The Hidden Costs of Buying a Law Firm: Managing Time, Effort, and Emotions with Michael DiGennaro

Michael DiGennaro: For both sides, buyer and seller. I love a mutually beneficial deal. That's what we look for all day. I'm a slayer of bad deals.

Melissa Shanahan: Well, good. Thank God.

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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: I'm so thrilled to be here.

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. 

Michael: Earlier in the weekend I had to release a client simply because I had asked them to get operational consulting help prior to selling the firm and they just wouldn't. They got other help on the stuff they like, but on the op side, they just they didn't do it. I was pretty shocked at the end of the engagement, not having systems in place to get financial records readily. You have to focus on that. It just is. You need a trusted delegate who is very focused on those things and that you rely on. The owner is great personally, a great person. I think that he has a very salable law firm, but it would be a lot more salable if he made some of the fixes and invested in the things that he really doesn't enjoy. 

There can be pain that's needed in order to avoid a lot larger pain that you will have in the deal process. I could see him getting very frustrated in the deal, and I just didn't believe I could get him what he wanted me to deliver to him because of this situation.

Melissa: If it's a lack of ability to focus or I see that even with great clients. It sounds like you also thought he was a great guy, had a great firm. Quarter to quarter, I mean they have quarterly priorities. We have 90 days for the things that we said we were going to do and so we need to do them. And there's times where I'll have a check in mid-quarter and thank God we have a check in. They're focusing on different things. What are you doing? Come back to the thing you said you would do and just finish it, get it done.

It really is challenging to hold focus, particularly as an owner, you're juggling many things at once, and it's easy to sort of get pulled into something else. It really is discipline to say, wait a minute, I have these three things I'm supposed to do this quarter. I need to do them, and I don't want to do them, but I'm going to do them because I said I was going to do them, and it's going to be important.

So I think focus is a big deal. It's almost depending on the degree to which someone needs help with that or has a real struggle with focus. You almost need somebody there consistently saying, how you doing? What's going on? How's it going? 

Michael: A coach, a deal therapist.

Melissa: A deal therapist. Yes.

Michael: In my camp, a deal therapist. Yes, all valuable. And some of it might be just procrastination and there's a lot of talk about what procrastination actually is and that it's not laziness, but it's hidden fears almost of not being able to do something correctly and so they avoid it. There's avoidance rather than ripping the Band-Aid off and plunging in.

And if you don't, if you're not being as successful as you'd like, having a consultant like you in their corner is invaluable. It'll make it less painful.

A lot of the reason for sale, especially when you're not looking for an immediate succession plan, like an older attorney might want a succession into retirement. But there's lots of sales that are done by owners simply because they want help. They want capital to provide operational and managerial support because they are doing so many things.

I have profound respect for these law firm owners that can wear the hat of business owner and lawyer in the trenches lawyering and forefront of the marketing, driving business development and marketing for the firm. They're doing three different things. And that doesn't make any sense from a business perspective to be doing three different things, some of which you like, some of which you don't, some of which you're good at, others which you're not. You don't get to release all three of those responsibilities immediately in a sales position. It's going to take a lot of pain, at least in the short term, to unwind from those responsibilities.

And part of that will be preparing for the sales process with things like Q of E or operational consultants. Then it will be an integral part of the sales process where you're marshaling your resources to get your financials to the buyer and to get other data to the buyer, case inventory, et cetera. It's very time-consuming. You're adding a fourth commitment to your plate. You're involved in this deal, which is time-consuming as well.

But it is short-term pain for a long-term gain. This is what I tell my sellers, is that on consummation, in this deal, you're able to rewrite your contract as to what your life will look like post consummation. You're not going to be doing it all. You're not going to be operating or managing the firm. You don't necessarily have to be lawyering anymore.

Typically, you can have a replacement come in and do the lawyering for you. You will just be transferring the goodwill of the firm over to new ownership or any other duties that you might like to add to your plate that you enjoy doing or would drive even more value in your firm. It is something worth slogging through in order to reach the light at the end of the tunnel.

Melissa: Yeah. This conversation is more on the sell side. I would imagine most listeners are more interested in that side than the buyer side. But I didn't want to not have the buyer side picture because as you know, I had a client that almost bought a firm, didn't because the deal fell through, which was unfortunate, which can happen, right?

When you, buying businesses can be such a leveraged way, meaning you're leveraging the other business for growth. And I don't think people think about it. I think it feels too far out of reach. I think in some instances, people are wrong about that, but they don't have any knowledge about what it would look like to enter into that to grow.

Michael: The sell-side conversation is important because we're now painting the picture of what your seller is going through. If you are a buyer, your buyer is aware of all the things going on with the seller. Frustration, anger comes up in these deals. And buyers need to be aware of that. Sophisticated buyers are aware of what goes on with a seller and what their emotions. That in of itself, that knowledge and awareness of what's going on in the buyer's mind and all of the challenges that a seller is facing, a buyer will be ahead of the game just being aware of those things because again, the relationship in these acquisitions is very important. 

The value of these businesses are highly reliant on goodwill and relationships. And so that's one of the things that distinguishes them from other types of transactions. It's not an HVAC business, it's not a nail salon, it's not a laundromat. These aren't put the suitcase of cash down and I walk away and here are the keys.

The seller will be in this game with the buyer for a significant period of time and buyers need to be able to manage the relationship through the deal with the seller.

I have a client right now. I'm in a deal with them and they said one of the nicest things to me. I saw them at a conference recently and they're like, we're in deals now with you representing one of the targets and we're in deals with unrepresented targets. And they told me any day of the week, they would prefer to have someone like me representing the target than have an unrepresented target. Now, they're going to pay a fee because we get fees from both sides, we just get more from the sell side if we're fully representing them than we do from the buy side.

So even though they're going to pay a fee to us in this deal, they still would rather have us there because they recognize our role in managing those emotions between buyer and seller and conveying frustrations and managing frustrations and it's very important.

Be wary of who is representing the seller or if the seller is unrepresented, because you may have a lot harder time with an unrepresented seller, much harder than you would in doing it. They told me that we just make the deal process a lot smoother, that sellers have are not familiar with concepts like EBITA and revenue trajectories and all sorts of things and what adjustments are and why and what are adjustments and what aren't adjustments, expectations on value and things like that.

I've had buyers, private capital buyers, that are thinking, we might like to just retain you to place you as a counselor to these unrepresented targets to make our lives a lot easier. Buying can be challenging. Having the right resources at your disposal is important to do so. And not just capital resources, but sound counsel, legal, advisory, et cetera in your corner is very important to getting deals done. 

Melissa: Mhm. Absolutely. No, I love that you said that because we started getting into the sale side, but to your point, it's very helpful to paint the picture of what it's like to be on that side for many. And so if you are buying, understanding what they are dealing with emotionally and the stress that comes with the deal and the deal fatigue, understanding that will help you put the right resources into the deal to get the deal done well. 

Michael: In one of the large deals that I recently did in Q3 of last year, one thing I warned the buyer from the outset was, don't handle these deals the way you have in other industries.

The deal almost fell apart when the buyer was going to “let the lawyers hash it out.” No, no, no. You're saying that your lawyer target is not going to be involved with his lawyers in the deal, and see all the changes that are being made and all the asks. That seller took it very, very personally what was going on. Very personally.

And that wonderful relationship and rapport that I, from the start of the deal, cautioned the buyer that they needed to maintain, the deal nearly evaporated over these frustrations. You don't just let your advisors hash it out and battle it out to get the best “deal” that you possibly can get. You need to nurture and water and take care of that relationship from the inception throughout the deal process, into post-consummation.

Again, you're going to be with this individual for years on end, and maybe in an MSO deal, it'll be as a co-investor. They'll be a co-investor with you buyer, helping you grow the MSO project, do subsequent acquisitions. The way buyer and seller treat each other is very important in a deal. 

Melissa: If someone is considering acquiring a law firm in the next two to three years, what should they be doing now to prepare? There's the operational side. What else do you think? In the next, if they're going to do this in the next couple of years and they want to buy firms, what do they need to be thinking about now?

Michael: Well, I think the first thing is that what do I want to buy? I see a lot of buyers that come in and say, I just want a cash-flowing law firm. It's all about cash flow. Now there's a lot more than just cash flow. Again, that's the mindset of this is just a business, and it's not.

It could be the forethought of I will get scale in operations from buying a specific type of law firm and doing roll-ups in that space, and that's where the value would come. Learning from the sophisticated players in the space, they usually have what's called an investment thesis. It's not just, oh my investment thesis is to buy all cash-flowing law firms that exist on the planet and aggregate them together because that's not a strategy. It's just a financial thing that might last for some time, but it's not really a business strategy for going forward.

I think realizing what the opportunity is and coming up with a coherent business strategy on acquisition is important.

Understanding the legal framework from which you're going to acquire a law firm is very important. How are you going to do this? Is this going to be a conventional acquisition where you're going to put some cash down and earn out the seller or is this something different than that? Is this going to be just a conventional share-for-share merger of firms?

But you need to think through what does your buy look like. I want 100% control and that's important to me, I'm the buyer. That's a different type of acquisition than I'm bringing another partner into the ranks of my law firm. So thinking through your goals there and the structure of what's going to go on is important.

Lining up your financing. How are you going to finance this deal? Do you just have lots of cash reserves and you're just going to finance it out of cash? So there are SBA loans for sub $5 million deals. You can use SBA lending. You can go out and get pre-qualified. We have trusted partner lenders on our website. You can go and get pre-qualified for a certain loan package so that you know what you can buy. You also signal to the seller, hey, I have the resources to go and actually do this deal. You want to signal your credibility as a buyer to the seller. Some of the sophisticated buyers don't signal that effectively as they do things in the deal structure which scares sellers.

For smaller buyers, there are certain things that you should do to demonstrate to your seller that you're a credible buyer. You're knowledgeable, you have the right resources to bring to bear on this transaction. You've talked with advisors, and whether that's a deal advisor or a lawyer or a fiduciary, ethics council, all those are very important in being able to effectively do a deal. So that's a great way to get prepared to do a transaction.

Melissa: And I guess that is something else they can do is start to find those partners. And that doesn't take two to three years, but that needs to be on your checklist of things that you're going to do prior to putting your foot on the gas with something, is to find the trusted partners that you were just mentioning that you're going to need when a deal, when it's time.

Michael: Exactly. And of course, getting your own house in order is financially, operationally, you have the right staff in place. All those things are important which can be done for the three-year gap that you have. There's all of that plus vetting all these other resources and making sure you have the right resources to bring to bear. And we talked about the at least $25,000 to make sure that you have, maybe not in super small transactions, but in transactions of a million, two million dollars, etc. You need those resources there or you can really get a bad deal or the deal might not go smoothly or it might fail after consummation, but having those resources in place are very, very important.

Melissa: I hear sometimes people talk about wanting to buy or wanting to sell and you can hear in their voice if they're in a hurry. And that is just not the way to do this. All the things we're talking about, you cannot do quickly well. You really do have to put one foot in front of the other and take your time, and you could speed it up if you have the right partners. There's desperation I hear people wanting to do these things, whether it's because they're excited or whether they're burnt out and tired and just want to offload this firm. And there's a bunch of other reasons why someone would feel in a hurry. No. No. Don't do that.

I know sometimes people feel like they're in a really hard spot where it feels really difficult to not just push forward and do, get themselves involved in a deal or it's not easier. To your point, deal fatigue and going through all of that, this is not going to be a quick process. It's certainly going to involve time and effort and energy and resources, money. So it's not your saving grace. You don't just get to take a deep breath once you decide to sell or buy. Yeah. 

Michael: Both sides are going to be committing resources to the deal. It's time consuming as he said, can be resource intensive. But if you're strategic and thoughtful and intentional going into the process, it can really pay off for both sides, buyer and seller. I love a mutually beneficial deal. That's what we look for all day. I'm a slayer of bad deals.

Melissa: Well, good. Thank God.

Michael: Yeah, worry about what both our buyer and seller clients would think of us. A transaction should be a mutually beneficial transaction. Both parties should get value out of a transaction. That's the reason for doing a transaction.

Melissa: Yes. Well, man, if people have you guys on their side, what a win. It's so obvious the amount of integrity you have in handling these deals and being a bit of a liaison to some extent, even though you're probably for one side specifically, but your job is to get this to work. So how can we do that? What do you need to put into place? Tone down what you're saying.

Michael: We do aim to help our clients and we are good advocates and we act very much so as intermediaries simply because of the nature of this goodwill business whose value is very much goodwill, the transaction. So. 

Melissa: Yeah. Well, thank you for digging in on that with me. We're going to have you back to talk about the financial aspect. So, yeah, stay tuned, everybody, for that episode.

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