Law Firm Valuation

Valuing a law firm is a challenge. Whether the law firm valuation is being used to buy, sell or merge a law practice; admit a new partner or buy out a retiring one; establish a buy-sell agreement; or any other purpose, fixing a realistic value for the firm is critical.

Regardless of the reason you’re interested in learning the value of your practice, having an accurate figure allows you to successfully determining your present situation and map out your future business plans.

The Basics of Legal Practice Valuation

Legal practices – law firms – are service businesses, as are all professional practices. They usually do not offer a tangible product (something you can touch) and their primary assets revolve around their people.  Law firms in particular require a high level of expertise needed even to start a new practice. This adds a level of complexity in gauging the appeal of the firm to an outside buyer.

Attorneys must be licensed to practice law in the jurisdictions in which they provide legal services. An attorney’s license is not transferable and therefore does not have market value within the traditional definition of that term. But it obviously has value to attorneys, because without it, attorneys cannot practice law.

When an attorney sells out or brings in an associate, no professional license is being transferred, and generally there is no value of a professional license per se reflected in the transaction. When a law firm with a collection of licensed attorneys is sold, there may be an element of value in the transaction similar to that of an assembled skilled workforce in an industrial business.

Law Firm Goodwill

More than other types of businesses, the value of a law firm depends on the skills, reputation and efforts of individual attorneys. Therefore a portion of the total value is due to the personal reputation or skill of the owner(s) and may not be easily transferable to a buyer. This is known as professional goodwill. In certain cases professional goodwill has no value to a buyer.

Practice goodwill, on the other hand, results from the practice’s successful operation over time. A firm with an established history and distinguished reputation can attract clientele without relying solely on the visibility of individual attorneys. If law firm partners make deliberate efforts to bolster the image and value of the firm itself rather than its members, a prospective purchaser would pay more for the practice goodwill you have created.

Key Value Factors for Law Firm Valuation

While any privately-held business needs strong financial performance to create value, each industry has particular “value drivers” that wield a strong influence on the attractiveness of a specific firm.

• Specialization – When the success of the practice depends on the talents of a specific individual or group, the practice becomes more difficult to sell and therefore is worth less than an otherwise identical practice with less dependence on any one person. A specialized practice tends to rely on referrals from other professionals who base their referrals on the reputation of the specialist. Another attorney, therefore, cannot merely take over the specialist’s practice and expect the referrals to continue uninterrupted.
• Pricing – Across the legal and accounting industries the billable hour is now in question. Fixed-rate or ‘value’ pricing has made inroads as clients now expect better results at a reduced rate. These changes may hurt firms’ profitability.
• Corporate Profit – Legal firms that cater to the corporate sector rise and fall with the increase and decrease in activities like IPOs, M&A, and private equity transactions.
• Legislation – Whenever new laws or regulations are enacted, people turn to lawyers for tell them what it means. As legislation increases and gets more complex, the need for attorneys grows.1

Every legal practice appraisal should be especially mindful of these elements and analyze them objectively from the perspective of a third party buyer.

Rules of Thumb for Law Firm Valuation

There are rules of thumb for law practices that can give you a rough idea of your company’s value. Law firm valuation rules of thumb are straightforward and simple, but remember that they ignore every aspect of your practice that makes you unique from your competition.

That said, rules of thumb can still serve as a good reference point. See the industry multiple listed below provided by Tom West, editor of the 2010 Business Reference Guide (Business Brokerage Press).

Law Firm Valuation Rules of Thumb2

• 40% to 100% of annual fee revenue; firms specializing in estate work would approach 100%; may require earnout.

Approaches for Realizing your Practice’s Value

There is no single law firm valuation method that can be used for every practice. No two practices are the same, so valuation analysts will choose between three different approaches when valuing your practice.

• Income Approach: Methodologies centered on this approach fix value to your practice by anticipating your future income-producing capabilities.
• Asset Approach: When the assets of your practice count towards a significant portion of your its value, this perspective is commonly employed.
• Market Approach: This approach focuses on comparing your practice to similar practices that have been sold. However, compiling this data for the comparisons can be difficult in some areas.

Valuing a law practice is never simple or straightforward. However, a law firm valuation performed by a credentialed appraiser will provide you with a thorough report that explains the value of your firm in a logical and readable report that can help you successfully plan for the future of your practice.

Looking Forward in the Legal Industry

The legal industry averaged annual growth of 1.7% from 2006-2010 and is expected to continue growing at 2.8% from 2011 to 2016.3 This is a time of uncertainty in the industry, as many firms have recently experienced reduced revenues and cutbacks in staff. But smaller firms previously unable to land larger clients are now in a competitive position. Nimble firms that can capitalize on the new opportunities in the industry should find growth in revenues and overall value.

Choose the Valuation Firm You Can Trust

A valuation for a law firm is far more than an aggregate of the firm’s total assets. We recognize that your professional practice can have tremendous value beyond what exists only within your office. Using an experienced and credentialed valuation firm will ensure that all the unique aspects of your business factor into the valuation analysis.

Please tell us about your situation through our contact form or call (800) 895-4100 and one of our Value Advisors can speak with you right away. We welcome the opportunity to hear about your practice and offer our help if necessary.

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1 IBISWorld. (2010, January). Law Firms in the US. Retrieved from IBISWorld Industry Market Research database.
2 West, Thomas L. 2010 Business Reference Guide: the Essential Guide to Pricing Businesses and Franchises. [Worcester, MA]: Business Brokerage, 2010.
31 IBISWorld. (2010, January) Id.