When negotiating legal MSO deals, preparation and mindset are just as important, if not more, than spotless financials. Apply these strategies to get the best possible terms with investors.
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The Legal MSO. The end of administrative woes and the initiation of massive infusions of capital and a “second bite of the apple” (cash out later) that can create generational wealth.
Sounds great, right? It can be, but only for the firms that get good deals. Since this structural phenomenon is so new, the best deals that will ever be made are happening right now. But so are the worst. (See our article, “The 7 Pillars of Legal MSO Deals.”)
The firms that get the former aren’t always the most profitable; they’re the best prepared.
Yes, clean and clear financials are important, but as in any negotiation, psychological strategy is just as important, if not more. Like an athlete preparing for a match, having the right mindset can pave the way for success.
Psychological Strategies for Negotiating Legal MSO Deals
What follows are some mental strategies that will help you negotiate favorable deals with legal MSOs.
Make Sure Everyone is Truly Onboard
Start with internal alignment, because nothing will quietly kill your law firm’s valuation faster than a fractured partnership. Funds spend an inordinate amount of time reading between the lines of partner dynamics. One disengaged senior partner, one skeptical rainmaker, one “I’ll go along, but I don’t like it” voice in the room can function as a latent poison pill. It introduces execution risk, integration risk and retention risk, all of which are factored into valuation and “downside protection.”
Joshua Porte, a nationally recognized MSO attorney at Holland & Knight, put it this way:
“Any potential discord among the partners can dramatically heighten transaction risk for a prospective buyer, so having clear alignment among the founders in terms of the reasons for entertaining a transaction and the post-closing vision is critical. Deals have and will continue to fall apart if this alignment does not exist.”
The firms that command premium outcomes have already had the uncomfortable conversations.
They have real consensus not just on doing a deal, but on why they are doing it, what success looks like, and how they will operate post-transaction, i.e., “adoption.” They have what former FBI Negotiator Chris Voss calls “buy-in” in his book “Never Split the Difference.”
Buy-in is not forced or even a reluctant agreement. It’s a genuine belief that what is proposed is truly a good idea or concept. When investors see that all the key people have buy-in, they recognize the value of that and deal structures improve accordingly.
Think Like An Entrepreneur
The most sophisticated firms and attorneys are thinking like entrepreneurs before they ever meet with an MSO. They have just had limited resources on which to build. Prior to meeting with an MSO, they’ll sit down and ask themselves and each other:
“What would we do to grow our firm if money were no object?”
They examine their current marketing strategies and evaluate what could be done better. They pre-identify lateral partners, small firms and strategic practice groups they would pursue if salaries and other costs were not a factor.
Rethinking their growth strategies in advance does two things.
- First, it signals to the MSO that capital can be deployed intelligently, immediately and strategically.
- Second, it reframes the firm from a passive recipient of capital to an active growth platform. “Platform” is a magic word with PE operators and investors. A law firm might grow, but a platform is already set for growth. That distinction alone can result in a meaningful impact on both deal structure and economics.
A firm that says “we might grow” gets one deal. Investors present a very different deal to a firm that says, “Here are three target firms, a pipeline and two ways we believe we could modify our marketing strategy to increase ROI”.
Embrace That Software You Hate: It’s a “Lever”
Equally important is identifying “operational levers” (areas in which a firm can improve, that will increase profitability) before diligence begins. Intake conversion rates, billing software, retail pricing, technology gaps, and workflow inefficiencies are not weaknesses in this context. Properly framed, they are opportunities for capital to increase profitability.
Funds are not buying perfection. They are buying the delta between where you are and where you can be with help from capital and enterprise pricing solutions. The firms that perform best when negotiating legal MSO deals are the ones that know their data and have already identified at least a few areas of potential improvement and the potential increase in profitability that upgrades could provide. They can articulate these “levers” with precision. They do not hide their inefficiencies. They quantify them and position them as potential for upside. (Related: “Law Firm Valuation: If You’re Not Tracking Your Data, You’re Already Behind.”)
Learn the MSO Deal Basics from Experts
There is also a practical reality too many firms ignore until it is too late. You need to understand how these deals actually work before you are in the middle of one. Concepts like preferred returns, waterfall structures, clawbacks and participation units are not academic. They directly determine whether your “second bite of the apple” (the big money that comes later) is meaningful or minuscule. A deal that offers 6x EBITDA (basically net profit, including equity partner salaries) but caps the equity rise on the back end at four times initial value is nowhere near as good as a deal that offers 4x EBITDA and 10 times the value on the back end.
It is also important to gain an education so that your partners don’t go into shock when they see a provision wherein they might have risk — which is unavoidable in all such deals.
Austin Maloney of Hunton Andrews Kurth has observed this first-hand:
“We have seen very successful, sophisticated attorneys get uncomfortable with fairly standard terms that are introduced to them for the first time as final documentation is being negotiated. Ideally, the learning process happens in advance of that point.”
A strong MSO attorney will protect you from structural mistakes. A seasoned advisor will protect you from strategic ones. The attorney ensures the documents say what they should. The advisor ensures you are pursuing the right deal with the right partner.
Define the Deal Requirements, Including Equity Stakes
Before entering the process, disciplined firms also define both their short and long-term goals, as well as their non-negotiables. Not in vague terms, but in specific, enforceable concepts. Valuation, control over hiring and firing, governance of the firm and succession are all thought out and scribed. They also pencil out what they want to protect in the way of compensation philosophy, parameters around capital deployment and cashout provisions.
If you do not define these in advance, they will be defined for you, often incrementally and often too late to meaningfully push back.
One of the more nuanced but increasingly important moves is the early identification of who participates in the equity. This is not just about the top-line equity partners. The firms that create durable outcomes often equitize continuity partners in advance, even at modest levels. Two and a half percent here, a small participation unit there. It aligns the next generation and reduces the risk that value walks out the door post-closing. The same logic applies, selectively, to key business personnel.
If a COO, head of marketing, or operations lead is critical to execution, give them a stake in the MSO side. This can materially de-risk the investment and, not coincidentally, improve a firm’s negotiating posture.
Additionally, it protects the firm’s succession and legacy.
Be Highly Responsive
When the process begins, execution discipline separates the serious from the speculative. Responsiveness or lack thereof is not a courtesy. It is a signal. A portent of how a firm will act as a partner in the future. Investors interpret delays, incomplete data, and inconsistent communication as either a lack of decisiveness (critical for entrepreneurship) or a lack of professional courtesy. Nobody wants to commit to business relationships with a law firm that displays either. The firms that know in advance they must be highly responsive — even if it means just a quick text stating that they’re swamped in a trial — are viewed much more favorably by investors.
Bottomline When Negotiating Legal MSO Deals
The throughline here is simple, even if the execution is not. The best outcomes are earned well before the LOI arrives. They are earned by partners who mentally prepare themselves. They are the product of alignment, preparation, education and strategic clarity. Firms that prepare themselves psychologically are not reacting during deals. They are shaping them.
Frederick Shelton is the CEO of Shelton & Steele, where he advocates and advises attorneys and law firms on M&A and Legal MSOs. He can be reached at fs@sheltonsteele.com.
Ayven Dodd is the President of Shelton & Steele. He recruits partners and groups for law firms, as well as advising them on MSOs. He can be reached at ad@sheltonsteele.com.
Image © iStockPhoto.com.
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