Law Firm valuations in the post-Covid market

Law Firm Valuations

“What is my firm worth?” is the question that we are most frequently asked when dealing with firms where partners are looking to retire – i.e: they want to be acquired. Almost all firms will survive the Covid period but once we are through it, we expect a lot of partners will want to exit especially as the PII market hardens further.

Whilst it is certainly true that firms are not worth the 3 x profit or 1 x turnover which owners of other businesses might expect, it is not all doom and gloom and a well-structured deal can allow a canny owner to exit with real value. There are 5 elements which should add up to a proper return:

Net Asset Value. At the very least, the firm is worth Net Asset Value. Simply put this is calculated from the assets on the balance sheet minus the liabilities and can be paid out over an agreed period.

Run-off: Whatever you think about the mad system (and England & Wales seem to be the only jurisdiction in Europe with it) a pound saved is a pound earned and so at the most basic level if you can find another firm to take your firm over and become successor practice you have already made a return. For example, if you run a general practice turning over £1,000,000 with a fair amount of conveyancing and a good claims record, your PII is likely to be around 5% or £50,000 pa. To close, the run-off will be in the region of £3 x premium or £150,000 plus IPT at 12% meaning that being taken over has saved £170,000 and this is before saving on storage and other closure costs.

This is the same in real terms as being paid £170,000 for your firm and because with normal metrics, a £1,000,000 firm might produce a profit of £250,000 the seller is in reality getting 68% of profit which is an excellent return. This is a saving and so is tax free of course.

Consultancy: In the above example, upon takeover the seller would expect to work for 12 months as a consultant to hand the clients over and bed in the new firm. This might not need to be full time, but would probably start full time and then diminish towards the end. Some deals we advise on have a 24 month period, but in our experience 12 is enough and the second 12 months is a little like having Banquo’s ghost sitting at a desk.

It would be reasonable in this 12 month period to split the profit with the acquirer so that the deal largely pays for itself, and maybe the seller might earn £120,000 and the buyer £130,000 for this 12 months. Depending on how the contract is structured the seller could earn most of their £10,000 per month at a very low tax rate (c10%) taking maybe £1000/month as consultancy and £9000 as price paid to qualify for entrepreneur’s relief.

Therefore, already the seller has safely moved over the clients to the new firm, has protected the staff and avoided the costs and disruption of closure as well as earning around £110,000 in real net terms and saving at least £170,000 giving a real return of £280,000.

Further, what we often see is that the seller will remain as a consultant to the firm, attending events as needed and referring clients across being paid on an ad hoc basis. Most Partners are attached to their firms and are not ready to cut the ties and an arrangement like this should benefit both parties.

History: There is often a real benefit to a new entrant taking over an existing firm. We have recently been advising a firm that has been in it’s premises on a high street for 30 years. They are a known and trusted firm and many local people see them as “their solicitor” so the firm or individual taking them over will benefit from this history. There is also likely to be a large will bank which will provide ongoing work for years and whilst there is no formula for working a value out, an extra payment to acknowledge this history, maybe £20,000 in the above example, might be negotiable because for the buyer this is a lot cheaper than starting up from scratch.

Premises: Often the retiring partner will own the offices, or have them in a pension scheme. If the firm were to close they would need to be re-let and so an additional benefit might be to agree a 5 year lease with the new owners. If this was, say, £10,000 pa then this is an extra £50,000 that the seller has made from the deal.

Therefore, when it comes to valuing your firm for acquisition, the stock answer that no-one pays for goodwill is probably correct. But as shown above, by being flexible and sensible, the seller has actually made in real terms c£350,000 from the transaction at very attractive tax rates and can retire elegantly.

Ampersand Legal is a specialist business dealing with law firm M&A and we have developed a specialism helping partners in smaller firms retire. For an initial non-obligatory conversation please contact Andrew Roberts on andrew@ampersandlegal.co.uk.