Buying a Law Firm: What Needs to Be in Place First with Michael DiGennaro

Melissa Shanahan: You're signing up for a marathon, and people don't realize that they are, and they're not fit. So they are, they are going to get to mile 10 and be frustrated and want to be done. And there's a long way to go.

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Welcome back to the Law Firm Owner Podcast. I am thrilled today to be talking once again to Michael DiGennaro. Thank you for coming back to the show, Michael.

Michael DiGennaro: I'm so thrilled to be here.

Melissa: For those of you who haven't seen the interviews I did with Michael previously, I highly recommend you go back and watch those. Michael is from The Law Practice Exchange. And last time we were speaking, we talked a lot about what it's like to sell your firm and things you need to think about.

And this time we're going to talk about being on the other side of things. Before we dig into it, would you mind just giving everybody a reminder of who you are and what you do? 

Michael: Sure. Absolutely. Thank you. So I'm Michael DiGennaro. I am the chief growth officer at The Law Practice Exchange. I'm a former practicing attorney. What we do here at The Law Practice Exchange, we are two things. So we are a true electronic exchange, which is sort of a cross between eBay and a dating service, where buyers and sellers can transact directly with each other.

And separate and apart for that from that, we're an advisory service where we advise not only those participants in that exchange, but other firms as well that may want private representation, buyers, sellers, etc. And we're an advisory service. So that's where I sit. I'm the head of the advisory service now at The Law Practice Exchange. I work on tiny deals, sub $1 million deals all the way up to $50 million deals and more.

Melissa: Yeah, I can only imagine. Just the things that you see, they just must run the gamut. That's why I feel really lucky to have you here to talk to you. You've seen a lot, you've experienced a lot. And the audience that we have, I know that there are questions in the back of their mind, and if they aren't there yet, they will be soon about planning for succession, for exit, what does that look like? And so that's why I really wanted to have you on to do the sale side conversation.

I feel fortunate that you're here and you're willing to talk about this stuff, because this is a world that unless you're in the world, it's very difficult to understand and to navigate. You really have to educate yourself and so thank you for being here.

Michael: My pleasure.

Melissa: Maybe opening it up to on the front end, when does buying a practice make more sense than growing organically?

Michael: So we have attorneys that may have been fed up with large law firms. And they wanted to do something on their own, but they don't want to start the wheel from scratch. So they buy a law firm. And it doesn't have to be a giant law firm. It could be a small law firm.

The smallest law firm I've sold to date was a $125,000 solo practice just outside of Charlotte, part of a plan by a younger attorney who wants to build a million-dollar revenue practice in the estates field. And so he's bought several practices through our exchange and some of them with me facilitating on the sell side.  But that's an example of a smaller lawyer who's has a small practice and wants to grow it to a bigger practice. And he's doing it through acquisition.

We have lawyers that went to law school that are backed by private capital that are there just because they're lawyers doing a buy, and they're doing it on behalf of some sort of investment project. It doesn't have to be necessarily a large investment project. It's just that they're the face of the project because they're a lawyer.

We also have law firms that are entrepreneurial and willing to do a true purchase of a law firm rather than doing a conventional merger. And what I mean by a true purchase is a cash-down earnout type structure, or cash-down equity swap type situation where the seller will get some cash for their practice and also equity in the new law firm. So that's another type of buyer.

Then we get into the higher-powered buyers, I want to say, the ones with a lot more capital. We have alternative business structures out of Arizona and Utah. And I would say definitely that Arizona predominates in that. We also have larger private capital buyers that are using an MSO model, and that's a management services organization for those unfamiliar with it. It's a giant phenomenon now in law firm acquisition, where they're acquiring firms that are 50 million in revenue and above, but also they're using that model to acquire smaller firms, part of a roll-up strategy. And a roll-up just means that you're acquiring a lot of different practices and aggregating revenue with those practices.

We have buyers that have an ABS, they're using an MSO, and they also have a law firm. And they have lots of structuring flexibility on how they do acquisitions.

Melissa: Could you just for listeners who may not know, what does ABS stand for?

Michael: The alternative business structures out of Arizona and Utah have led the forefront of that. Puerto Rico is also now an ABS commonwealth, if you will. And then I believe there's interest in other states in this model. I think it's Washington State has interest and also Tennessee. 

Melissa: So if we go back to that question, when does it make more sense to buy versus organically? I mean, I have more specific questions, but basically, it should be looked at as an option. If someone wants to grow their footprint or wealth or reach or if they want to grow their firm, they should be looking at this as an option that they they could consider, not just growing organically the firm that they own. Is that, would you say that that's generally true?

Michael: That is generally true. A lot of this is predicated upon access to capital, and smaller law firms, SBA loans are a viable option to do a law firm acquisition. But there are other sources of capital as well. And access to capital is important in order to be able to effectively manage the the part to pull off an acquisition. 

Melissa: What conditions should exist inside of the buyer's firm before they consider getting themselves into a deal and acquiring another law firm? 

Michael: Yeah, so a lot of this is about processes and procedures, which are really key for any successful deal is having processes and procedures and operations and staff, all of which can effectively absorb the acquisition.

And so if you don't have tight processes and procedures yourself, and you don't have this organizational, operational infrastructure, it's going to be very difficult to take on a completely different target infrastructure. You may have mess on your side and a different type of mess on their side. And what you have is just a bigger, more complex mess when you merge. And you don't want that.

You can always optimize and and change and perfect those systems. You should have a functioning operations and systems in place. Do you have an understanding of the financial picture of your firm at any given time? Are there standard operating procedures in place? Are there KPIs, key performance indicators in place to manage performance of clients and staff, etc.?

Those are really important, such that your firm is actually running like a business, and it's not just a job, effectively a job, not a business, but a job for yourself. I think those are all important. You will be inheriting a lot of new systems. Maybe they're even better than yours, and that's great. You'll get benefit from learning from the target systems. But in a lot of instances, they won't be. And so you have to be prepared for that.

Melissa: I think a lot about having this stuff in place if you're going to sell, because it will increase the value for you to sell. I didn't necessarily think about it, but it makes so much sense that the same things need to be true if you're going to purchase a firm or acquire a firm. It's important to be organized, no matter what side you're on.

Michael: Yeah. I was in a deal where it was going to be a simple transfer of equity from a senior partner to a junior partner at the law firm to operate the firm financially and manage those records and manage all the sys— that just wasn't there. And I think it was a bit overwhelming for that junior attorney. And so maybe that wasn't the right time. That sale was tabled until the junior attorney had a better understanding of what it takes to actually run a law firm.

Getting equity sounds great until you realize that that may also entail managerial responsibility for operating a business. And law school never really teaches you how to run a business. That's not what going to law school is about. That's something that entrepreneurs and MBAs and the business-minded among us understand. Not many lawyers understand that. 

Melissa: The senior attorney who was selling or transferring equity, did they have a good handle on it? They just hadn't mentored, coached, taught the junior person yet, or maybe it's questionable if they had?

Michael: That's exactly it. They had not mentored the junior in anything other than the practice of law. While the prospect of equity for the junior sounded great, there's also, what is the saying? With great power comes great responsibility. That's exactly the case. With great power comes great responsibility.

The power is really what's sought after. I guess the power of generating, of getting profit and dividends and all of that, and having a say in decision-making now where you may not have had it before. But there's a lot of responsibility that comes with that. Many lawyers are not prepared for that responsibility. They're happy to have equity when it's just means they're getting a profit share and making some decisions. With smaller firms, frequently it means something else. It means that you will be playing an active part in the management and operation of the law firm. 

Melissa: You need to be organized. You need to understand. You need to educate yourself and be willing to invest in those things, be willing to invest in getting organized and understanding what you're entering into and the responsibilities of running a firm, to your point.

We talk a lot about in Velocity Work. One thing that we pride ourselves on doing is getting people's houses in order, just extremely organized from the different lanes: financial, operational, cultural. That's not to toot our horn and say, "Hey, everybody needs to work with us first." But I'm proud of the work we do because of this. It's a missing link for so many people. So they really need to find their path to not being a mess.

Michael: Yeah, and an operational consultant is invaluable. And it's not just the buy side. It's the sell side as well. In fact, I see this more from the sell side, because I I operate more frequently on the sell side than I do on the buy side, though we are effectively intermediaries in these deals and we're counseling both sides.

But from a sell side perspective, the value that you get from the sale of your law firm will be significantly limited if you do not have good processes, systems, and procedures in place before affecting a sale. And I see a lot of sellers that just don't like that. And so they might be running from a systems problem. I see problem people have with staff. There's political issues at work with divergent interests. And they think that, well, the deal advisor is going to sort them all out by just selling the firm to a new owner. And no, we're not. We're not.

I've just told one seller this recently. Look, let let me just cut to the chase. Here's the situation. You want this. The other person, the minority partner, is not telling you what they want. And the reason why they're not telling you what they want is because they don't want any change at all.

So you need to force their hand and either make them commit to a transaction or part company or de-equitize them or whatever it needs to take. But selling your firm is not going to resolve that problem. It's just going to create problems for your buyer that will linger and fester post-consummation.

Right now I deal with a lot of personal injury law firms, and I have owners that love the bright, shiny objects and the marketing and the commercials and all that, but they don't want to pay attention to their systems or processes at all. If it's not the fun stuff, they really should have hired someone who really wants to lead those systems and processes.

For many of those firms, I will tell them, "I will not rep you until you go to an operational consultant and get some of this, not all, not perfect systems, but some baseline functional systems in place before attempting a sale."

On my part, I warn them about limited value that they will capture in the sale. But a lot of it, my interest is them not getting deal-fatigued. And you can be nine, 10, 11 months into a deal, and they're frustrated because they have to keep producing information that they can't readily wrap their heads around or or acquire, or they're piecing together information from various sources, and they're so frustrated by when a sophisticated private capital client has them in due diligence and is trying to assess the true value of the law firm, and they just can't produce this. And that just drags on, and the seller gets frustrated with the buyer, and the seller gets frustrated with me. The reality is you have a lot of problems that should have been resolved prior to going into the sale. 

Two things that I recommend. For the bigger clients that are with private capital, I recommend quality of earnings on the sell side. You shouldn't really go into a deal with private capital on the buy side without having a sell side QofE. And we have a great trusted partner that does QofE prep. And the same thing, if we can get someone to focus on those systems and procedures, even if they just take three months doing that with a consultant, that's wonderful for us. It makes the deal process so much easier.

Melissa: I love talking about this stuff. I think the more people can wake up to this, the better. You were talking about getting deal fatigue, and you gave a specific experience of that. It makes me think about you're signing up for a marathon, and people don't realize that they are, and they're not fit. So they are, they are going to get to mile 10 and be frustrated and want to be done. And there's a long way to go. The more you can be organized and the more that you have some baseline of systems and process, the more fit you are to enter into something like this and not feel like the soul has been sucked out of you.

Well, thank you for digging in on that with me.

Michael: Sure, absolutely. Thank you.

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