For many law firms, making the decision to merge, acquire, be acquired, or sell, is a significant step with a range of factors involved before a final decision can be made to proceed.

Taking this decision is the first step but it is likely to be a difficult one. Many transactions of this nature are borne out of necessity for the firm to survive rather than a strategic step.

There are many issues the decision makers should consider when taking a decision to acquire or sell a law firm. It is a lengthy and often expensive process even when done correctly, so it is essential to ensure you obtain the best possible advice to minimise risk and unnecessary stress.

Business valuation

A vital first step if you have decided to sell your business is to ensure you carry out a business valuation. A business valuation uses a series of measures to arrive at a sensible figure for a business’s worth.

If you are selling your company, or part of it, the value of it will depend on how much money it makes and how much profit it generates over time.

For a quality valuation, you will need accredited forensic accountants who have been trained in the latest market trends and techniques.

In terms of valuing a law firm, this is not an exact science. The actual value can only be determined by negotiations between an informed and willing buyer and an informed and willing seller.

Professional practices are usually valued using one of three valuation methods:

  • Applying a multiple to maintainable fee income
  • Applying a multiple to maintainable net profits or earnings
  • Valuing the net recoverable assets of the practice and determining whether to add an element for goodwill

The valuation does not tend to be lower than the value of the net recoverable assets of the practice.

Also, if the practice was to cease trading, the valuation would be based on the break-up value of the net assets.

On this basis, the net recoverable amount of assets would be lower than that of a continuing basis.

Agreeing a sale price

Once the value of the business has been ascertained, you will need to come to an agreement on a sale price. This involves looking at the results of the business valuation and the working capital items. For instance, debtors, creditors, and liabilities.

This is something you must get ahead of so there are no nasty surprises for either party.

If you are acquiring a law firm, then this aspect should be handled by the selling side. They will offer you a price and you will decide based on the valuation, working capital, and any other evidence, whether this is a reasonable fee that you are willing and able to pay.

How to finance the deal

Once a deal has been struck, if you are the acquiring firm, you will require some kind of financing in order to complete the sale, unless you are able to pay cash.

Acquisition finance effectively becomes a choice between debt, equity, or a combination of both.

Debt involves borrowing money to be repaid, plus interest, whilst equity involves raising money by selling shares in the company.

There are a number of ways the deal can be financed involving debt. One is ‘senior debt’, which is a secured term loan and is debt that takes priority over other unsecured or ‘junior’ debt.

It is usually a relatively short term (3-5 years), and the debt may carry a fixed or variable interest rate.

Senior debt is best suited for already well-established businesses with strong management, a good track record of profitability, and sustainable cash flows.

Other debt options include ‘mezzanine debt’, which is a loan that can be converted to equity in case of default.

It is high risk and therefore expensive, but its flexibility makes it an attractive option for funding acquisitions.

It is usually provided on an interest only basis, making repayment more manageable than other debt structures.

Mezzanine debt is most appropriate for businesses that can’t attract enough senior debt, but don’t want to dilute equity further as it fills the gap between debt and equity.

Asset Based Lending (ABL) is the most popular alternative to bank financing for funding a business acquisition.

With ABL, you can use the assets of the company you wish to buy (and your own company’s assets, if necessary) as collateral for a loan.

The asset-based lender will make advances at rates from 70% to 90% against assets including receivables, inventory, plant & machinery, and property.

This is a popular method because, depending on the strength of the company’s asset base, it is a very effective method of generating capital that may not be accessible through traditional lending facilities.

This option is best for businesses with good management, systems and controls, and a strong asset base.

Risks involved

Whether you are buying or selling a law firm, you need to undertake a comprehensive review of risk management within the firm, including related systems and processes. If these are not particularly strong, then you must accept that there could be challenges during the integration period, and you will need to plan how you will combat these.

You also need to be aware of the impact on your Professional Indemnity Insurance (PII). If you are purchasing a practice, you must ensure that you have communicated with your broker at a very early stage to ascertain the position of your current insurer.

Will the profile of the firm still fall within their appetite and underwriting criteria? Will there be an additional premium charged and what will their renewal position be? Will there be any changes as far as the self-insured excess and limit of indemnity is concerned?

On the other hand, it could be that the acquisition of a particular firm changes the profile of your firm for the better. This could be seen in the possibility of opening additional markets at renewal.

Ultimately, you must understand and anticipate all the potential scenarios that could happen when you acquire a firm, the good and the bad.

Furthermore, if you carry excess layer PII, you will need to decide if this also needs to be endorsed prior to acquisition to confirm cover for the newly purchased firm’s activities.

Regardless of this decision, becoming a successor practice is a good opportunity to review whether you need to increase your overall limit of indemnity going forward.

Culture clash?

Another important risk factor to be aware of is a potential culture clash between firms. This could be an issue irrespective of which side of the transaction you are on.

You must ready yourself and your staff for the change and be sure to embrace the cultural change the transaction will bring. You must not underestimate the inevitable difficulties and period of destabilisation that accompanies even the most successful merger.

Many lawyers, and people in general, are not fond of change and one thing you can guarantee that any merger will bring is change.

New colleagues, changes in responsibility, office moves, and new systems and processes, can be disruptive and must be managed by those in charge.

Moreover, lots of firms have fundamental differences in their culture which will need to be considered when a merger is taking place.

One successful firm may be built on old-fashioned values, with a strong traditional client base, and prefer a formal way of business, emphasising professional values, like strict dress codes etc.  Another equally successful local firm may have open plan offices, a less rigid dress code, and a progressive, more fluid outlook on how to do business.

Without careful consideration of how to manage the imminent culture clash, a merger between these two firms would likely be a nightmare, and a subsequently messy de-merger could be on the cards.

Smooth transition

Any successful merger will require a considerable amount of management time to achieve a smooth transition. Even seemingly straightforward administrative tasks can prove tricky and should be planned for appropriately.

The level of change brought about by a merger can unsettle even the most content employees. Some may reassess their own position and personal ambitions.

Ultimately, even the smoothest law firm merger is usually accompanied by a period where there is a noticeable increase in staff turnover and an unsettled environment.

To guarantee a smooth transition during an undeniably stressful time, ensure you have the support you need to move forward or engage expertise to secure the support.

Williamson & Croft’s transaction service specialists provide personalised, proactive, and reliable client support that is tailored to your unique needs. We stand by our clients at every step of their journey toward achieving a safe and successful business transaction.

No matter the size or type of organisation you operate, our specialists have the expertise and resources to provide the right solutions to clients. Our goal is to help you identify and achieve your business objectives – we take the stress out of complex business transactions such as those discussed in this article.

If you would like to learn more about our comprehensive accountancy services or would like to discuss how our transaction services can help you, contact us today.