Exit issues for small firms and sole practitioners
With the majority of law firms in England and Wales having fewer than five partners, and with many of those partners being close to retirement age, how to achieve an exit is becoming ever more crucial. Tom Blandford considers how smaller firms can achieve the transition.
The basic option is either an internal or external sale. Whilst an internal sale might be perceived as being more straightforward, you have to have the right people in your firm, who are both willing and able to take over. This might require a strategic recruitment drive a few years ahead of planned retirement dates, and starting a conversation early about what the future of the firm looks like.
If the next generation is not keen to take ownership of the business, you may be able to make changes in the present to manage any concerns (eg if there are worries over risk, take the opportunity now to incorporate the partnership into a limited liability vehicle).
If it is an external sale, many partners will look to their immediate competitors as potential acquirers, given the obvious synergies. Equally, some deliberately avoid their nearest rivals and look to become part of larger firms with more depth and breadth to their services.
There are also several consolidators and so-called ‘succession solutions’ that are actively looking to acquire multiple firms in short timescales.
Becoming an owner of your firm has to be an attractive option – ultimately, you need to be good at what you do, and be profitable. There are a number of ways to achieve this. Obviously, some will be financial (eg controlling overheads), but others are much less tangible (are your staff well-motivated and trained, for example?).
Whichever route you take (and there are several), maximising value in an exit scenario is not something you should start thinking about only as you step into the negotiating room. Have a five-year plan, and exit the firm on a high point, when potential acquirers / incoming partners can perceive the value they are getting.
An internal process is relatively easy, but still requires the updating of members’ agreements and perhaps the hiring of specialist accountants to value items like WIP. An external process would start by identifying potential suitors. We always advocate an initial meeting over coffee to assess firm culture etc, but do not discuss valuation at this stage. This is for two reasons:
- you are about to enter into a negotiation with them – it helps to see them as human beings
- you are likely to be working with them for a period – at least to allow for a low-key handover, but possibly for many years more in a fee-earner / consultant role – and as such, a cultural match will likely be very important.
From then on, each exit process will depend on the firm, but it will usually involve some form of due diligence (which ranges from an hour or two of looking at files, through to weeks of formal appraisal by specialist accountants); initial valuation and offer; negotiation of price and heads of terms; tax structuring; and, ultimately, a signed sale and purchase agreement.
Now! It is not necessarily a short process, as when it comes to exiting, it is vital to ensure the firm can survive in some manner without its principals. This may mean ‘widening’ client relationships early – this means making sure a client has multiple people at the firm that they know and trust – as much as possible, to allow for any changes in personnel and the transition of fee-earners. It may also mean professionalising your management and support functions, so that the managing partner is no longer required to run the business.
Whatever the exact requirements, the acquirer needs to see how the firm survives without you. That handover plan may well be measured in years, rather than months – so start now.
If you are bringing a new partner into the firm, there is a chance that their capital contribution can pay for the exit of others. This succession model is very common for internal promotions, where it is understood that the incomer is ‘paying’ for the retirement of the outgoing partner (however indirect or notional that payment may be).
People do still pay for goodwill, though not in every case, and it does vary considerably based on the attributes of the firm. Even where they do not pay for goodwill, there are still issues to discuss, such as the realisation of WIP, current and capital accounts.
It is also common for outgoing partners to be employed as consultants for a handover period, and for capital account realisation to be undertaken in instalments over a long period of time. As this represents the retirement ‘nest egg’ of the outgoing partner, they will likely want to take tax and investment advice to make sure that this pot of money is protected into their future as much as possible.
The ‘nuclear option’
Ultimately, you do have the option of simply winding down and closing the firm. However, that can be a very onerous process, in terms of collecting debts that might otherwise go unpaid; finding a good home for clients and staff; and the cash for closure liabilities, such as redundancy, onerous leases and PII run-off cover.
Exiting a small firm and handing it over is not an easy task. It can also be a very emotive one: after all, this is the firm you have built up over many years. For that same reason, you should give the succession process the respect your firm (and its clients and staff) deserve. Investing the time now in making your firm attractive and finding the right acquirer (whether internal or external) will pay dividends in the future – not least in a comfortable and financially secure retirement.
Tom Blandford is legal sector director at Armstrong Watson LLP.
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This article is a general guide to the issues that we see in practice. It is not a substitute for professional advice which takes account of your personal circumstances. No responsibility can be accepted for any loss occasioned by any person acting or refraining from action on the basis of this article.