I’m going to lead with a secret. The things that make a firm attractive to buyers are exactly the same things that make a firm a joy to own.
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What are the top three reasons a firm is an attractive acquisition — and a joy to own?
- It is financially healthy.
- It has a great culture.
- It is not wholly dependent on the owner.
Here’s why these three matter.
1. Financial Health
Everybody wants a firm that is profitable — and of course, that’s the first thing a buyer looks for — but not everybody knows what “profitable” means or exactly how much profit is really profitable.
Profitable Firm Runs on the Rule of Thirds
At Cathcap, we believe in running a firm on the “Rule of Thirds”: 1/3 of revenue goes to the people doing the work, 1/3 goes to overhead expenses (including marketing), and 1/3 goes to profit. (See: “The Best Compensation Plans Use the Law of Thirds.”)
But there are two additional things to consider:
Some firms can increase the profit percentage from 30% to 50%.
Your firm’s ability to increase the profit margin is generally correlated with the amount of risk in the way you get paid.
- Low risk. Firms that bill hourly are passing most of the risk to the client. You work an hour and bill that hour. Assuming you have the cases, your team is hitting their production goals and you have good collection practices, there is very little billing risk. These firms stay close to 30%.
- High risk. At the other end of the spectrum are contingency firms. These lawyers may have to work years before they might get paid. There is a lot of risk in that they might work for years and not get paid a penny. These firms should be running a little closer to a 50% profit margin.
- Moderate risk. In the middle are firms that bill flat fees. These lawyers have said that no matter how much they work, the price will be the same. Even if they must chase and work a case for years, the $1,500 flat fee agreed on at the beginning is all the client pays. On the flip side, they might be able to solve that problem in 15 minutes, and the client still pays the entire $1,500. Profit should be on a sliding scale between 30% and 50%.
Profit does not go 100% into the owner’s pocket.
Profit is used to pay taxes and can be reinvested back into the firm to fuel growth. However, those reinvestments must be intentional and tracked. When you are looking at the value of your firm, the best number to track is Seller’s Discretionary Earnings or SDE. SDE is a combination of your salary, any personal expenses you run through the firm, and the profit.
Most firms sell at a multiple of 2.5 to 4X of SDE. The higher the SDE, the higher the value of the firm.
How much profit does your firm produce?
Are you in that 30% to 50% range? If so, you are an attractive acquisition target and you are enjoying the fruits of your labor.
2. Culture
As an EOS Implementer, I know that culture eats strategy for breakfast. Creating a team that knows the vision of the firm, is executing that vision and is healthy makes all the difference. If a firm doesn’t have this, owners tend to feel they are constantly putting out fires. And nobody wants to buy or own a firm that is on fire.
How do you create that strong firm culture?
Easy. Invest in your people. Does your firm have:
- A strong vision of where the firm is going, and how you are going to get there?
- The right reporting structure?
- Everybody in the seat where they can shine?
- A number given to everyone for which they are accountable?
- Core values that are used to hire, fire, counsel, promote and reward the team?
- Great hiring and onboarding process?
- A documented operational training program?
- Career development plans for each employee?
A strong culture, especially one that includes accountability, means that all your people are rowing in the same direction. Consequently, goals are met, targets are exceeded and drama is kept at a minimum.
3. Owner Dependence
The last component buyers look at is how dependent the firm is on the owner.
How much time and effort from you does it take to keep the firm going in the right direction. The less time and effort you put in, the more valuable the firm.
How do you achieve this?
- Make sure the marketing of the firm doesn’t revolve around you and your name and image.
- Don’t be the only salesperson.
- Document the 20% of processes that accomplish 80% of the work.
- Understand and be able to increase or contract the capacity of your firm to meet your work needs.
- Make sure you are leveraging technology to monitor all of this.
By slowly working yourself out of the day-to-day operations of the firm, you increase the law firm’s value. The new owner knows the firm they bought will continue to operate as it did before the sale.
Let’s Recap What an Attractive Firm Looks Like
An attractive firm’s annual profit is between 30% and 50%, with the owner taking home a nice SDE. The firm has a great culture, which results in highly trained people who don’t turn over very often and own their roles. And it takes very little time or effort from the owner to keep it all going.
Why would you want to sell this firm? Most people would keep it for the “mailbox money” it creates.
If your firm doesn’t resemble what I described, now is the time to start working on your firm.
More Law Firm Financial Tips from Brooke Lively
For more tips on building a more profitable law firm, read:
- Why You Should Prep Your Law Firm to Sell — Even If You Don’t Want to Sell
- What Should Be on Your Law Firm’s Dashboard
- Are Your Law Firm’s Financial Systems Ready to Scale?
- Law Firm Profits: 5 Ways You May Be Sabotaging Your Firm’s Growth
- Law Firm Overhead: What It Is — and What It Isn’t
- Building a Law Firm That Pays You First
- Understanding Law Firm Profits — And What to Do With Them
- How Are Law Firm Owners Paid? Total Compensation vs. Salary
- Funding Growth: Are You Starving Your Law Firm?
Image © iStockPhoto.com.
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