Structuring Successful Law Firm Deals: Fit, Strategy, and MSOs with Michael Di Gennaro

Michael Di Gennaro: You see lawyers in all these television shows as big, bad, confrontational individuals. Lawyers hate confrontation. There is a problem. We need to sit down, talk about this problem, and come up with a solution.

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Melissa Shanahan: Hi everyone, welcome to the Law Firm Owner podcast. I'm so glad you're here. And I'm so glad that our guest, Michael Di Gennaro, is back to talk to us from the Law Practice Exchange. Thank you for coming back again. 

Michael: Thank you, Melissa, thanks for having me. Always a pleasure to chat with you and your audience. I get a good read on people usually in 15 minutes. I used to be an attorney recruitment professional. You need to read people quickly and understand what you're working with. And I think that's served me very well.

I mean that's the distinction between who I am. I'm not a former attorney, a private equity M&A attorney. I come at this as an M&A advisor, and I think that's important, the difference between an M&A advisor and an attorney, and how they represent clients.

Melissa: You try to bring a level head to the playing field. It's not what everybody's looking for. 

Michael: There are transaction costs in deals, real transaction costs. In every deal of size, you need an M&A advisor, an M&A attorney, ethics counsel in the relevant jurisdiction, and you'll probably need an M&A tax attorney as well, or M&A tax, not necessarily attorney, but professional that will help you understand, in light of this deal that was crafted, how is that going to affect you personally from a tax perspective? And should we structure it differently for your personal financial circumstances?

I think with those four advisors in place, you can really get a deal done, but it's costly. And because of that cost, there are just sizes of firms that don't make sense to do a deal. Now you can do an alternative arrangement that is effectively a deal, dependent on what happens after consummation, et cetera, which is just a formula for the next x number of years. If revenue is here or you can use EBITDA, is here, you're going to get this payout for a number of years thereafter. That's a very simplistic explanation and a simple type of earn-out arrangement, but there are arrangements that you can come to.

And I think that's where that particular deal I was kind of trying to steer it toward is like, let's just do an earn-out deal. Literally against my own financial interest. Let's just do an earn-out deal. Let's save you all costs. We'll get an arrangement whereby you can start revenue sharing quickly without all the trappings that are needed.

Melissa: So that's interesting. I was certainly hesitant to ask you anything about that particular deal. And you're right. I think you were brought in to try to help push this puppy along because it just seemed to be stalling out in tension and not really going anywhere. You did your best.

Michael: It's really hard to solve relationship issues. I've called bullshit in deals. There's a good offer, and then the junior partner comes in and is like, I want this interrogation presented to the buyer about their deal. Present everything in triplicate to me by this deadline. Who the hell are you? 

Melissa: Oh my gosh. 

Michael: The senior partner wanted to go forward. And I just told them, look, you keep asking your partner what he wants. I know what he wants. I'm a lawyer. I know how lawyers operate. You see lawyers in all these television shows as big, bad, confrontational individuals. Lawyers hate confrontation. There is a problem. We need to sit down, talk about this problem, and come up with a solution.

I've been thinking about this topic recently, it's interesting. I always look at what are bad breaks and what are good breaks. I think folks really need to think about what their interests are and whether interests align with the party that they either want to start a relationship with or were in a relationship with, and ask themselves, are my needs being met?

If they're not, there's an issue that needs to be addressed and confronted, having some sort of mutual recognition. It's we can either work this out, so both our needs are met, or we recognize that both our needs are met and they're not going to continue not being met if we move forward together and just have an honest handshake, kiss on the cheek, parting of the ways, whatever it is. I think that level of harmony is really what would be much better. 

And I do have a very specific example. You asked me how my week went at the beginning. I was like, it's been a pretty rough week. I guess what I was alluding to is I had a deal that just blew up this week. And I saw it in slow motion. It was about to blow up. And a lot of this was due to, I think, ego of both buyer and seller, buyer's lawyer, seller's lawyer in this instance.

Melissa: How big of a firm?

Michael: A handful of million dollars, I think a four or five-million-dollar firm. Basically, the buyer's view is that the LOI is just something non-binding, and let's start dating. And, you know, from a seller's perspective, you have the most negotiating power in any deal prior to signing your LOI.

One great takeaway from the CM&AA training I did, CIMA training, certified mergers and acquisitions advisor training that I just completed last week in Dallas, it's that the seller has the most negotiating power in a deal that they will ever have prior to signing an LOI. So, buyer wants to rush seller into an LOI. Seller wants every question in the book answered prior to signing LOI. And both positions are wrong. They're just wrong. 

This is a dance, right? You're dating. The dating is before the LOI is signed. And so you both need to be on good behavior. Both need to wow each other and feel excitement. If you're just showing excitement to get to the LOI stage and then don't follow through and continue that through the process, things are going to fall apart.

We did what we call over-lawyering. So I guess the difference between us as a M&A advisory slash brokerage entity is that again, not in our interest necessarily, yeah, please sign that LOI because there's a giant fee on the horizon. Would you yourself sign this LOI right now? And the answer is most always no.

There needs to be adequate protections and provisions built into an LOI so that you can move forward with a deal into the due diligence phase in which case you're going to grant your buyer exclusivity. You're not going to be shopping your deal to other players at during that time. You need to make sure state law requirements are being met with the deal.

Never, ever tell a client to rush them into the LOI. We're closer to the date that we're going to get our fee when the deal is completed. Also, I don't think it helps deals actually get completed, at least not in the law firm space for a number of reasons. 

The point is, in that deal, buyer really didn't want to provide any additional information, at least not in writing. Seller wanted to interrogate buyer with volumes and volumes of questions. Those two positions were at odds, and there was this dance that was done.

The reason why you're making my day a lot better is because reflecting on that, even though this was a down point for my week, there is a valuable takeaway. Yes, adequate protections, but don't let lawyers take over a deal.

There's a reason why you have an M&A advisor instead of a lawyer navigating the whole deal. And that's because they are acting very much like a recruiter, right? They see the whole process going along. They're trying to have positive relationships with the buyer, positive relationships with the seller. They're acting as a back channel. I was acting as a back channel. And all of this was stringing along call one week, two weeks, and then I'm like, I don't feel the love from buyer I was feeling before. And it was boom, the deal blew up. 

Melissa: So you mentioned within 15 minutes, you really get a good sense of someone. You know, after having had conversations or interactions with both sides, how soon would you put money on this deal will happen or not? Because I imagine you have a sense early on like, we're going to go through the motions here, but I just get the sense this is going to stall out or this is going to blow up, but we'll see. 

Michael: I look at two probabilities. Probability is getting the LOI executed and then after that, getting the deal executed. Some of the reason why I prefer a more robust letter of intent than others might is because if you really want a full understanding going into this marriage of what this is going to be, we don't want these misunderstandings coming up as we're writing our vows.

That's maybe more appropriate, doing some diligence on each other, but we're getting prepared to write the asset purchase agreement if it's an asset purchase transaction, the stock purchase agreement if it's a stock transaction. You're getting ready to write these agreements, we don't want to go back to hashing out serious deal mechanics or consideration or have those types of misunderstandings.

If things are going to kill the deal, it should be that the diligence doesn't support the offer that was made in some way. It shouldn't be because we were actually talking about two different things when we signed that in game. You need to get those understandings out now. Because of our process, I'm much more confident after an LOI is actually executed that the deal will blow up.

In this instance, I have four law firms under LOI currently. Those deals are going relatively smoothly now that they were under LOI. In those deals, I really look how the parties are behaving in due diligence. The parties are really cooperative with each other and really helpful, and really nice with each other. I'm like, great, that's a match made in heaven. This is really going to work post consummation. They're going to work together well. It's going to be a successful deal.

If there's lots of frustration and tension, and the parties aren't paying nicely in the sandbox in the due diligence, that's a pretty good sign that post-consummation things aren't going to work out well. I guess with this deal, it looked like it was a match made in heaven, but the LOI wasn't signed. Until an LOI is signed, it's really hard to say whether a deal will go forward or not. 

Melissa: I wasn't sure the exact question to ask, but that is a question that's been on my mind, the one that I asked you. I wasn't sure what answer I was looking for with that. More it just feels like you see so many deals, you probably have a really good sense in the beginning.

But I hope that for listeners, like it is for me, it's interesting, there are sort of two milestones that must be hit. One is Letter of Intent, and the other is actually full execution of the deal. And knowing that how important that first milestone is, getting that right, that makes all the difference. That sort of increases the odds that the deal will go through with less friction than what otherwise might be the case.

And so I hope that, you know, that's something that sticks with people because whenever if it is time for them to buy or sell a firm, how important that first step, that first milestone is and getting it right and sort of writing the vows so to speak. That's a really good way to say that. That makes a lot of sense. And knowing because I don't think, I think it helps people to see the milestones instead of just need to get a deal done and letter of intent is just a step along the way. No, that's milestone one and doing it right matters. 

Michael: I look at that is, let's not misunderstand what this deal is. If the deal we are constructing is predicated upon information that is not accurate, not because of mine that there's anything nefarious going on. It's just that a deeper dive into due diligence, beyond what's done in order to write the LOI doesn't prove out the value that was assigned. Let the deal fall on that. Don't let a deal fall because both parties had a persistent misunderstanding of what the deal was going to be.

Melissa: The persistent misunderstanding, I was going to mention this to you when we were talking about confrontation. A CEO I used to work for was brilliant in terms of business. And one thing that he drilled into our heads was how important it is to be high-confront. Not confrontational in an aggressive way. But if there is an issue or a frustration, you run towards it. You do not avoid it. And the faster you run towards the frustrations or the misalignments, the more everybody can get on with their lives.

And I really think about that. They don't like to confront these things because it takes a certain amount of courage if you're a certain kind of person, especially, that creates fear and severe discomfort. But it's the way through with the highest level of success. 

Michael: I think the other problem that people have with confrontation is because if you've ever worked in some sort of hierarchical corporate environment, being the guy that's confrontational and willing to challenge management on the way of thought processes is a great recipe for getting shown the exit door in an expeditious fashion. There's problems and they're not going to change because we're in control and we know better. I'm not a yes man.

If you've ever been in an environment like that, the training that corporate environment has for you probably doesn't serve you well as a business owner. This is relevant in the sense that as lawyers, let's say you're in a larger law firm, the training that you have, you know, maybe keep your head down. Maybe that's the ethos and don't challenge a partner on anything whatsoever. That sort of training doesn't serve them well with what you were exactly saying. And obviously that's a business professional that knows how to do business. 

Melissa: Okay, this is all spiraling downwards. We need to have an actual conversation about expectations and what's not happening, et cetera. And for certain people it may not feel tough to do it, but they don't do it elegantly. We were talking about high-confront. There's an art to having high-confront. There's an art to that with being effective. People have a sort of an aggressive association with that word, and that's not what I mean.

Let's come back to the MSOs. Thinking of smaller firms, and we talked about this a little bit before we really got going in the conversation. Can you talk about instances where there's interest in small firms, but also what you've seen in the landscape?

Michael: Five million small businesses, five million and up, you'll enter the lower middle market and middle market deals, where really all the law firm transactions now are in that sort of range. Probably a few that are larger. Some of them are minority investments, they're not just outright acquisitions at that size.

MSO deals are not just for large law firms. We have an entity that's sort of rolling up smaller law firms via an MSO vehicle. And so instead of being granted equity in sort of at the law firm level from the mother law firm, they get MSO equity instead, the MSO that's servicing the mother law firm.

And so that is one opportunity. They are rolling up smaller law firms. They're operating in a way where they can acquire a law firm, do a law firm to law firm transaction as a first step, and do it in a very conventional manner, and you don't need 10 million plus revenue law firms to do those types of acquisitions. That's just one example, a private capital-backed project. As far as these firms doing it in a preemptive way, that's another thing.

MSOs are a tool, the tool du jour, if you will, that private capital is using to do these acquisitions and roll-ups of law firms. If you think about it and you think about what lawyers excel at and what they typically do not, at least stereotypically, it makes a lot of sense to separate the business functions of the law firm from the legal services that are provided. Why? Because a lot of your owners, they have three hats.

They're management, operations, et cetera, all the things that an MBA or a business professional would do and normally be in charge of at a company. They're also practicing law, probably, especially if they're not right at the exit stage and haven't done everything right to put themselves in a more redundant seat, which they should be as a good sign that they're truly a business. And then finally, it's the marketing involved with getting new clients and whatever that is, whether it's television commercials or conventional wining and dining of clients, they still have a marketing role. So they have to do all three of those

Even when you're a partner at a large law firm, you're really only doing two. You're doing origination and production, not managing and operating a law firm. And so that type of separation makes sense for a lot of reasons.

One, you can bring in a top non-lawyer business professional to help operate and manage all of the back office that your law firm might need. And that frees you up then to practice law and do business development, which everybody makes more money that way. You drive more revenue to the firm, everybody makes more money, everybody's happy. Also, the services that are provided generally tend to be higher quality, or you can get best in class. If there is indeed growth capital behind the MSO, you might get best-in-class technology. You might have other resources available to you to enhance the actual services that are being delivered.

Some of the benefit to this is what I call a preemptive MSO of your law firm. You set your law firm up under an MSO structure before you're ever thinking about doing a deal. And maybe you are thinking about doing a deal in the future, and maybe private equity is your buyer or private capital, but you're set up already in a nice system which makes it easier for the acquisition to go through in the future, may make you more attractive.

But also, again, thinking about your family. And I've heard on one of my calls that a family in the situation where one of the members was a lawyer, the others were non-lawyers. And what they wanted to do is set up an MSO. And so this must have been 10 years ago. It was blessed by ethics counsel. Again, hearsay, but I hear a lot of things. So I'm going to say them. So, within the bounds of reason, of course. 

And so basically, you set this up. It's maybe for your family members, like they can have jobs now at the law firm, managing and operating the law firm and you're keeping the management almost sort of close to you and participating in the upside of the law firm through an MSO arrangement. So it could be a good succession planning play or it could be a good play to set yourself up for a future external sale of the law firm. 

Melissa: If you're in that example with the family, there's one lawyer, and then the family basically they set up an MSO. The family can work in the MSO, run the operations side of things, run the business side of things. Why not just have your family work in the firm and handle all the operations the way that they want to?

I guess what you're saying is they're playing a longer game and that's the vision that they had was to give options down the road, potentially is why. I guess I don't understand. Right now, families, I have clients that the family or the spouse works inside of the business, is really a big part of running the operations. There's some really great partnerships, husband and wife clients that I have. When would someone like you encourage a firm to look at setting up an MSO for their firm, versus just run it really well. 

Michael: So, again, always having some sort of sound operations currently in place. How do I set this up for exit, or how do I set this up for succession? So your family members can work at your law firm, but they can't share in the profits of the law firm.

Melissa: Okay.

Michael: There's a lot of family members that are on payroll at law firms that they come in and answer the telephone for an hour a day or whatever. There's also some tax reasons why they do it.

One thing I would do is consult your tax advisor and determine whether there are any tax benefits where you could be taking more home at the end of the day from an MSO arrangement versus a traditional one. I'm not an accountant or a tax advisor, but I encourage you to consult with one.

The second thing could be, you want these family members fully incentivized to actually do work for the law firm. You want them invested in the growth of the law firm. And paying them a salary is great, but sharing in actually being able to inherit the promise of potentially being able to inherit equity is a great prospect as well.

Third reason I would cite, and these aren't all the reasons. These are just ideas floating to the top of my head. The sale of practice restrictions, again, are onerous in all jurisdictions. Fire-selling the law firm of a family member that's a lawyer is disastrous in terms of value. It's disastrous for your clients, for your staff, all of those things. So you can actually operate and manage the law firm, and just go to a recruiter and hire a new attorney. 

Melissa: How would equity be split? These are two separate entities. MSO and the firm. The money that comes in because of the legal services, MSO has to profit from that as well, right? 

Michael: Right. You have a bunch of assets, right? And now they're all purged out of that firm and they're now part of the MSO, right? So then the value of that equity at the law firm level diminishes significantly, right? The MSO that had nothing in it now has purchased all of these assets effectively. And so the value of that, the equity of that entity increases. Real value is in the equity of the MSO, right? Because it now has all the assets and it will be leasing those assets back to the law firm.

The equity of the law firm is still held by a lawyer, but you might get a straw lawyer to hold that equity. It just has to be held by a lawyer. And so, you cannot have a direct profit-sharing arrangement between the MSO and the law firm. It has to be a services agreement of some sort that's ethically compliant to not trip, you know, state bar restrictions on that. 

Melissa: So basically, because the MSO on its own can't make money, the law firm is making money. Right, like those are the services that are charged for. 

Michael: Yes. 

Melissa: Okay. So money flows into the law firm, and then how does it get to the MSO?

Michael: Oh, the law firm is paying for the services that the MSO is providing to the law firm. So if you're a law firm that no longer has a name, you don't own your name, you don't own your website, you don't own all of those intellectual and goodwill property assets are also owned by the MSO.

Melissa: The MSO. Okay.

Michael: So good luck getting clients if you don't have a law firm name. 

Melissa: Right. Okay. And then, of course, sticking with then ethics and bar regulations, et cetera. What is something you might see in terms of kind of payments, the decision on the structure of payments to the MSO for their services? Is it a percentage of revenue? 

Michael: It can mimic profit. That's the big restriction. I'm new to relatively new to this. I've done two MSO transactions to date in the law firm space. I have all of these five now four transactions were to be done under an MSO-type acquisition. But I do not know quite how to structure those arrangements to make them compliant. So. 

Melissa: Okay. Okay. And compliance, that's where you would turn to your team of people that you hire. Right?

Michael: Typically, it's the buyer that's doing that. It's the buyer with the deep pockets that's doing that stuff, hiring lawyers. There are some very sophisticated lawyers in the country that are doing these MSOs, so Fisher & Phillips and Josh Porte at Holland & Knight are probably at the forefront of MSO acquisitions in the law firm space right now. 

Melissa: And they're out of Chicago? 

Michael: Fisher's out of Chicago and New York and I think Josh is out of Nashville. 

Melissa: You mentioned that these can be really lucrative deals for law firm owners to enter into. 

Michael: Yes. 

Melissa: Because of the purchase price, because of the value that is being transferred to the MSO. I don't know, I'm trying to I'm trying to imagine how it's so lucrative because it still would, you'd still be looking at EBITDA as in terms of this deal, depending on the firm, let's say they don't have a lot of systems and process, but that's what the MSO is going to provide that structure.

Michael: Provide. Because should try to best-in-class those systems and processes and all that other stuff. 

Melissa: But it almost seems like they'd get it for cheap because they're going to do it. So they're not paying for that benefit, so to speak. 

Michael: They will be paying for that as part of the services arrangement that they're paying fees for are the provision of those types of services.

Melissa: The MSO is buying a firm, and usually in a typical type of deal, which I don't even know what that means, but not an MSO-style acquisition, you're paying a premium for people who have their ducks in a row, and they have their house in order, and because it's going to make it easier for you to run that firm. It's going to be less messy.

But for an MSO, they really don't, do they not care because they're going to institute it all and they're good at doing that and that's what they do. So is that of value to them the way that it would be in a different deal type?

Michael: So the answer is yes, and the answer is also no. And I'll clarify that. A lot of what for good private capital back projects, they're looking for their platform firm. So the first acquisition they do, it's of size, a firm of size in the legal services type that they want to do. So personal injury is hot now, but there's other trust and estates, et cetera. So they find a sort of ideal platform that they could tweak a bit and enhance a bit and inject capital and definitely to grow. But generally pretty good systems in place, and then they can work off of those systems.

And then what they acquire typically after that are what they call tuck-ins. And tuck-ins are smaller firms that you can bring to the MSO platform, you acquire their assets as well. But then you achieve a lot of value by deploying your best-in-class systems back to that.

So the price that you pay for it is a lot lower than what the value you could realize by really injecting management, capital and best-in-class systems to it. And so that's valuable for another reason. I think that's the clearest play for private equity or the classic play for private equity.

We come in, we identify all these problems with your company, we enhance management, we enhance operations, we do all these fixes that we learned about in Wharton or Harvard or wherever. And then we turn an okay company into a great company, and we sell it for a higher price than we bought it for. They're familiar with that, having the operator of a broader project in place that's a little bit I think more removed from a lot of these folks than the simple buy, fix, sell model. There's a broader project involved.

But with the MSO, you also get economies of scale. So redundant technologies and there's redundant people, there's redundant staff. There are a lot of redundancies in vendor agreements, et cetera, where you're unlocking a lot of value, synergistic value, simply because those things are redundant and not needed anymore. And so the real value of being part of an MSO project is what they call the second bite of the apple.

So a lot of these firms can be purchased for a certain price. As a law firm seller, you'll retain a portion of what's called rollover equity. So it's actually that rollover equity is equity in the MSO, and then as the MSO project grows and expands, you'll have sort of exit paths, a way to exit that equity and sell it back.

And so sometimes selling back that, let's say 30% stake, total value of that stake becomes more than the price at which you'd sell the law firm to begin with. That second bite of the apple, that's where the from the seller's perspective, they can really command a lot of money.

You need to be in the project together as a co-investor for a number of years. It could be three, it could be five, it could be 10. You need to be in the game for a period of time, and you're going to put your investor hat on.

And so these projects can be really exciting, especially for those folks that are, let's say late 40s, in their 50s, early 60s, they're like, I don't want to retire, but I know I need a succession plan. I need to get that in play. I need to take some chips off the table because I want to optimize my own personal financial portfolio. And I want to be part of something exciting and different. There's a lot of interest in being the first in to these MSO projects now so that you can have a strong hand in helping navigate the space and recommend other investments and use your connections, et cetera.

It can be a quite exciting project for a lot of lawyers, especially ones that are entrepreneurial, business minded. It's like, wait, I don't have to fix the toner cartridge, and I don't have to hire and fire staff anymore as well as run to court and have a knockout drag out battle in court. Their lives get better and they do something more interesting, more akin to business than lawyering than they did before.

Melissa: I would imagine easier than the other path of really getting this thing really prepared for a sale, like a transfer of equity to another party, not an MSO. And I would imagine that's a more arduous path, at least based on what I'm hearing. But that's probably not entirely true.

Michael: Yeah, I'm not going to sugarcoat it. A sell process of any type of a firm is onerous. You're going to be having all three jobs, some of which you hate, and on top of that, you're going to be in this process that is a lot of work. It takes a lot of work and energy and focus and commitment to work through the deal process to completing a deal. 

Melissa: No matter what type of deal, is that what you're saying? MSO style or…? 

Michael: What I would say is that these MSO transactions, the level of the diligence requirements of a private capital will far, far exceed that of other types of transactions. So everything will be scrutinized, and that takes a lot of time to get all that information bundled up, discuss the information, and then negotiate the results.

If you're going to still be in the game for another 10, 15 years, you still have to be doing something. If you say you want to do stuff, you don't want to completely retire yet. Just you got to look forward to what those 15 years are like versus what your life is like now. 

Melissa: I mean, okay, so I guess due diligence is way more involved with private capital MSO. And I guess what I'm wondering is what will kill a deal with the due diligence? What are the kinds of things that will make the MSO walk away or the private capital buyer walk away that may not have surfaced in a more traditional deal structure? 

Michael: So, you're always going to have to understand revenue and EBITDA and your financial picture. And some attorneys are that I don't pay attention to this. Bright shiny object. They don't pay attention to operations, bright shiny object. And so getting some attention and focus is problematic.

Two, thinking that you've succeeded in everything else in life, another challenge you're going to succeed at. That's very optimistic. I appreciate your confidence in yourself, but yeah, deals go sideways.

Not willing to spend the money on the appropriate advisors that will definitely kill your deal or if your deal goes through, it's because you're getting robbed effectively. Yeah, let's get this deal done. $10 million less than what you could have gotten it had you used advisors, right?

Or you didn't tax optimize it in a way or whatever it is, right? So under-relying on advisors, over-relying on your advisors. The choice of lawyer. The lawyers that are transactionally minded and those we like a lot. They want to get a deal done, but they're also protecting the client. And they know the right balance of protections versus just trying to slug it out to bill that extra hour on every little minute detail that is very irrelevant. That can kill deals too, because it increases the transaction costs for both parties. Lawyer seller sees their attorneys' fees mounting and are like, we need an end to this and I don't see any end in sight.

And then, you know, the obvious one, systems, processes, and procedures. The weaker your systems, processes, and procedures, the more painful the process will be. I guarantee it. When you're asked to produce data that you just don't have, or…

Melissa: And you don't know how to get it.

Michael: The data is there, but it's not resident in any system yet, or you have no system in place to like pull that data. And you have to start canvassing your lawyers for certain of that data. What cases are you working on?

And there's a thing called deal fatigue, too. Like, after a while, I'm like, I want this to stop. I can't do this anymore. And then, you know, leaving deals because of that. So you got to buckle up, you got to be ready. And part of this is being prepared to go into a deal.

And so, if you're going to talk to private capital, you should absolutely, absolutely have a sell-side quality of earnings done because the buy side will do it. There could be significant difference. We're in a deal now, I was on a Q of E call earlier and we had our Q of V provider provide one estimate of EBITDA, which was significantly higher than what buyer produced, and it uncovered a lot of errors in the analysis that the buyer did.

Yeah. Yes, they're going to make everything all the protections and conservative assumptions for buyer. That's a known though. That's negotiation, right?

Melissa: Yeah. But that’s not what you’re referring to.

Michael: What I'm referring to wasn't, you know, if it's not done correctly, you know, you're talking about millions of dollars in EBITDA and there's a multiple off of that. So you're leaving millions of dollars on the table. So you need to be prepared for that. You need to have your data in place.

You need to have a coherent story. Get your story straight as to why you're leaving, what's wrong here? What's wrong? That's the first thing that goes up. Why are you selling? If you have such a great firm, why are you selling it, right? So you do need plausible reasons for exit. That's it, you know, it could be like, yeah, I want to grow my firm, but I'm not going to work 80 hours a week anymore to do it. That's a great plausible reason to do an MSO transaction with private capital.

And being well prepared to go into a deal, we always require a comprehensive valuation and analysis and LPE valuation and analysis of the firm. So we want to get buyer down to earth on what they're really going to command. I'm going to get eight times revenue like my friend when I talk at racquetball. No, you're not. They don't know what the multiples are. I know what the multiples are. They don't know what the multiples are.

Melissa: Yeah. Right. I know, I love you said, I know what the multiples are. You don't. And if you do know what the multiples are, which I hope people who have listened gleaned some frame of reference on what you can expect.

And I don't know if you remember me asking you this on one of our talks, I said, everybody always acts like not you, but just when you hear talk about multiples, there's a lot of uncertainty being able to say what you'll get because it depends so much about the firm and the circumstances and the reality of the firm.

But knowing what an ideal range is and what's possible, can you decide that's what you're going to freaking get? I'm going to get my house in order so that I can be within that range. I'm going to, instead of walking into a deal, like, I hope I get the multiple I'm wanting, decide you're going to get the multiple you want, and go get yourself in order, which is not easy. I do understand that. There's no magic wand for that.

But at least you're lining yourself up with a target for yourself instead of just saying, I'm going to get my systems and process in order. I'm going to do things I think I should be doing, which is a good thing to do. But you can be a dog with a bone, I would imagine, with getting in a range and knowing what it takes to give yourself that opportunity. Which kind of makes it more fun to line everything up. 

Michael: Right.

Melissa: To your point, don't be delusional. You're not going to get eight. That's not happening. I think if I remember correctly, what you said to me before was somewhere between three and four is like top for a non-MSO style acquisition. 

Michael: Yeah, I would say you could top for most conventional non-contingency type practices, if you get a three, you got a, you got a generous offer for your firm. Right?

Melissa: Okay. Yeah.

Michael: I would say the exception would be if private capital didn't find the secret sauce in scalability, you did as a law firm owner. Then you can get beyond three and up toward the contingency practices.

There's contingency practices or consumer practices where there's obvious scalability and those types of practices are commanding, well-run can go anywhere three, five to five plus these days. I wasn't using the five last year, I'm using the five this year. Yes, with the increased interest, and I think private capital seeing that it takes a lot to get a deal done, they're willing to up the number a bit. And so yeah, fives have been offered. 

Melissa: But through an MSO-style.

Michael: It happens to be an MSO-style acquisition, yes.

Melissa: That's not necessarily what you meant. You could acquire a personal injury law firm, for example, via a non-MSO methodology, right? But…

Melissa: And still see five as a multiple.

Michael: Hypothetically, yes. Yes. 

Melissa: Hypothetically.

Michael: Yeah. The value should be the value. So what we do is calculate fair market value for a firm. That's what a financial buyer would be. Hey, this is a business, I don't care what it is. These are the cash flows, these are the history, whatever. This commands this value as a business.

And then there's also synergistic values that a law firm can have. We have the same case tracking management software. A number of these vendor agreements that you're in now, we already have that too. That's not going to be a cost. So redundancies in staff and systems and processes and things like that, there's a real synergistic value to certain buyers, and in those instances, you can command significantly more than what the fair market value of the law firm is.

Anything that makes your law firm look a lot more like those service industry businesses that are commanding the higher multiples will increase the multiple. All of your clients are through advertising sources, right? None of them are tied to you personally. Right? You just need to go out, and I don't know, dance on a truck or whatever you do to bring in your clients once a year and refresh the ads and all of that. Yeah. That starts to become more like a regular business. And so, hence the multiples increasing in those circumstances.

Melissa: In any acquisition, as the seller, if it's very difficult for you to get your hands on the data they're going to be looking for, they're going to need. And even more so with private capital. The deeper they're going to dig and the more granular they're going to be with due diligence. And how much of a disadvantage it is if you can't provide the data. It's somewhere, but you don't know how to get your hands on it. It slows everything up. Maybe it eventually kills the deal because it's just not getting done.

I hope people hear that. Could you imagine that the reason that you can't move forward with something that would be beneficial to you is because you aren't organized. That's it. That to me is so unfortunate and common, I think.

And I was just thinking of hopefully speaking to listeners, I have consults with people consistently and when I ask what their revenue was for the prior year, they can't answer that question. Let alone profit margin. Gosh, there is an opportunity here that exists. To me, it's step number one is just get organized. You can optimize numbers later, but just get the data first. 

Michael: I had a client recently, and it's unfortunate because I like this gentleman a lot. Systems aren't in order. A great firm, but too much chaos, I think, to successfully navigate the deal process without getting utterly frustrated. They may well succeed just because it's such a great firm, but as far as the deal process, I had really concerned that individual, the owner would be very frustrated.

And I had recommended let's table this 90 days. Connect with one of our trusted partners, a consultant that will analyze your systems and operations and really help you overhaul them. At least to an extent where they're somewhat viable. You don't have to be perfect, but just systems and processes in place that will help the deal.

Didn't listen, and I unfortunately had to part ways with that client just because I think the process would become too overwhelming and it would present frustrations for me, for the client, they would get frustrated with me. And so unfortunately, I had to part ways with that client.

But, you know, that's how important having systems and processes are. It can kill your deal process, but what it will do is you'll definitely get some sort of discount or haircut from what you could actually command. Private capital's watching your ability to get this stuff. They're watching your every step in how you navigate the deal process. And so if you can't prove what you say you have, why should they pay for that?

Melissa: Let's say someone is interested in being a part of an MSO-style acquisition. How do people seek that out to be a candidate, I guess? 

Michael: The Law Practice Exchange consists of predominantly two verticals. One is a true electronic exchange, which is becoming the Zillow of law firm transactions. And that's where buyers and sellers can transact directly with each other. It's almost like a dating service, if you will. And you can tell them that you're looking for an MSO-type acquisition because you're not done. You want to grow. You don't want to just sell and be done. That's great. 

So you can announce that in the exchange or you could come to me and say, look, I'm a lower middle market firm and I want sort of more white glove type representation in my transaction and here are the types of buyers I'd like you to find for me with a strong preference for MSO.

And I could probably get you in front of clients of all shades where you can compare what the offer is from private capital in an MSO project and what the offer would be in a more conventional type of transaction, and see which is better.

Beyond the consideration that one can get for these transactions, I would say first and foremost, fit is more important than anything else. Fit is more important than finance. Invariably, lawyers, even though they say this is not their preference order, the stewardship of their law firm is the most important thing to most lawyers. Who is the one who is buying my law firm? Are they going to fire all my staff? Are they going to treat my clients poorly? Will they tarnish my reputation as an individual in my community? I don't want that. I may take a lower amount of money if I get the right steward. They're finding that legacy protection is an added benefit, especially in an MSO project.

The other two things, structure, deal structure. What is my role? You're telling me my life is going to get a lot better after I go through this descend through the nine levels of hell to get this deal done, right? When I come out the other side, sweating with the fire and brimstone, having scorched me. Really, I want it to be better. I want to know that my duties are limited to this. I'm only practicing law for these number of hours. I'm really going to have an investor role and a say and help steer and guide the investment project. How does that look as well?

And then finally, it's total consideration or some total of the consideration paid for the law firm. How much cash, how much rollover equity, how much purchase price adjustment? That's the third. And again, lawyers will say, no, no, no, it's going to be the money.

Chasing headline valuation is amateur hour stuff, right? You haven't been counseled appropriately if you think you're just going to chase headline valuation.

I've had the same buyer client make two different offers to one of my clients, one at a high $30 million mark and one at a mid $30 million mark. And despite all the protestations of that client from the beginning of the process, they took the lower offer. 

This goes back to why a competent operator is so important. They want to really have faith in the person that's going to be really spearheading this project. They want to know that it's going to be successful, not only because they have a financial interest in that, but, you know, that person hopefully is sort of a visionary and has a high probability of success in delivering what was promised to them. 

Melissa: One question that also came to mind is how often with an MSO-style acquisition, once it's done, is there a world in which the lawyer who sold to the MSO has issues and there's friction between the two? I would imagine that's a risk, but does that happen very often? So I'm wondering if you've seen that yet. 

Michael: I think, unfortunately, in this space, some of these transactions are too new. When I started doing this, we were representing small law firms in the Carolinas. That was over three, three and change years ago. And now, it was really the last year and a half where we saw a really strong interest and the development of these types of transactions.

So, as far as the ones that I've seen or worked on so far, I haven't heard of any problems. There are MSO/LSL projects that have had more track record. When you speak to the lawyers that the portfolio, again, that word portfolio, when you speak to the portfolio law firms in that project, they have a lot of positive things to say about the transaction.

If you get to consummation, you must have a lot of faith, rapport with the operator of that project. 

Melissa: Okay. And circling back, so I realize, for listeners, I realize this could be all over the place. That's partially because I'm learning. And so my brain thinks of things later to ask.

Michael: Even attorneys that are used to doing these MSO deals in other spaces, they're finding that the legal, the legal space is so novel and the nuances of these transactions are so novel. 

Melissa: If somebody listening wanted to look into that as an option for their family, what professional do you turn to weigh considerations? 

Michael: I would say the first place you want to talk to is a lawyer versed in MSO transactions for law firms. Previously mentioned Holland & Knight. So it really depends on the type of size of the project and what's at stake there, what the benefits that those owners have seen from those types of transactions in dental or vet, et cetera, and to start the conversation. And I'm sure that lawyer would tag in someone with specific expertise in law firm MSO transactions for further counsel. That would really would be where I would point you first. 

Melissa: Thank you for chatting. I think all of this is great conversation, even if, again, I'm thinking about the audience, if some of this felt slow because of the types of questions I'm asking. I really appreciate it. And I think if listeners have questions that were sparked because of this episode, I highly recommend emailing us or dropping us a line. We leave a way to do that in the show notes because if you're willing to come back, I could maybe have a list of questions from listeners. 

Michael: Yeah, willing to come back. Love this. Love chatting with you always. It's a pleasure. 

Melissa: It'd be interesting to stay abreast of kind of what's going on in your head and in your world.

Michael: Sure. 

Melissa: Well, thanks again. 

Michael: Appreciate you having me here, Melissa. It's always great chatting with you.

Melissa: Hey, want to watch the video of this episode? Head over to Velocity Work’s YouTube channel. You’ll find the link in the show notes.

You may not know this, but there's a free guide for a process I teach called Monday Map Friday Wrap. If you go to velocitywork.com, it's all yours. It's about how to plan your time and honor your plans so that week over week, more work that moves the needle is getting done in less time. Go to velocitywork.com to get your free copy.

Thank you for listening to The Law Firm Owner Podcast. If you're ready to get clearer on your vision, data, and mindset, then head over to VelocityWork.com where you can plug in to quarterly Strategic Planning, with accountability and coaching in between. This is the work that creates Velocity.