the rule, the lawyer must stop practicing, period, without a transition period to help the buyer consolidate his/her relationship with the existing clientele.

Resolving this issue can involve negotiating the length of escrow, focusing on minimum notice of sale to be given to the clients. An extended escrow could encompass one year or some other time constraint desired by the buyer and agreeable to the seller. If this is not possible, however, the parties can combine a merger with a buy-sell agreement. Such a situation creates partners who can enforce an agreement of separation (sale of a partner interest). And, with Rule 1.17 now allowing the sale of a practice area, it will be possible to sell part of the practice at a higher price (to address the real worth of the full practice), the balance of the practice being transferred at a later time when the lawyer wants to terminate his work regimen entirely, but at a lower price. The combination of the two would represent the actual full purchase price for the firm.

Concluding Thoughts

This discussion is not intended to be an exhaustive review of financial aspects of retirement or the valuation of law practices. Practice realities and retirement needs are different for every lawyer. What is common to all lawyers is that these realities and needs must be faced. Lawyers who fail do so, in effect, are throwing away the value of their practices, in the process relinquishing their life's work without getting anything in return. Lawyers should not ignore perhaps the largest asset in their estate, their practice. The value is there. After investing years of hard work and financial resources in growing the practice, effective planning allows any lawyer to reap the benefits of that value and the extensive investment of time and effort that created it.

Ed Poll, J.D., M.B.A., CMC, principal, LawBiz Management, helps law firms increase profitability, coaching them on issues of internal operations, practice development, and financial matters. He practiced law for 25 years, has coached lawyers for 20 years, and is the author of 13 books. Poll is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a board-certified Coach to the Legal Profession, a charter member of the Million Dollar Consulting' Hall of Fame and Recipient of a Lifetime Achievement Award, State Bar of California (LPMT Section). He can be reached at 800-837-5880, www.lawbiz.com, www.lawbizblog.com, and www.lawbizforum.com.