Recently I spoke with a prospective law firm seller. A buyer had expressed interest in her firm as a way to add a new practice area with an existing client base, but the terms hadn’t been finalized.
As we delved into her expectations for the sale, she told me she wanted to work for the buyer for two or three years after the sale on the following terms:
- Maintain her current salary,
- Receive an origination bonus for each new matter that came from her client base and that she brought to the buying firm, and
- Be paid for transitioning the practice to the buyer and training the buyer team.
When I added up the total, it was almost the total adjusted net earnings of her firm. Effectively, she wanted to sell the firm and still keep the benefits (like selling your car but being able to drive it whenever you wanted afterwards).
Unfortunately, those expectations won’t work for any buyer.
Like all businesses, an acquired law firm pays for itself through the profit generated after the sale. Whether the buyer pays cash or pays for the firm through a bank loan or seller note, the firm’s cash flow is the source to pay the buyer a return on his investment or the debt service due on the loan or note.
As the cash flow from the firm is reduced, the amount to be applied to ROI and debt service is reduced, as well as the value of the firm. Would you pay the same for an investment that paid you $1,000 as one that paid $100? Of course not.
And while some buyers may be willing to acquire a firm that has little or no cash flow, in the vast majority of cases there is no value without cash flow and the firm cannot be sold.
Sellers must focus on the motivations of a buyer and the financial feasibility of the transaction to maximize the value of their firm. With unreasonable terms, the value of the firm is zero.
To ensure the terms work for seller and buyer, we create a transaction model for each sale that shows firm cash flow, buyer ROI, and debt service arrangements based on current and projected future performance. This and other tools we use protect the seller from too low a price and from the deal failing after closing.
