As Chartered Accountants, we are often tasked with the responsibility of evaluating and appraising various businesses and assets. In today's discussion, we're diving into a unique but increasingly significant realm, valuing interests in law firms.
The legal profession is dynamic and ever evolving, and the valuation of interests in legal firms requires a specialised understanding. In this article, we will explore how we effectively assess the value of interests in law firms and delve into the key drivers that underpin this valuation.
THE METHOD – SUPER PROFITS
Legal firms are typically valued using the Super Profits method, which involves establishing super profits after accounting for a market salary and interest on capital. An after-tax multiple is then applied to these after-tax super profits to ascertain Goodwill.
The valuation process commences with determining the firm's Future Maintainable Earnings (FME). We gather 4 to 5 years of financial data to identify trends and potential normalisation adjustments. Once FME is established, the subsequent step involves subtracting an appropriate market salary for equity partners. This deduction ensures that a business returns a salary to its working owners at a fair market rate. Equity partner market salary allowances in Auckland legal firms can vary, ranging from $180,000 - $250,000 for small firms to $300,000 - $400,000 for top-tier firms.
The next critical step is determining an applicable after-tax multiple, which usually falls within the range of 1 to 3 for legal firms depending on a range of factors. Following this, the calculation of Goodwill takes place. Goodwill represents the profit that offers an enhanced income to the owner, which is not solely dependent on their individual efforts within the firm.
KEY DRIVERS
In our experience, the biggest key driver that contributes to an increased business value is transferability. The personal nature of law means that clients often identify more with a lawyer than a firm. Although this has distinct market advantages, it is imperative a firm markets its own brand to attract potential buyers. In our view, law firms that prioritise delegation and possess a healthy leverage structure tend to command higher value in the market. This is particularly the case where with confidence an internal transition can occur with very little loss of client relationships. Efficient systems and delegation processes in a firm help drive transferability of interests in a legal firm.
Another aspect that enhances transferability and appeals to prospective buyers is the implementation of a robust IT system. When a legal firm employs a cloud-based storage system with streamlined online processes for how authors interact with clients can increase the level of client transferability and in turn increases the firm's value. Such systems make the firm more accessible for potential buyers and facilitate a smoother acquisition process.
CONCLUSION
Valuing interests in law firms can be in intricate undertaking that demands a critical analysis of both financial trends and the complexities of the legal profession. Legal firms must ensure they have a robust brand presence alongside modern IT systems to attract potential buyers.
Our team of experts at Moore Markhams specialises in providing a range of forensic accounting and investigation services specifically designed for the legal profession. Operating in a complex and often challenging sector, our professionals comprehend the nature of our clients' requirements and serve a significant number of legal firms and barristers throughout the country. Click here to get in touch with one of our experts.