The Cruel Joke Being Played on the Legal Profession

Somewhere, by someone, the rumour was started that smaller legal practices (and bigger ones too, for that matter) have little goodwill value on sale.
Now like all businesses, there are firms that rightly should have little or no value.
Those ones that produce little or no profit for the law firm owner are unlikely to be attractive to anyone. These practices will be the ones where the retiring law firm principals literally walk down the road and beg a neighbouring firm to take over their files.

Is there any reason though, why a well-run law firm shouldn’t be worth good money on sale?

The first question that arises, is what is good money?
When talking in seminars I often talk about the prices that practices in various other professions sell for.
For the sake of discussion, let’s talk about a practice with $1,000,000 in fees.
In Australia, a reasonable accounting practice of this size, might sell for 0.90c to $1.20 per $1 of fees. In other words $1 million in fees might be worth somewhere between $900,000 and $1,200,000*
A financial planning practice with recurring fees of $1 million might sell for $3 in the $1 of fees, or somewhere around $3,000,000*
A legal practice with $1 million in fees in many cases may ultimately sell for 20c to 30c per $1 of fees, or $200-$300,000.*
Of course there will be variations in these figures, but these are general ballpark figures.

Does difference in profitability explain the difference in valuation of goodwill?

I don’t think so.

I would suggest that in normal circumstances, the profitability of these practices may well be reasonably similar and certainly not as dramatically different as the valuations would suggest.

What is the reason for the variation?

I suggest to you that the difference comes down to the perceived quality of the recurring income.
The accounting practice may well generate some recurring income from annual financial statement preparation and annual tax returns.
The financial planning practice may generate recurring income from commissions on insurance products and review fees and/or commissions for investment advice.
The fact that the financial planning practice is worth so much more, is a reflection of the perceived quality of the income stream.
In the accounting practice, if the client leaves, the income stops.
Take the financial planners insurance commissions. The client may well stop using the planner, but unless they go to another planner, the original financial planner may continue to earn an ongoing commission for the product that they sold some years before without having to do any work at all.
It is all about the “stickiness” of the income.
Now this is not a conversation about the rights or wrongs of commissions. It is attempting to explain why different practices are valued as they are.

So what about the valuation of the legal practice?

This is where the cruel joke comes in.

If you believe that your practice has little or no value, will you try to increase the value?
I suggest not.
There is lots of evidence of this quirk in human nature.
The best I know is Roger Bannister breaking the four minute mile.
Prior to Roger Bannister breaking that milestone, it was considered impossible, a feat beyond human endurance.
So until Roger Bannister, no one really tried to break it.
Once the milestone was broken however, 18 or 19 people also broke the record in the space of the next 12 months.
What had happened?
People suddenly believed that it was possible, so they tried a bit harder.
Back to legal practices.

What would happen if you now believed that legal practices could be worth good money, say similar to an accounting practice?

What are the steps you would need to take to achieve that quantum leap in valuation?

Step 1

Yes, your practice does need to make good money. Take that as a prerequisite. It will need to make at least the same profit as the accounting practice to be valued at a similar amount, in my opinion.

Step 2

You need to address the predictability of your income.
What could you do to make your income more predictable in the same way as the accountant has their tax returns and the financial planner has their commissions and investment reviews…..?
You see, I’ll bet your mind is already coming up with ideas.

Certainly there are types of practices that aren’t as conducive to developing recurring income streams, but it is worthwhile at least investing some time thinking about what might be possible.
It really isn’t that hard is it, once you dare to believe that it is possible.

ACTION STEPS
Colin Ritchie passionately believes in the future of the legal profession and knows that helping firms to dramatically improve profits and practice valuation is his way of ensuring that the legal profession has a bright future.

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• DISCLAIMER

The figures expressed above do not profess to be a valuation of your law firm, accounting firm or financial planning firm or indeed the correct methodology to value your firm. To get a valuation of your firm you need to consult a appropriately qualified practice valuer, who will take into account your specific circumstances.