A business is ultimately worth only what someone is willing to pay for it, and that is particularly true if the value of a practice has not been maintained. Even practices built up through years of effort will lose value if neglected for just a few short years.
The value of a law practice is based on a lawyer’s success as reflected in the organization’s goodwill. It involves the firm’s reputation, practice-management system and way of doing business — all the intangible elements that made the practice successful.
A firm with provable goodwill will be worth more than a firm with bad publicity, a declining client base, obsolete technology, or malpractice and disciplinary matters.
Goodwill issues are just one illustration that a business is worth only what the buyer is willing to pay, and time is an important consideration. The value may be different at different points in time — and valuation and price may not be the same thing.
But in the context of buying a business such as a law practice, one must look to the expected future earnings of the practice. It is clear that such earnings potential can be damaged by attorneys who do not maintain earnings capability before the practice is sold. These are just three of the tangible ways that this can occur, making a practice worth less — or even worthless — at the time of sale.
Many small-firm lawyers facing financial pressure resist buying or updating technology because they are overwhelmed by the high up-front expense.
Software and hardware going on 10 years old are obsolete. A firm may not be using case management software or document assembly software or may not be backing up and storing client electronic files. The absence of technological updates severely diminishes a practice’s worth.
Worthless financial controls, (especially when accounting for client trust funds)
Trust accounts can grow so large that the record-keeping becomes flawed and develops errors. Every state imposes a fiduciary duty to properly account for clients’ trust funds to prevent misappropriation or negligence.
Failing to use appropriate accounting software or an outside accountant to reconcile trust and bank account records each month is inviting error, state bar inquiry and all kinds of trouble, any of which can render a practice sale moot.
Client records should be “appropriately safeguarded” per Rule of Professional Conduct 1.15, and client contact information should be current in all forms: phone numbers, email addresses, postal addresses, etc. The rule stipulates no minimum time concerning how long safeguarding must be done.
Failure to provide for the security of these files is a failure in the overall duty to act competently and diminishes valuation. Failure to maintain accurate client contact information shows that the firm has not communicated with clients to ensure that service is satisfactory.
Either issue concerning records can mean that the firm lacks viable client information to pass on in a sale.
The aforementioned shortcomings are far from the only factors that can erode a firm’s worth, but any or all of them are sure to have a negative impact, or prevent a sale altogether.
Edward Poll, principal of LawBiz Management, is a coach and law firm management consultant. He can be contacted at email@example.com.