Solo & Small Firm Conference 2015 Financial Aspects of Succession Planning: Valuing a Law Practice

Transcription

1 Vermont Bar Association Seminar Materials Solo & Small Firm Conference 2015 Financial Aspects of Succession Planning: Valuing a Law Practice May 15, 2015 Basin Harbor Club Vergennes, VT Faculty: Arthur Greene, Esq.

2 Financial Aspects of Succession Planning: Valuing a Law Firm By Arthur G. Greene, Esq. May 15, 2015 Solo and Small Firm Conference Vermont Bar Association Basin Harbor Club Vergennes, Vermont

3 Arthur G. Greene Consulting, LLC focuses on both law practice management and the strategic and financial aspects of maintaining a healthy law firm ( Following a successful career as a practicing lawyer, during which he served as managing partner of a firm that grew to 70 lawyers, Arthur has turned his professional focus to management consulting with small and mid-sized law firms. In recent years, his consulting practice has included profitability studies, firm audits, strategic planning, partnership agreements, compensation plans, succession planning, transitions, alternative billing methods, and other aspects of operating a successful law firm. He has lectured, conducted workshops and authored articles and books on a variety of law firm issues. Arthur s most recent publication is Arthur Greene s Practical Guide: Succession Plans for Law Firms and Rewards for Retiring Lawyers (2013), which is available for purchase on his website. Arthur is also the author of The Lawyer s Guide to Increasing Revenue, Second Edition (2012) and a co-author of Effective Law Firm Management Strategies (2015), both available on the American Bar Association website. Arthur is a long standing member of the American Bar Association and has served as Chair of its Law Practice Management Section in He is a Fellow of the College of Law Practice Management. Arthur can be reached at agg@arthurggreene.com. Kathy Fortin can be reached at kwf@arthurggreene.com. 2

4 Financial Aspects of Succession Planning: Valuing a Law Practice Determining value for purposes of transferring a law firm or a law practice is not easily understood. Firms do not go public with information about their transactions and there is little in the legal press on the subject. VALUATION PROCESS Lawyers often ask: Is there a rule of thumb? The answer is no, there are no reliable and workable rules of thumb that can be applied, particularly with regard to solo practices and small firms. While general business valuation techniques are relevant, the unique nature of the law business makes the process far different than valuing interests in a manufacturing company or a retail operation. Even comparing law to other personal service businesses, there are too many variables to lend the valuation process to shortcuts. What is Being Sold? Any valuation process has to start with what is being sold. Most law firms have hard assets, work in process, receivables and good will. While clients cannot be bought and sold, the possibility that the successors can retain the existing client base is the most important factor. The client retention possibility will depend on the nature of the practice, the relationship of the clients to the firm and the likelihood of repeat business. The firms that retain the most value in a transition are those with institutional clients or a firm brand that reaches beyond the reputation of 3

5 any individual lawyer. In a sense, the good will component is the firm name and a network of contacts that represent nothing more than an opportunity to retain or acquire clients. The type of the practice is critical to any valuation discussion. An estate planning practice with a vault full of original wills likely has more value than a personal injury practice where the reputation of the PI lawyer is the key factor. If the firm s clients have repeat business the practice is more valuable than if each client has a one-time need. If the firm has strong branding, independent of any particular lawyer, the firm will have more value than if clients identify only with individual lawyers in the firm. Lawyers that are focused on succession have the ability to create or increase the value of their firms based on decisions made along the way. Valuation Approaches firms: When we look at the legal profession, we see three methods being used for valuing law Arbitrary Valuation Process For lack of a better approach, many small firms simply set an arbitrary price when transferring an interest in the firm between partners or to a new partner. Sometimes the amount to be charged is set out in the partnership agreement and other times it is set on an ad hoc basis when transactions occur. Although common, such an approach is not recommended. It lacks credibility and does not position the firm well for the long term. Formula Technique Some firms develop a common sense formula to value the firm that focuses on financial data, without applying sophisticated business valuation techniques. The following are examples: Example #1 The value of the firm is determined by adding together: The value of the real estate (if any), 4

6 The fair market value (or in the alternative the book value) of any furnishings, equipment or other personal property, The amount of the receivables, or a percentage of them, after eliminating clearly uncollectible receivables from the list, The amount of the work-in-process, or a percentage of them, after eliminating old work-in-process that is unlikely to be billed, and The value of the good will (subjectively determined). Example #2 The formula total is then divided by the number of share or points outstanding to get a value for each share or point, for purposes of setting a price on any transfer. The value of the firm is determined by: Averaging the net profits (compensation and benefits to the owner(s)) of the firm for the past three years and applying a multiplication factor. If there are several partners, the formula total is then divided by the number of shares or points outstanding to get a value for each share or point, for purposes of setting a price on any transfer. No specific formula is appropriate for every firm. DO NOT simply adopt a formula, wherever you read it, without substantial analysis and consideration. These examples are shown as conceptual approaches that can be considered in developing a formula. Business Valuation Appraisal Technique To apply a business valuation technique, the firm or solo practitioner would need to engage a business appraiser with experience valuing law firms. 1 In addition to reviewing recent financial reports, the appraiser would interview some or all of the lawyers to learn about the firm s client base, its practice methods, its billing methods, its marketing and its 1 I wish to thank William Howell, ASA, CPA/ABV/CFF, a business appraiser with substantial law firm valuation experience, for his contribution to this section on the Business Valuation Appraisal Technique. Bill s contact information is Howell & Livermore, 500 N. Commercial Street (East), Suite 502, Manchester, NH (Tel ) 5

7 approach to public relations. The goal is to evaluate both past performance and the firm s potential for the future considering possible retirements of one or more of the key lawyers. To apply a business valuation technique, let s start with the fundamental principles of financial theory. In such a process, the value of any asset is considered to be a function of several interdependent factors: Benefit Stream The purchase of an interest in a law firm should result in some form of a benefit stream such as higher compensation, higher bonuses, profit distributions, and so forth. The purchasing partner needs to compare his or her financial relationship with the firm before becoming a partner - with the expected financial relationship afterwards. Timing of Receipt of the Benefits The value is dependent on the timing for receipt of the benefits. Given that the capital requirements of a law firm are rather low, the cash basis profit may generally be available for distribution. Risk of Deviation Future benefits are typically discounted by a factor to reflect the risk of receiving a return relative to alternative investments that may be available to a Buyer. For professional service firms, the risks are typically believed to be at or above the higher end of the range. That is because the profits generated by the firm are directly attributable to the personal relationships between the law firm partners and their respective clients. Avoid business appraisers with limited experience valuing law firms for the purpose of transferring ownership interests. Only appraisers with a good understanding of the unique nature of law firms can properly develop an acceptable value. Some firms have the valuation determined by a business appraiser each time there is a transfer of an interest in the firm. Other firms may engage an appraiser to set the value initially and then use the result to create a formula to apply in future years. Run the Numbers A formula approach needs to be developed by trial and error and, yes, backing into a formula that will result in a fair number which will work for the retiring partners as well as the associates buying an interest in the firm. In any discussion of value, each side (sellers and 6

8 buyers) needs to recognize the concerns and the well-being of the other party. Payments for purchase of an equity interest in the firm are often allowed to be made over time. No one benefits if the required payments to retiring partners are so large that the firm is doomed and liquidation occurs. The goal is a fair payment to retiring partners balanced by the reasonableness of the investment by the next generation of lawyers. Evaluating a formula based on whether it will work in a given situation may seem unscientific, but when dealing with small and mid-sized firms, backing into a formula is the only way to achieve a workable result. Once a formula is in place, if the firm grows and becomes more successful, the value of the firm will go up and when the next generation retires they will benefit from their success. On the other hand, if the firm flounders and downsizes then the next generation of partners will not be rewarded for their sale price may be less than the amount they paid. Compensation Issues Law firms are different than traditional businesses in that the partners compensation is based largely on their own productivity. Partners are the owners but they are also part of the work force producing the revenue. The line between compensation for productivity and profits for having an ownership interest is blurred. To increase value, one goal is to create a firm that is sufficiently successful that it produces profits over and above the fair compensation paid to the partners. With an opportunity to purchase an ownership interest in the firm, the associate will want to have some idea as to what the return will be on the investment, short term and long term. Unless elevation to partner will result in a significant monetary return, then paying a significant sum in order to become an equity owner may not be appealing. For firms without a true profit 7

9 component, the associate may decide it is not worth investing to become an equity owner if the only change is taking on liability. Unless the partners are receiving profits, over and above what might be considered fair compensation, the firm value will be limited. Why Law Firms Are Unique In the valuation process, appraisers refer to the collective value judgment of market participants. Typical words and phrases include: Open and competitive market Buyer and seller acting prudently Assuming neither is under undue stress We quickly see how law firms present a unique set of circumstances for appraisers to consider. Open and Competitive Market Except in unusual circumstances, law businesses are not sold in an open and competitive market. Law businesses usually get transferred to internal successors or as a result of some type of merger or acquisition. As a practical matter, in small firms there may be only one interested potential buyer. One potential buyer does not make a market. Buyer and Seller Acting Prudently Acting prudently assumes the parties have choices. While buyers and sellers will try to act prudently, in most law firms there are other factors that make it difficult to make good judgments. Perhaps the associate has spent his or her entire career in the firm and does not have any other reasonable career opportunity available. Perhaps the retiring partner has no choice but to leave his practice behind, whether or not there is any basis to be paid for it. Acting prudently considered in light of limited choices is not the same as buying a real estate property in an active market. 8

10 Neither Partner Acting Under Distress In an open market, there are numerous potential buyers and sellers. That is not the case in the transitions within a law firm, or even in the merger or acquisition scenario. The retiring lawyer has to sell; realistically he or she can t decide to practice law for another 20 years. At the same time, the associate may find that his or her continuing employment is conditioned on purchasing an interest in the firm from a retiring partner. It may be that neither the partner nor the associate are free from some type of duress. Business appraisers can provide a value for the firm that can be useful in setting up a formula or establishing the underlying value for a transaction or readjustment of shares. Only appraisers with law firm experience will be able to cut through the numbers and understand the impact of other aspects of the firm on its value. Valuation as an Art, not a Science Whether the firm hires an appraiser or develops a value on its own, there will be a heavy subjective component in the valuation analysis. At the end of the day the reasonableness of the number will depend more on the specific circumstances and the inclinations of the buyer and the seller than any objective or subjective valuation process. Valuing the shares of a law firm is not a math problem. In fact, the determinative factor will likely be whether the benefit to an associate moving into the partnership ranks will be perceived as justifying the purchase price. Finding the right dollar amount is the challenge. Valuing ownership interests in a law firm is more an art than a science. 9

11 Building Law Firm Value When working with small firms on the transfer of ownership from one generation to the next, it becomes obvious that some firms have substantially more value than others. For example, a successful firm with a good reputation, a positive culture, a substantial client base and high compensation to its partners will have a significant value. On the other hand, a struggling firm with a limited client base, a troubled culture and disappointing compensation to its partners will have limited or no value for purposes of transfer. The differences in firm value result from a number of factors, some of which are within the control of the partners. While some partners may find themselves stuck in firms of limited value, there are always some factors affecting value are within the control of the partners. This section discusses what partners can do to build what is sometimes called partnership value within their law firms. Initiatives to Build Value Partners need to recognize that the decisions they make (or don t make) will affect the value of the firm for purposes of transfer to the next generation. Unfortunately, many lawyers focus only on what the firm needs to do to meet the next payroll or fund a year-end distribution, while ignoring more the significant issue of creating more firm value. Each of the following initiatives will both make your firm more successful and will create greater value for purposes of transfer to the next generation: Branding A brand name law firm means a lot to any marketing effort. Typically there are a limited number of brand name firms within any community. For many clients, the important factor is 10

12 that they are represented by a well-recognized firm in the community. They feel good they can say that they are represented by a lawyer in say, Jones & Smith, PLLC. The name means something. They feel it may give them an edge in any controversy or legal discussion. Firms attain brand name status as a result of the firm taking an institutional approach to any marketing efforts. Individual lawyers can be highlighted, but it is the firm that is the constant in any advertising. The individual lawyers need to have a strong presence in the community and they need to promote the firm in any discussions. And, finally, handling important legal matters successfully will reinforce any efforts to strengthen the firm s brand. Some small firms hire public relations specialists to make sure the firm name gets its due recognition in the community. But for those firms with limited resources, individual efforts to build the firm s brand in the community can make a difference. Client Base Some firms have practices where clients have once-in-a-lifetime issues and rarely return for additional services. Other firms build a client base of clients who return from time to time, as needed. Business clients are more apt to produce more repeat business than consumer clients, but vibrant practices can be built with consumer clients and word-of-mouth recommendations. In determining any initiatives to expand the firm s practice areas, consider the likelihood of repeat business. For example, perhaps you could develop a practice representing start-up businesses. Or, you could get into doing collections for the local hospital or a credit card company. You might consider insurance defense work and have a continuing flow of business, even though the rate would be lower than your other work. The key here is to think about how to attract repeat business for the firm which is not dependent on any particular lawyer. 11

13 Strong Positive Culture A firm s culture can be described as the result of the attitudes, personalities, policies and decisions, past and present. The culture can be positive or negative. It can based on times past or be the result of the current members of the firm. It is usually attorney driven, but in some firms it is staff driven. The firm s culture can be either a building block upon which the firm s success is based, or a hindrance which stands in the way of meaningful improvement. Do not underestimate the significance of the firm s culture on an effort to lead the firm to a higher level of success. Changing a culture is a challenge. Underlying attitudes and behaviors change slowly. But, the good news is lawyers can create a shift in culture through a unified and persistent effort. It will only happen if all the lawyers are committed to the effort as a priority and act as positive role models. It is rare to find a law firm that has reached financial success without having a superior culture, in which each person is provided with the best possible environment to succeed, free of distracting internal strife and unnecessary stress. Long Range Planning Firms that develop a vision for the future and establish a long range plan prosper more than firms that just plod on from day to day hoping for the best. In order to develop a long range plan, most firms hold annual retreats in order to give the planning process the necessary attention. Often, there is a substantial amount of preparation involved, sometimes with consultants guiding the process. Once a plan is in place, monitoring progress and updating the plan is critical. Some firms monitor progress at monthly partner meetings and revisit the plan in a retreat setting every five 12

14 years. Other firms revisit the plan each year at the firm s annual retreat. The details of the process are less important than the commitment to have a strategic plan and to track progress. Healthy Capitalization Many law firms are undercapitalized, particularly firms where the partners are motivated to take out as much money as possible at year end. Draining the bank account every December 31 is unfortunate because the firm ends up borrowing to cover current expenses when cash flow is off and the carrying of debt becomes too common. Believe it or not, some firms will borrow to pay partners when there are cash flow problems. These firms are headed for trouble. The most valuable firms are those where the firm has retained sufficient earnings in order to fund initiatives and navigate through any cash flow problems. The partners in undercapitalized firms need to bite the bullet and begin building a reserve in order to create the opportunity for greater success. Ample Partner Compensation The profitability of small and mid-sized law firms can vary widely from dismal to lucrative. Prominent lawyers within the community can have very different levels of financial success. In the last analysis, it is not just the lawyering skills that affect the financial health of the firm, but rather successful the lawyers are at firm management and practice management. The most successful law firms have good leadership and a strong positive culture. They understand the need for an effective client intake process and the importance of meeting or exceeding their clients expectations. They are effective in their use of time and as a result they have a high billing realization ratio. Their clients understand the need to pay for the legal services in a timely fashion and are provided the option of putting the fees on a credit card if they have cash flow issues. 13

15 Unfortunately, there are too many small firms that do not pay proper attention to these standard management matters and the partners in those firms may be struggling to provide themselves compensation any higher than that of their lead secretary. Those are the firms that have no value for purposes of succession. Who would want to pay money to become part owner of a firm is depressing financial results? It should go without saying that operating the firm with good management and the resulting strong revenues in an important factor in developing value to what the partners will be transitioning to the next generation. SUCCESSION PLANNING OPTIONS FOR SOLO PRACTITIONERS AND SMALL FIRMS The goals of a succession plan should be (i) to make sure your clients on-going needs are well taken care of, (ii) to provide you with the flexibility you need to enjoy some personally rewarding retirement years, and (iii) to maximize the value you receive for the law practice you have built through many years of hard work. The goals are achievable, but only through a planning process. In most circumstances, age 70 is too late to successfully address the necessary planning. If you are in your 50s or early 60s, now is the time. The key to succession planning is to recognize that it is a process, not an event. That process should begin five to ten years before the practitioner approaches retirement age. Identifying a successor and developing a step-by-step transition process takes time. The succession plan will require the successor lawyer to develop leadership abilities, understand management responsibilities, and participate in an orderly plan for the transition of client relationships. The solo practitioner and the small firm have the following choices: 14

16 Wind Down and Close the Office If the practitioner(s) has either not considered or has not accepted the possibility of a succession plan, the result will be an eventual closing of the law office. In many respects, this may seem easier than grooming a successor; on the other hand, this approach will not capture any value for the retiring practitioner and it will leave long-standing clients with uncertainty. The abrupt approach is for the solo to announce the closing of the office as of a given date, thereby providing all clients with the time for an orderly process in selecting a new lawyer to take over. The gradual approach is to stop taking new matters and go into a wind-down mode which involves completing most or all existing projects. A transactional lawyer can successfully wind down a practice in 3 to 6 months. A trial lawyer may be tied into existing cases for 2 or 3 years. Recruit a Successor Some practitioners will want their law office to survive them and can engage in a process to hand pick a successor to whom they will entrust their clients legal matters. The successor can be a younger lawyer groomed to become the owner of the business. After a few years, the new lawyer can be offered a partnership, which can be tied to an exit strategy which includes an appropriate compensation arrangement for the retiring practitioner. This succession approach requires a 3 to 5 (or more) year process. Merger The practitioner can merge with a solo or with a small law firm. This type of arrangement usually involves a two or three year exit strategy. Often the retiring practitioner is provided an Of Counsel arrangement with appropriate compensation. The Of Counsel duties may vary, but a critical component is continued involvement with the clients as matters are transitioned to different lawyers. Experience has shown that some continuing involvement of the retiring lawyer is critical to the new firm retaining the clients. Acquisition by a Large Firm Practitioners with a high level practice and a strong client base can be attractive to some large firms. There have been numerous instances where large firms have brought in successful practitioners and offered a mutually advantageous exit strategy for the practitioner. It must be noted, however, that the practices of a select few would be attractive to a large firm. 15

17 Sale Law practices have not been the subject of straight sales until states adopted some variation of Rule 1.17 of the Model Rules of Professional Conduct. Prior to the adoption of Rule 1.17, indirect sales took place in law firms through internal arrangements requiring buy-in and pay-out as partners entered and departed from those firms. That indirect method allowed lawyers in firms to sell their practices, which put them in a different position than solo practitioners. Theoretically, the adoption of Rule 1.17 provides solos similar opportunities to those held by lawyers in law firms. While the more traditional method of an internal transfer may still be preferable where that choice is available, Rule 1.17 now allows a straight sale to a third party. Key provisions of Model Rule 1.17 include: Seller has to cease practicing law or practicing in the area of practice that is being sold. Written notice and a written request for consent to transfer the client s representations must be given to each client and must include (i) the proposed sale, (ii) the client s right to retain other counsel, (iii) the fact that the client s consent will be assumed if he doesn t take any action within 90 days. (Note: further provisions if the client cannot be given notice). The fees charged cannot be increased by reason of the sale. There are other conditions, and the specifics may vary from state to state, so it will be important to review your local the Rule in its entirety. See Rule 1.17 of the Vermont Rules of Professional Conduct. Given this array of possibilities, the practitioner needs to consider which choice best suits his or her needs in achieving identifiable personal goals. While a wind-down to close an office requires a lot of administrative detail work, it can be an easier road to follow than grooming a successor. Finding a successor or identifying the appropriate lawyer can be difficult. Not only are you concerned with legal competence and client service requirements, but shared values and work ethic become critical. You also need to recognize that no matter how careful the selection 16

18 process, it may take a year or two before you know if you have struck the right match. Failure and the need to restart the process is always a possibility. Here is the main point. Practitioners have choices, perhaps many choices. But the lack of any planning causes most practitioners to approach their retirement age not knowing that by waiting to take any steps they have reduced the choices available. Many practitioners close their doors because they failed to consider the alternatives and take essential steps in advance of their retirement. SUCCESSION ISSUES Many small law firms are first generation firms, led by their founders during their 20, 30 or 40 year existence. Clearly, the retirement of the founder challenges the continued existence of any small firm. In the small firm, the successor (or successors) may be lawyers who are already working in the firm. While that should make succession easy, most small firms do not plan and succession becomes hard to accomplish. The founders of most successful small firms are both strong leaders and rainmakers. When they grow the firm, they tend to look for lawyers who can service clients that the founder has generated. Rarely, do they look for other lawyers with the same leadership and marketing skills that they possess. As a result, the other lawyers assume a supportive role and do not develop the skills necessary to successfully lead the firm. Succession planning for a small firm involves: Making sure the ages of the firm s lawyers are balanced across more than one generation. Making hiring decisions based on the eventual future need for leaders and rainmakers. 17

19 Educating all lawyers in the business of law; that is, how the financial model works and what is necessary to attract clients and make the firm financially successful. Looking for opportunities to involve all lawyers in some aspect of management, in order to evaluate whether they have the skills to be future leaders of the firm. Making sure the evaluation of the firm s lawyers includes contribution to the culture of the firm and its shared values, in order to reinforce the importance of those qualities in the future leaders of the firm. Developing a client transition plan which involves the next generation of lawyers participating with the firm s most important clients, while protecting the more senior lawyers on issues of compensation and status. All of this takes time. The succession planning process starts with hiring decisions and continues with activities designed to train future leaders. Any firm with senior lawyers in their late 50s should be addressing succession planning. Succession planning is based on an assumption that it is desirable for the law firm to grow and/or evolve from one generation of lawyers to the next. In a sense, succession planning institutionalizes the firm, which results in the health of the firm superseding the needs or desires of any partner. Decisions are made based on what is best for the firm, not what is best for any particular individual. Putting the firm first is truly a transformative process. Partnership Structure Regardless of whether your firm is a sole proprietorship, a partnership, a professional association, or a limited liability company, there are many ways to structure a succession plan. A two-tiered partnership can be incorporated into any ownership structure and it represents a good way to get a lawyer involved in some management issues and learn whether that lawyer has potential to be a future leader of the firm. It represents a good transitional step between associate and equity partner. 18

20 When it comes to structuring the exit plan, Of Counsel arrangements or consulting agreements are excellent vehicles for providing the retiring partner with a reduced role and appropriate compensation, based on a variety of factors which may include the value of the business being transitioned. Lawyers structuring such a deal have great flexibility. The entity structure should not stand in the way of creating innovative approaches for succession from one generation to the next. Generational Spread of Partners Some aspects of succession planning are pretty simple. For example, as you grow your firm make sure you hire from different generations. You would be surprised to learn how many small firms grow by adding lawyers from the same generation as the founder and end up with all the partners in the same age group. It is not uncommon to have firms beginning to think about succession planning and realize that all the lawyers are in their 60s. Leadership Requirements and Management Responsibilities Rarely do we see a successful firm without strong leadership, which makes leadership a critical succession planning issue. Some believe leaders are born, not developed. Others embrace the concept of leadership training for associates. We won t solve that debate, but the point to take away is that successful succession involves identifying or developing one or more effective leaders. Management is unlike leadership and involves different skills. Every law firm needs individuals who are organized and have the ability to carry out policies and effectively implement new plans. The majority of the management duties can be delegated to an office manager or a suitably skilled member of the staff. 19

21 Entrepreneurial Spirit Solo practitioners or founders of small law firms are likely to possess an entrepreneurial spirit. Without it, they would be out-of-business. Lawyers added to the firm may or may not have an entrepreneurial spirit. Too many small firms hire because there is a need to cover an existing work load and not with the idea that they are choosing future partners. This common failure in the approach to recruiting not only discourages the best candidates, but tends to result in assembling associates who are looking for a job, not those with an entrepreneurial spirit, who are looking for an opportunity to own or lead a law firm. Small firms need to think about recruiting future owners and then assist them towards firm ownership. Transitioning Clients Clients are not commodities that can be easily transferred from one lawyer to another. They cannot be transitioned like a mortgage from one bank to another, with little notice to the consumer. The lawyer/client relationship is intensely personal. The Rules of Professional Conduct require that it is always the client s choice as to the lawyer who will represent him or her. All of this highlights the importance of an orderly transition of clients. For example, a client is less apt to exercise his or her right to move to a different lawyer if the senior lawyer introduces the client to his future successor years in advance of the senior lawyer s departure from the firm. In an ideal situation, both the senior lawyer and the successor lawyer both participate in the client s legal matters over two or three years, giving the client the opportunity to develop a relationship with and to build confidence in the new lawyer. However, even in the best of circumstances, transitioning clients is a challenge. Most reasonably sophisticated clients know more than one lawyer in the community and while they may have been loyal over the 20

22 years, the retirement of their lawyer provides an opportunity to switch. Many firms have been surprised to find that, even with their best efforts, the retention of the clients of a retiring partner has been a challenge. Control Issues There are other challenges associated with succession planning. One is control. The sole practitioner, or the founder of a small firm, may have been in control for several decades and at a senior age is inherently unable to give up that control. The two-tier partnership structure is often a good solution for the founder who is not ready to give up exclusive control of his firm. Some senior lawyers find a way to make a transition work; other lawyers end up closing their office rather than giving up control. EXIT PLANS FOR RETIRING LAWYERS The success of a law firm comes from good decisions made by the partners and through many years of hard work. There were likely profits the partners could have taken out as compensation, but chose to leave in the firm to support its growth, largely to benefit the next generation of lawyers. As a result, fairness requires new partners to pay something for acquiring an ownership interest in the firm from those partners who are either retiring or reducing their ownership interest. There are several types of rewards that can be considered for partners at the end of their careers. They may include one or more of the following: Return of capital, Payment for the sale of their ownership interest in the firm, Funded retirement benefits, 21

23 Unfunded retirement benefits, and/or Compensation from Of Counsel arrangements. What may amount to an appropriate benefit package is firm specific. What might be suitable for one firm could be totally inappropriate for another. One anomaly to have in mind is the small firm that is struggling and not providing a satisfactory level of compensation to its partners. Comments made by partners in those firms are Who would want to be a partner in this firm? Who would pay money to be an equity partner here? In those circumstances, expecting an associate to buy an interest in the firm is unrealistic and having firm resources to reward retiring partners is probably out of the question. The solution, of course, is to make an effort to build partnership value. Retirements can cause financial stress on any small firm, so careful analysis needs to be conducted before structuring exit plans and committing to payments to departing partners. Every lawyer owes it to themselves to explore the different types of rewards that can be provided to founders and other senior partners who have developed successful firms to transition to the firm s next generation of lawyers. CONCLUSION Any effort to create what is sometime called partnership value takes nothing more than employing good management practices to the firm. It starts with a leader who can convince everyone that the benefits of improved policies and procedures and better management are well worth the effort. Employing good management practices and improving the value of the firm go hand in hand. Succession planning involves several specific considerations that every firm should address: 22

24 1. Making sure the ages of the firm s lawyers are balanced across more than one generation. 2. Making hiring decisions based on the firm s eventual future need for leaders and rainmakers. 3. Educating all lawyers in the business of law; that is, how the financial model works and what is necessary to attract clients and make the firm financially successful. 4. Looking for opportunities to involve all lawyers in some aspect of management, in order to evaluate whether they have the skills to be future leaders of the firm. 5. Making sure the evaluation of the firm s lawyers includes contribution to the culture of the firm and its shared values, in order to reinforce the importance of those qualities in the future leaders of the firm. 6. Having a valuation process that can be employed to set a realistic value on the firm for purposes of supporting the transfer of ownership interests in connection with the plan for succession. 7. Developing a client transition plan which involves the next generation of lawyers participating with the firm s most important clients, while protecting the more senior lawyers on issues of compensation and status. But back to the main point, which is that small firms and solos need to get beyond the day-to-day work and plan for the future. Make decisions about growing the firm and creating a firm identity. Address succession planning and have an exit strategy that will allow your clients to continue to be well represented and, at the same time, will permit you to retire gracefully, achieving rewards for the value of the firm you have created. 23