Considering the sale of your law firm can be a daunting prospect. The number one piece of advice that most people will give you is: allow yourself enough time to prepare.
While no two practices are the same – as each has different value drivers, client profiles and internal dynamics to manage - an average sale process takes nine to 12 months to complete, from appointing advisers to regulatory approved completion. As a rule of thumb, plan to spend the same amount of time, at least, preparing your business for sale. You’ll need to focus on key factors impacting valuation and carefully consider your exit options.
What drives law firm value?
The value a buyer will place on your business will be driven both by factors that are in your control and those that are outside of it (e.g. the macroeconomic environment). From the factors that you can control, they mostly distil into one single number – your earnings before interest, tax, depreciation and amortisation (EBITDA). This number is typically how buyers will perceive the success of your business, and the larger it is, the higher the valuation that you can expect to command.
How can you improve your EBITDA?
Lots of variables ultimately make up your EBITDA, but in the year(s) running up to launching a sale process, the two highest-impact activities you can focus on are:
1. Your top line - keeping your fee income as high as possible (preferably without any over-reliance on one or two key clients)
2. Your cost base - effectively managing your costs while protecting quality and compliance.
A 20% EBITDA margin is historically considered very good (after allowing a notional salary for equity partners), but the industry trend has been more in the 10-20% region given the rise in employment taxes and other costs. How high your EBITDA margin is will play a large part in the valuation multiple that is used for your firm.
Buyers will apply a multiple to your EBITDA number to arrive at an ultimate valuation of your company. Unhelpfully, the legal sector has a wide spread of multiples from 2x to 8x, depending on a wide variety of factors:
the absolute level of your EBITDA
the EBITDA % margin
breadth of your service offering
client concentration
geographical diversity (local, national, or international presence)
fee earner concentration, depth of team (especially those below equity partner)
reliance on key individuals, or whether the entity has a brand in its own right
A local firm with an EBITDA under £1m might be towards the bottom end of that range, whereas a national firm with EBTIDA over £5m might be towards the top end of that range.
Structuring a deal in line with your succession plans
Who you are selling to will also play a role in the overall value and structure of a deal. An exit to a trade company (e.g. a competitor) with a full cashout will likely attract a lower valuation than a private equity acquirer who might ask you not to take very much cash off the table initially and stay with the business for three to five years in order to sell out at a higher valuation in the future.
The influx of private equity money into the legal services market over the last few years has opened up an array of options to consider when preparing for sale, which should prompt some fundamental questions for owners early on in the process. Do we want to sell out entirely (100% cash-out deal), partially (minority deal), or partner with somebody like a private equity firm to raise capital with the aim of significantly growing over a three to five year period before selling out together at a later date?
The answer to this question will also have an impact on how owners should think of their own succession within the business. What would be the impact if you left today? Has enough mentoring time been spent with the next level down to enable them to step up into your shoes, were you to exit? Do your key clients leave with you, or have they had a curated client handover plan in the run-up to any sale process? Is more time needed for succession to be bedded in?
Given the risks often involved in buying ‘people businesses’, it is common for buyers to put forward a deal structure that links your sale payments to future business performance, and also locks you into the company for a period of time (anything from six months to two years is typical), to ensure a smooth handover process and internal consistency whilst the company transitions to new ownership. This is an important point, often overlooked by business owners looking to retire imminently, but not building in a post-sale lock-in period into their working plans.
Early planning and professional advice
The overall message is that there is a lot to think about, and preparing a company for sale is not something that can easily be rushed (with good results). Whatever size of business you are, your corporate finance adviser, accountant and lawyer will be able to guide and assist you through the process to maximise your company’s value.
Client story: Growing a legal practice through strategic acquisition
If you are planning on selling your law firm and would like to know more about how we can help, please contact our Corporate Finance Team on 0808 144 5575 or email help@armstrongwatson.co.uk.
