How to Value a Law Firm
I am preparing to deliver a webinar with my long-time collaborator and friend, Howard Hackney, on how to value a law firm and I thought it would be useful to set out some thoughts in a blog.
This is a question that we are regularly asked, as much of our work surrounds M&A in the legal sector, restructuring law firms or the appointment of new partners or the exit of existing partners, all of which require a value. I use the word partner to mean anybody who owns and manages a law firm, whether they are a true Partner in a traditional 1890 Act partnership, a Member of an LLP or a director and shareholder in a limited company law firm.
The starting point on value is always “How long is a piece of string?”. It can also be argued that the only true value of any asset being sold is what anybody will pay for it. It is also true that any asset, including a law firm, will have different values for different potential purchasers. An acquirer looking to fill a geographical gap in their market or a service provision gap that will enhance their existing practice will pay more for a particular firm than an opportunistic acquirer who will want to pay the least possible.
There are two main ways of valuing a law firm. These are based on a net asset value and a multiple of earnings.
Net asset value is simply the value of the firm’s net assets. The issues to consider here are whether there is any goodwill, and sadly there is often very little in law firms, and the value of any contingent work in progress (WIP) that is not recorded on the balance sheet. The current partners’ capital is not an asset, unless it is represented by cash.
The other way of valuing a law firm is to look at the average recurrent earnings and applying a multiple to it. We often take the last three years’ average profit, EBITDA – earnings before interest, tax, depreciation and amortisation – and apply a weighting to the most recent figures. We then look to adjust for any unusual items and – most importantly – to adjust for partners’ drawings/dividends. If a three-partner practice is showing average profits of £300,000, but each of those partners would need to be paid £100,000 as a senior solicitor, then that practice has zero profit. The multiple applied to the average earnings varies depending on the type and location of practice, but is anywhere (on average) between two and six times average retained earnings.
You can then throw into the mix additional variables, such as payment terms and the relative bargaining strength of the buyer and seller, and you will see that valuing a law firm is as much an art as a science.
If you have a query about the value of your law firm, or another law firm, please do get in touch.
– Mark Briegal