How do you value a law firm?

on 11 July, 2011 Email this Email this - Print this Print this

Ray Fox (from the Bottom Line Consultancy) sets about answering a question on the lips of many in the legals services sector. “It’s truly amazing how many times I get asked this question. There’s an old saying that if you ask 100 accountants a question, you’ll get 101 answers.  The problem with valuing law firms is that everyone has a different view and a different perspective.” Click below to read more…

For example, accountants seem to think that there’s a standard formula.  I’ve heard it said that the value is 2¼ x net profit.  I’ve also heard it said by other accountants that it’s 1½ x gross fee income.  Oddly enough, when Solicitors are looking to buy a Practice, they tell me that law firms don’t have a value.  Why do I not find that strange?  Stranger still, is that when those same Solicitors come to sell their firm, it does a value!!

Some years ago I was selling a small law firm in Handsworth in Birmingham.  I had an enquiry from a solicitor in a small Gloucestershire village.  He wanted to know what the firm in Handsworth was selling for. I asked him why he was interested in buying a practice in Birmingham.  He told me he wasn’t really interested in buying the firm, but assumed that since his practice had the same turnover as the Birmingham practice, the two firms would be worth the same.

When I explained to him that a firm in Handsworth with over 40,000 residents in a highly multi cultural and multi ethnic environment, about 4 miles from a major city centre might be worth a different amount to a firm in a genteel Gloucestershire village, he finally got the point.

However, net profit and gross fee income do have a part to play.  Having said that, take the example of a number of absolutely identical law firms, they are in the same town, they do the same work, etc.

  • Practice 1 has a dozen P I negligence claims.
  • Practice 2 has an excellent web site and is generating lots of work off the web.
  • Practice 3 is in the centre of a major shopping centre and has considerable passing trade.
  • Practice 4 has a database of 25,000 local residents and mailshots them regularly.
  • Practice 5 has a lease on a really old building and has a huge exposure to dilapidations when the lease expires.
  • Practice 6 has a 25 year lease without a break clause.
  • Practice 7 occupies offices owned by the Principal but the law firm doesn’t charge any rent so the profits are over-inflated.
  • Practice 8 also occupies offices “owned” by the Principal but this time the offices are actually owned through an offshore registered company so a higher than market rent is being charged to reduce UK income tax and take the rental income offshore to a tax fee environment.
  • Practice 9 occupies offices space without security of tenure and the lease is about to expire.
  • Practice 10 occupies offices space that does have security of tenure and the lease is about to expire.  This means that a potential buyer could take over the practice and move it to another location without any significant property related costs.
  • Practice 11 is owned by a Principal who is seriously ill and needs to sell in the next few months.
  • Practice 12 “employs” the Principal’s wife and children purely for tax purposes.
  • Practice 13 wants the firm valued because they want to incorporate.
  • Practice 14 wants the firm valued because the Principal is getting a divorce.

So here we have 14 absolutely identical law firms but they are all valued differently.  So, in simple terms, there’s really no fixed multiple as to the value of firms.  The only way to get a true valuation is to work with someone who sells law firms week after week, month after month and has done so for over 16 years.

Remember if you use your accountant to give you a valuation, the likelihood is that they have never valued a law firm before and have no more than a conceptual or theoretical idea as to how to value the firm.

Also bear in mind that if you have a valuation for incorporation purposes, HMRC are increasingly challenging accountants’ goodwill valuations as accountants have no real platform on which to base the valuation of a Solicitors’ Practice.

Ray Fox

7/7/11


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Topics: Hot Topics · Selling law firms
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