Selling Your Law Practice

Rule 1.17 of the North Carolina Rules of Professional Conduct permits the sale of a law practice subject to certain conditions. A change is afoot to make selling a law practice more attractive to retiring lawyers.  At its meeting on October 25, 2013, the State Bar Council adopted, subject to the Supreme Court’s approval, an amendment to Rule 1.17 of the Rules of Professional Conduct governing the sale of a law practice. The amendment would clarify that a lawyer who sells his or her practice to another lawyer may continue to practice law with the purchaser as an employee.[1]  The rationale for the amendment as stated in Comment [3] is permitting the seller to work for the practice will assist in the smooth transition of cases and will provide mentoring to new lawyers.  Now, not only can you sell your practice, but also the State Bar is making it more palatable.

Just because you may does not mean you can sell your practice. One solo lawyer opined the value of his law practice was his own self; when he walked out the door, there was nothing left to sell except some old, outdated office equipment.  Another solo lawyer opined that after 30 years of building a successful real estate practice, he thought his practice had real value. Although he was ready to retire, he was not willing to walk away without investigating selling his practice.  

To Close or Sell, that is the Question!

One assumption you probably should make is your solo practice has marketable value, even after you are gone. There are the tangible assets: books, computers, forms, buildings, etc. However, more than that, if your practice has existed a long time and you (and your staff) enjoy a good reputation in your community, your solo practice probably has “good will” value that another lawyer would likely be willing to pay for. The data may disprove this assumption, but there is no need to assume your practice has no value beyond your active involvement and hard work.

Timing is Important.

It might take some time to sell your practice, so retirement presents the best opportunity for making a profit on the sale. If you or your estate is under the gun to sell the practice quickly due to an illness, disability or death, this may diminish your chances of making a profitable sale.  So consider your time horizon and the longer the better.

How much is my solo practice worth?

Many factors go into answering this question.  Some of them include:

1. The nature of the practice.
2. The recurring business.
3. The time the selling lawyer has been in practice.
4. The number of clients the selling lawyer has and the concentration of work in a few clients.
5. The likelihood the clients (and perhaps staff) will remain with the practice after the sale.
6. The stability of the practice’s revenue stream from month to month and year to year.
7. The overall reputation of the firm.

The first rule is to hire a qualified professional to assist you in valuing your practice. Do not leave it to your CPA, unless he or she has specialized training in business valuation.  There are several organizations that credential business valuators, including the National Association of Certified Valuators and Analysts (NACVA), the American Society of Appraisers (ASA) and the Institute of Business Appraisers (IBA).  You might even call a domestic lawyer in your town that has experience representing lawyers and lawyers’ spouses in equitable distribution cases to find out which business valuators he respects.  Although keep in mind that a popular method for valuing law practices in family law cases, the excess-earnings approach, may not be appropriate for valuing a law practice for sale because this approach does not consider future prospects, up or down. It appraises a practice based solely upon what the practice has generated.[2]

There are at least three methods of valuing a business, including a law practice: cost, market and income. The cost method is used to value tangible assets. This is also referred to as the book-value method. The historical cost less accumulated depreciation equals book value. 

The fair market value method requires searching for comparable assets. This is an “apples to apples” approach. One usually encounters this method in home appraisals. This method is of limited use in valuing a law practice because there are usually few “comps” with which to compare the practice.

The income or cash flow method is probably the most widely used method for valuing a law practice for sale. This approach asks the question: After valuing the physical or identifiable assets, what is the stream of income worth to a prospective buyer?[3] A rule-of-thumb approach multiplies one year’s gross revenue by a multiplier. The result will be the value of the stream of income.[4] The gross revenue should be averaged over the last five years to even out good and bad years. Many experts suggest that prices typically range from .4 percent to 1.0 (40 percent to 100 percent) of gross revenues. Some experts suggest that a practice may sell for 300 percent of the prior year’s annual revenue.[5]  Whether the multiplier used is at the higher or lower end of the scale will depend on the factors listed above.

The successful and ethical sale of a law practice requires a lot of preparation. Rule 1.17 is just the tip of the iceberg; the process is “titanic.” [6] After deciding on a realistic asking price, one must identify potential buyers, payment terms, transitioning clients and client files to the buyer, handling closed client files, potential professional liability and disciplinary responsibility, substitution of counsel in pending cases, etc. We will address some of these issues in future articles.

Mark Scruggs is a claims attorney with Lawyers Mutual specializing in litigation, workers compensation and family law matters. You can reach Mark at 800.662.8843 or at mscruggs@lawyersmutualnc.com.