Assessing your practice’s retirement value Options

[Editor]

Senior lawyers in small firms may be much better positioned for retirement than their large-firm counterparts because of the retirement value of their practices.

Every firm represents an investment of years of hard work and financial resources in growing the practice and building goodwill. A vibrant client base and a strong professional reputation are real, though intangible, assets that can bring a higher selling price for a firm when the lawyer is ready to sell. It is rare that a practice would be so small and personal in nature that the purchaser would fail to retain the client base.

Although every lawyer will have different income needs in retirement, the law practice is an asset that can have significant value to consider for retirement purposes.

Valuation of a practice is typically based on a rule-of-thumb method after valuing physical or identifiable assets. This method estimates what the stream of income is worth to a prospective buyer.

Although a uniform and consistent standard has not yet been set for law firms, a general multiplier is in the range of 50 to 300 percent of annual gross receipts, depending on the nature of the practice, the transferability of the clients, and how much repeat business is expected, among other factors.

To determine a fair selling price, look at the expected future earnings of the practice. Some people will look at the earnings generated by the existing practice, but you can also include future earnings that may be based on the buyer’s talents. My approach is to settle on a fixed sum rather than a percentage of revenues; that allows the selling attorney to better plan his or her retirement revenues. It also prevents ethical concerns about selling client files, which is illegal.
One of the thorniest issues in selling a practice involves the issue of goodwill and how to value it. “Goodwill” is the reputation, client base and client loyalty that you have created over the life of the practice.

Typically, smaller firms understand the value of their client relationships and reputations and, when negotiating for the sale of a practice, discuss compensation for goodwill.

In a larger firm context, where the assertion is often made that the acquiring firm will not honor any asserted goodwill or the parties cannot agree on how to precisely define goodwill, there can be a “credit” for a factor that might be analogous to goodwill in terms of the cost of the capital buy-in.

Ultimately, a business is worth only what someone is willing to pay for it. Valuation may be different at different points in time, and valuation and price may not be the same thing. And, of course, not every older sole practitioner is perfectly positioned to sell a profitable practice. But the fact remains that the sole practitioner definitely has built something of value and may be in a position to enjoy the fruits of those labors.

The big-firm partner may have signed away his rights on entering the partnership. Reference to the partnership agreement, in that case, is the starting point.

And, if the big-firm lawyer feels aggrieved or forced into an unwanted retirement, or forced to leave equity on the table for others to benefit as he departs, he may have no alternative but to sue the firm alleging that he was merely an “employee” who was thus covered by age discrimination laws. He may be right, but that’s not an ideal end to a professional career.

Although every lawyer will have different income needs in retirement, a practice can be one significant asset that provides a source of revenue to meet those needs.

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