Where succession is unlikely to come from within, and sale or merger is the preferred strategy, it will be critical that the practice is ‘sale ready’. Maximising value is paramount for these practices.
For practices that are looking for succession from within, what does this process actually look like? This can be especially complex for goodwill practices when it comes to ascribing a value to the goodwill component.
Whether looking to external buyers or passing on a goodwill practice, the valuation of goodwill is inherently subjective as it is an intangible asset and in professional services especially, difficult to delineate between practice goodwill and personal goodwill. Unfortunately, this mindset can often lead negative impacts on the perception of value.
So what should a practice consider when looking to sell or valuing goodwill?
The future earnings of a practice correlate to the effort and exertion of existing and incoming principal(s) and the impact of exiting principal(s) can be significant unless key relationships (both internal and external) are transitioned effectively.
It stands to reason that the value of a practice is therefore likely to be significantly impacted by transition arrangements with departing principals. Highlighting the need to plan early and have documented plans in place.
Other factors that are likely to have the greatest impact on multiples used for sale or calculating goodwill of a practice are:
Size – larger practices are likely to have more diversified cash flows and are less likely to be unduly dependent upon a single individual within the firm.
Recurrence of revenue streams – annuity, compliance type revenue profiles are seen to be less risky than lumpy, project based income.
Client profile – costs to serve longstanding clients are typically lower than a practice with high churn.
Staff – a stable, experienced team is likely to serve clients better than the alternative.
Competition for buyers – if there is an ability to generate competitive tension in a sale process, this is likely to have a positive impact on value realised.
If a practice can exhibit one or more of the factors above, and assuming this leads to positive goodwill in a practice, it begs the question as to why principals would establish a non-goodwill practice?
In theory, as a firm grows, its valuation increases to a point whereby the admission of new partners becomes cost prohibitive. Incumbent principals should look to promote and recruit prospective talent based on merit, not on their ability to fund a significant goodwill payment.
Ironically, a non-goodwill practice that can attract the best talent is likely to generate more value in the long term than a goodwill practice whose value prohibits all but the wealthy.
For any legal practice to realise its maximum value it needs to generate profits that are sustainable, replicate results, have robust quality systems and processes and have some degree of uniqueness. For those with intangibles, such as goodwill, they also need to be able to have a value ascribed to this component.
Maximising the realisable value from a practice begins with making sure you are ready for sale and this starts with having a documented succession plan in place. In our 2016 survey, of the 34% of respondents indicated they had a document plan, while in 2017 it was 35%. The survey also highlighted that 46% of respondents continued to maintain a goodwill practice, which means almost half of our survey respondents will need to come to terms with goodwill valuations as they edge ever close to succession.
Let’s see if our 2018 survey, due out soon, will shed even further light on what legal practices looking to sell in order to succeed can do to maximise their valuations.