Selling your law firm
The purchase and sale of law firms are at unprecedented levels given the strategic changes that have taken and continue to take place in the “legal industry”. In this article Howard Hackney – who presented much of this in a Webinar to the Law Management Section in March 2013 – considers the issues involved and how best to maximise value.
“Not as much as you think” is the traditional answer you get from an accountant when asked “what is my law firm is worth”. However the starting point for selling your practice must be to have a realistic understanding of its value, of its strengths and weaknesses, the minimum value you need to achieve and the strategic reasons for wishing to sell. Assuming you have addressed all these areas and that you have “buy-in” from all owners of the practice, then you are ready to start the process.
Creating a competitive market
The objective in selling your law firm will be to obtain best value – this does not necessarily mean highest price as there may be other considerations such as loyalty to staff, a desire for a cultural fit, that clients will be looked after or that there is an ongoing role for some or all of the partners. However price is often the headline factor and to do this it is necessary to create a competitive market where interested parties (targets) know that they are not the only “player”. This is best achieved by the use of an independent “lead adviser” who will:
- guide you through and manage the whole process
- give an indication of market value
- assist in identifying potential buyers
- advise on market conditions
- lead the negotiations
- interpret and advise on offers received
- prepare an Information Memorandum
- control confidentiality
- advise on and consider the tax issues
In essence the lead adviser creates the market and provides impartial advice unfettered by the emotional considerations of the partners who are selling. Of course many “friendly” deals are done by direct approaches between managing and senior partners and these can work well. However “you do not know what you don’t know” and creating a competitive market allows for a proper assessment of the opportunities that may exist.
The Information Memorandum (IM)
Targets can and should only be approached when you are properly prepared to do so. This involves the preparation of an IM setting out key information about the firm such as its history, its financial performance, its service offering, its claims history, its property commitments, its banking facilities and covenants and its partners and staff. This document is the “sales pack” in which to display the firm’s best features. Inevitably the area which will have the greatest prominence will be the financial position and history. It is however vitally important that the document should not in any way be misleading – as not only may there be legal consequences when discovered (as they surely will be) but it destroys any credibility and damages (perhaps irrevocably) the negotiations. In fact the process of preparing the IM is crucial in both identifying negotiating strengths and weaknesses, “deal breakers” and in pre-sale grooming. The value of WIP is one such area to address as it is often not in as good a state as it should be. Dead files should be closed, old irrecoverable time written off and a fair assessment made of the true sales value of the WIP should be made with the input of all partners – both where time is unrecoverable but also where there may be “nuggets” of undervalue and it may be helpful to involve specialist consultants to interrogate the WIP accordingly. Targets should only be approached once the IM has been signed off and formally approved.
Identifying and approaching the targets
Target firms will be identified by working with your lead adviser. There will be local, regional and national players and neither you nor your lead adviser will have a monopoly on whom to approach. Working together you should attempt to identify perhaps a dozen possible targets. Such targets will be chosen based on full and proper market research on their likely interest in terms of types of work, personal knowledge, market reputation, geography, known strategic objectives and especially in the current market their financial strength and ability to pay. A small number is appropriate (although it can be widened at a later stage if necessary) with a view to maintaining confidentiality in the market place. A blanket approach is dangerous, as should the potential sale leak to the market this will damage value, as it is taken advantage of by your competitors. The lead advisor should make the initial approaches to the targets on a no names basis with limited information sufficient for them to decide whether they are prepared to sign a Non-Disclosure Agreement (NDA) following which the IM with the name of the firm would be released.
The formal sales process has now started and it should be controlled by the lead advisor in a specified timescale. Of the initial list there will perhaps be eight who receive the IM & perhaps six of those will wish to proceed to meet with you to allow them to determine if they wish to proceed to make an offer. Often after further enquiries it would then not be unusual to expect written non-binding offers within two to three months of issuing the IM. It will then take perhaps a month to interpret and clarify the initial offers with a view to identifying a preferred bidder with whom non-binding Heads of Terms will be signed giving a binding period of exclusivity to allow for Due Diligence (on each side) to be undertaken and for the final binding terms to be agreed. This should take a further couple of months so that from the issue of the IM to a binding contract is likely to take four to six months. The shortest timescale is unlikely to be anything under three months and if it takes longer than nine months experience dictates that a deal is unlikely to happen.
Tax is a vital ingredient of any deal and can both make a deal happen or be a deal breaker. LLPs and unlimited partnership will be selling assets – WIP, debtors, goodwill etc. etc. A Limited Company can sell shares in the company or sell assets out of the company. Sellers usually wish to sell shares to avoid a potential double tax charge. Buyers however, tend to prefer to buy assets as it avoids having to accept the financial history of the company. Which route you go down depends on the relative strength of your negotiating positions. However two key tax issues apply in both scenarios. Firstly the availability of 10% CGT via Entrepreneurs Relief (ER) where the “partner” needs to have had a 5% interest for at least one year. Secondly how much of the consideration is allocated to goodwill and how much to other assets – especially WIP. The goodwill in an assets sale should be subject to ER while WIP and other assets will be taxed at a higher rate of income tax or corporation tax as the case may be. Understanding the buyer’s position is important here as they will only get (phased) tax relief on goodwill if it is purchased via a limited company and then it will be in everyone’s interest to allocate as much as can be commercially justified to goodwill rather than WIP and other assets.
Selling your firm is a huge step – but one that many firms have done and are about to do. It is incumbent on the custodians of the firm to have a clear understanding of their strategic reasons for doing so, to get early buy-in from all partners and then to maximise value for all stakeholders.