Why do you need a law firm valuation?
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When a law firm valuation is required it’s essential that each factor and variable is assessed appropriately in order to calculate a genuine and accurate valuation of the firm. Whilst many people assume a law firm valuation is only required when it comes to selling the business, there are actually numerous instances which may indicate a need for the firm to be valued. Whether it’s the sale of the firm, the formation of an LLP, a new Partner joining the firm, the purchase of another firm or simply general interest, there are several factors to consider when undertaking a law firm valuation.
Key factors when valuing a law firm
Key figures such as the size of the business, turnover, gross and net profit margins are a good place to start when valuing a law firm but there are many more things to consider. The nature of the work the firm carries out it extremely significant when it comes to the valuation, as is the amount of repeat business the firm attracts. A firm which only offers services to private clients generally have less repeat business compared to firms which offer services to businesses or both private and corporate clients. Whilst legal services are frequently required during the course of business, individuals do not generally require legal services as often, particularly within the same legal field. For example, a department specialising in company contract formation likely to have a higher level of repeat business than a private client personal injury department due to the fact that companies routinely enter into contracts whereas individuals don’t often require representation for personal injury claims on a routine basis (unless they’re very unlucky!) Client retention and frequency of use will, therefore, impact on the law firm valuation and must be given due consideration when calculating the law firm valuation.
In addition to this, the staff of the firm will have a significant impact on the valuation of the law firm. As they operate within the service industry, law firms rely on the quality and reputation of their partners and employees. A number of well-known and highly regarded associates may boost the law firm valuation providing they are committed to staying at the firm following any subsequent sale. Similarly the reputation of the firm as a whole will have a bearing on the valuation of the law firm as will its marketing activities, length of service, predicted growth and profit trends over recent years.
The geographical location of the firm and its branches is also of paramount important when evaluating a law firm valuation. A private client firm located far from residential areas in a difficult to reach location may not compare favourably to a firm of equal size in a densely populated thriving area. Whilst the location of the firm is important, the locations of its competitors can also affect a law firm valuation. A town with numerous firms offering the same services may result in a lower valuation for the law firm than if it was located in a town with fewer or no competitors.
It is evident, therefore, that there are a plethora of factors to consider when attempting to calculate a law firm valuation. In an attempt to simplify the process various valuation methods have been put forward over the years. These provide an insight into the commonly respected factors when conducting a law firm valuation and indicate key areas that must be assessed when valuing a law firm.
Standard approaches to law firm valuations
Some people take the approach that multiplying the net profit or gross profit by specific figures will result in an adequate calculation whilst others take an income approach but focus more on projected growth than current profit when conducting a law firm valuation.
Alternatively, some focus on the assets owned by the firm when valuing in it and base the firm valuation on the value of both tangible and intangible assets. Another approach commonly used is to compare the firm to other firms within the market and value the law firm in comparison to other firms.
Whilst each of the methods outlined are viable methods which can be used to complete a law firm valuation, it is increasingly clear that there simply isn’t one universal method when it comes to valuing a law firm. An attempt to apply a standard formula and simplify the law firm valuation may result in inaccuracies with serious consequences for the firm, its partners and potential buyers. It’s essential, therefore, that the valuation of a law firm is conducted by a firm experienced in law firm valuations, such as us.
Specialised advice when valuing a law firm
In order to value a law firm accurately, it’s wise to consider using a company which specialises in law firm valuations. Rather than merely relying on the relevant figures to calculate the law firm valuation they are adept at accurately valuing the intangible assets which greatly affect the valuation of a law firm.
Whilst valuing a company operating within the sales industry that offers straightforward purchases may be possible using a relatively simple formula based upon the company’s figures, a specialist company experienced in law firm valuations is aware of the value that numerous other factors have upon the valuation of the law firm.
It’s common for people to assume that a law firm carries no or little professional goodwill in terms of valuation but this has been disputed by those experienced in carrying out law firm valuations. Whilst a professional experienced in valuing businesses may not initially place much value (if any!) on the goodwill of a law firm, a company experienced in law firm valuations will ensure that the value of the firm’s professional goodwill is incorporated into the firm’s valuation ensuring the law firm valuation is fair and accurate. The HMRC has highlighted this issue by investigating the value of goodwill that accountants place on firms to ensure its accuracy. This emphasises the need for a detailed and justified valuation of the professional goodwill of the specific law firm which can be obtained from an experienced practitioner rather than a nominal figure added to the final law final law firm valuation to represent the goodwill of the firm. We recognise the need for a valuation that applies to the specific firm in question and our skill and proficiency in this area allows us to operate successfully within the niche area of law firm valuations.
Similarly, a professional with experience in this area is more likely to be aware of upcoming changes to legislation that will see growth in particular areas. A legal requirement for certain business procedures to be carried out using a solicitor or a legislative change to commercial lease requirements, for example, indicates an increased need for services within this area and, in turn, more business for the firm. The impact the legislative change has on the potential growth of the firm can affect the valuation of the firm. Similarly, the introduction of complex legislation in a specific business area of industry will see a rise in people and/or companies consulting law firms in order to understand and apply the law effectively. Issues such as this can have a significant impact on the valuation of a law firm but may be overlooked by those without experience in valuing law firms.
Indeed, the partnership nature of the majority of law firms can prove difficult when conducting law firm valuations due to the profits being allocated between partners rather than being paid as dividends to potential shareholders. With continued discussion regarding changes to the management of law firms this is an issue which may prove important in upcoming months. The view of the management and the firm as whole regarding this issue could be important to the valuation of a law firm and to potential buyers but could easily be discounted without specialised advise when calculating a law firm valuation.
Whilst the standard formulas can provide a good basis for a law firm valuation, it is evident that there are other, more complex, factors which require evaluation in order to provide a detailed and comprehensive law firm valuation. With the HMRC assessing the accuracy of the value of intangible assets and the potential impact on the future of the firm, it is well worth instructing a company experienced in law firm valuations to carry out the valuation to ensure you discover the true value of your firm. In addition to offering business valuation services, Business Brokers UK recognises the need for specialised law firm valuation and has the experience and expertise to provide accurate and reliable law firm valuations.
