Just working hard and building your practice into a highly profitable one isn’t a guarantee that when you come to sell it, you will get well paid. The secret to getting well paid on sale is to focus on building value in a small law firm.
Let me demonstrate by sharing two recent experiences with you.
Recently I was meeting with a small law firm client who was explaining that they were looking at expanding their general practice law firm by buying another general practice firm with a close to seven figure revenue, in a nearby suburb.
The price that the seller wanted meant that the current firm profit represented a 100% return on their investment.
Most people I would suggest, might think that a 100% return on investment sounds attractive, particularly given that bank term deposit rates in Australia are around 2.5%p.a.
The buyer however felt that this price was much too expensive and was going to try to negotiate the price down to about half that before they got very interested in buying that firm.
Now the firm they were looking to buy sounded like a pretty good long established practice but still the buyer wasn’t convinced that the price was worth it.
At the other end of the spectrum, a client in Sydney paid $1 to buy a small firm that had billed $200,000 in fees the year before. While this is clearly a very small firm, those fees should have generated a profit of at the very least $100,000pa for the seller. Yet they were prepared to essentially, give the practice away. You can read more on this example in the following article (My client is buying a small law firm in Sydney for $1, but both buyer and seller are happy!)
On one hand you had a practice that was making a really good profit and on the other you had a practice making a living (and in Sydney that is barely a living), but in both cases the seller had not been able to demonstrate their firm value to the buyer.
Consequently one seller was happy to simply walk away and get paid nothing for their life’s work and the other was likely to have to accept a discounted price compared to what their practice could be worth.
Key Law Firm Value Building Point:
Just earning a great profit is not enough to ensure you build great value in your firm.
I have seen this in other professional fields where small practices are often sold at a certain price per dollar of revenue and profit is often overlooked.
This seems to fly in the face of the more usual way of valuing a small business which is based on a multiple of the business profit.
This may be partly due to the fact that the buyer may run it differently or have a different mix of expenses. While it seems crazy, I can assure you that profit alone may not determine the value of a small professional services firm.
In my discussions with legal practice brokers, the number one issue for buyers of small law firms is not profit but client retention (refer to “The most important issue that buyers are concerned about“).
While having a high profit firm is great, when it comes to selling, buyers are more interested in how they are going to retain the clients.
Knowing that, your value building strategy for your firm needs to be all about client retention.
Even in practices where clients tend to be one off such as a family law firm, this approach still has relevance.
For these types of practices the retention issue may well shift to the firm’s referrers and strategies to ensure that those referrals continue.
If I refer you back to my original example of the firm offering a 100% return, if the seller of the first practice had focused the potential buyer on what strategies he had implemented to ensure that the clients were retained, I feel certain that my client would have been more interested at the price the seller wanted and potentially significantly more.
There aren’t many successful small businesses that you can buy on much less than one year’s profits and there is no good reason in my opinion why many smaller law firms need to be worth that or less.
If you want to build the value in your law firm, how can you increase the chances that the clients you act for, continue with the new firm?
If you can implement strategies to achieve this, then your firm is worth more to the buyer and it could mean hundreds of thousands of dollars more in your pocket as the seller.
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Disclaimer: This article contains information of a general nature only. It is not advice tailored to your specific circumstances. Before you act on anything contained in it you should obtain your own professional advice.