Thinking of Purchasing a Smaller Law Practice?:  Consider These Things

PerformLaw has seen an increase in the number of attorneys interested in purchasing existing law practices rather than starting their own firms from scratch. The purchase of a law practice is not a simple undertaking, but proper due diligence can make sure your particular objectives are achieved.

These transactions are almost always on a prospective basis. A typical structure has the seller retaining all of the AR (Accounts Receivable), WIP (unbilled time), and Liabilities as of a specified cut-off date. If needed, the buyer can purchase any hard assets for a negotiated price.  Occasionally, these transactions include intellectual property, which can impact the calculation of future revenue sharing. For example, a personal injury lawyer may have a publicly recognizable firm name associated with a marketing approach that generates new cases.

Intellectual property related to a process or service delivery is harder to value.  For example, custom debt collection software used in a collections practice. The value of this type of asset would depend on any competitive advantage gained over what is readily available on the market.

Due diligence is easier in a prospective revenue only deal and focused mainly on supporting any assumptions of future sources of income.  In our experience, the payment period runs two or three years and can range from 15-25% of gross collected revenue, depending upon the profitability of the work.

A riskier deal might include a payment based on an agreed-upon baseline revenue amount paid over a period of years. For example, a multiple of agreed-upon recurring revenue or profit at sale date paid over a period of years. I’m less comfortable with this structure, but I have seen one or two in the past.

As for due diligence, I would request the following:

• Three years historical revenues (billed and collected basis) by client and a distribution of timekeeper hours by client;
• Three-year salary history for any retained employee post-acquisition;
• Compensation history of any partners in the transaction;
• Copies of any relevant employment or compensation agreements;
• Copies of any lease agreements the buyer is assuming – office equipment and space;
• Lien or secured financing search for any purchased asset ( the firm’s bank may have a pledge of all firm assets);
• A listing and description of any intellectual property claimed by the seller;
• Proof of tail coverage for any acts before acquisition;
• A list of any one time or recurring charges that the seller expects the buyer to assume;
• Any fee-sharing agreements with Co or Referral counsel;
• Engagement letters for any assumed clients;
• A listing and disposition of all trust balances attached to cases moving to the acquiring firm;
• A listing of all outstanding WIP (fees and costs), AR (fees and costs) for cases moving to the acquiring firm; and
• Three years income statements and balance sheets.

The structure of the transaction dictates the due diligence depth. For example, if it is a go-forward agreement on new cases only, many items on the list are not necessary. If the transaction is a purchase of the firm’s assets and includes an assumption of liabilities, you are likely safer commissioning a CPA to do an audit.

If an insider is buying the firm, a simple agreed-upon procedure engagement with the neutral CPA may suffice.

As you know, each deal has its unique characteristics, and due diligence on the buy side can expand or contract based on the buyer’s perceived risk.