Law Firm Acquisitions: Deal Structures and Financing Explained with Michael Di Gennaro

Michael Di Gennaro: The buyer and seller will be in bed together, for lack of a better term, for years after consummation of the transaction. The relationship matters probably more than any other aspect of one of these deals. The relationship between the buyer and seller matters in order to make the transaction successful.

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Michael Di Gennaro: We all know that lawyers can tend to be control freaks and perfectionists. A lot of the stereotypes that are in the profession, there are certain personalities. It's a self-selecting profession for the most part. This is a common phenomenon that we see, and losing control can be frustrating.

Melissa Shanahan: Welcome back to The Law Firm Owner Podcast with special guest again. Back with me is Michael Di Gennaro from Law Practice Exchange. Thank you for coming back again to talk about another fun topic.

Michael Di Gennaro: Yeah, thank you for having me, Melissa. It's always a pleasure chatting with you.

Melissa Shanahan: Absolutely. Same. I love chatting with you. Well, today, everyone, what we're going to dig more into, we did sell-side conversations four or five months ago. Those aired more recently than that. And then now, we've entered into the buyer-side conversation. Now, this one specifically is around the financial aspect of being on the buy-side. The first question I have is, I know that there are many listeners that don't consider themselves a candidate to buy a law firm. I think it feels too big, too much of something that they don't have.

And obviously, one of those things is capital. And there are people who just have a bunch of cash set to the side, but there's more people that do not have just a bunch of cash sitting to the side to be able to do a deal to buy another law firm and to have an acquisition. So, I'm curious what you would say to people who assume that they don't have what they need in order to do this? 'Cause I think you could probably bust some myths.

Michael Di Gennaro: Happy to bust myths. There's a lot of aspects of law firm transactions that can make them financially more palpable in terms of capital resources than transactions for other businesses. And the first is that a lot of our deals are a portion of cash down with the remainder earned out over time. Basically, there's an either performance or guaranteed payout to the seller over a period of time, somewhere between two to three years. How much cash down? Is it 70%? Is it 50%? And the fortunate answer is no, it's not. Frequently a lot of it's between 20 and 33% cash at close.

So if you're going to buy a million-dollar revenue law firm, if your transaction is going to be valued at a million dollars, you're putting 20% of that down, $200,000, maybe $300 or a little bit more than that. A lot of the deals that we analyze, we make sure that they cash flow for the buyer to be a viable deal. So that means whatever proceeds, whatever profit that they're going to be achieving with this deal after careful analysis, that profit in and of itself will be able to finance those earn-out payments on a going-forward basis. With that and proceeds from loans that the buyer may take out, they'll be well-covered and the deal will be taken care of that way. So that's one good thing is that they're not all cash at close transactions, typically.

The other thing is that there are resources for smaller buyers. I'm thinking of SBA loans. I believe the SBA's limit now is $5 million on a transaction, so they will fund up to $5 million transactions. The other good thing is that banks are providing alternatives now to SBA financing. SBA financing has a significant amount of restrictions on it on how a deal is financed. And so, there are lenders now getting into this space that will finance law firm transactions with more conventional capital solutions and not just for giant transactions. I'm talking about for bite-sized transactions as well. That's another resource. At Law Practice Exchange, we work with trusted partners. Deal funding is one of the resources that we have on our website. And so you'll see SBA lenders there as well as these other solutions that I'm referring to.

The other thing that lawyers should keep in mind is about how much student loan debt that they went into to go to law school. And you can buy a law firm for less than the debt that you took out to go get your law degree.

Melissa Shanahan: That's so true. So true. That's good for people to realize.

Michael Di Gennaro: Yeah, absolutely. One of the most recent transactions that I worked on was an acquisition of a $50 million revenue law firm. I'll tell you that when I first came here over three years ago, the smallest one that I worked on was $125,000, and it was a young man who's building a $1 million revenue trust and estates practice through the acquisition of small law firms with senior partners that are looking to retire, solo practitioners. And so, when we talk about a law firm acquisition, the devil's in the detail as to what type of law firm. Are you looking to buy a $50 million revenue law firm or are you looking to get into a solo practice, get integrated, get into the groove of running your own business as a solo practitioner? You can start somewhere. We have acquisitions of all of these sizes that I mentioned, between the $100,000 range all the way up to the $50 million range and more.

Melissa Shanahan: Yeah. Yeah. So it's it's on the table. Every listener, if they decided, "I want to look into this as an option for myself," there's a path for them, just like we talked about in the last episode. We talked about what do you need to do to get your house in order before you go buy a law firm, but it's not off the table, no matter how small you are, really.

Michael Di Gennaro: Absolutely. And it could be scary. A lot of these solo practitioners are eager to mentor young lawyers that want to take over their practice. They're flattered by the prospect that you may preserve the brand of the law firm and continue it for an indefinite period of time, that you'll continue to take care of the clients that they've developed over a period of time. And they're flattered by that and they'll mentor you not only in the practice of law, but also in how to manage a small solo practice or even a small law firm.

Melissa Shanahan: Assuming they know how to do that.

Michael Di Gennaro: Correct.

Melissa Shanahan: Some of them do not. What you were just talking about is a lawyer coming out of a larger firm that wants to buy their own, 'cause you said sometimes if people are nervous that they don't have experience of running a business, that's who you're referring to, right? All of our audience would, you're all law firm owners, so they have some experience. Doesn't mean they're great at it, but they do have some experience.

The other thing, which you started to get into this, but wondering if there's anything helpful you can share beyond what you've already said about deal structure. Now that we're in the buyer mentality, what are some different deal structures that people can expect to have as options?

Michael Di Gennaro: A lot of the most common type of deal that we have here at the Law Practice Exchange is the conventional cash down earn-out type deal. And that's a portion of the cash down and the remainder of the proceeds of the transaction are earned out by the seller over a period of time, two, three years. Those earn-outs can take the form of guaranteed payments, pure performance payments, but likely a combination of guaranteed and performance payments over time. So that's one of the most conventional transactions we have.

Melissa Shanahan: So you said two to three years generally.

Michael Di Gennaro: Yes.

Melissa Shanahan: What is a scenario in which it would be longer? Is it just a bigger firm, bigger payouts? Or not necessarily 'cause it's all relative and it still should be two to three years? Are there instances, do you see very often deals going beyond that in terms of time?

Michael Di Gennaro: They can. And then it could be a negotiation point from buyer is wanting to have these payments stretched over a longer time horizon. It doesn't give you a guarantee that the seller is going to agree to that. For pure financial reasons, I think sellers are more open to having those payments over time. If it's sort of a commitment to transfer the goodwill and client base of the firm, and so there's an overlap between what we estimate it will take the seller to transfer the goodwill and client base over to the buyer and the payouts during that time.

So when I refer to earn-out, I'm really referring to two things. I'm referring to the length of time that it will take to transfer the goodwill and client base over to the buyer. And I'm referring to the payments made to that seller for being successful in doing that, especially if they're performance-based. If they're guaranteed, that's another thing. But if they're performance-based, that the success of transferring that goodwill and client base over to the new owner overlap those performance-based payments.

And we'll see it in things like maintenance or increase in revenue, maintenance or increase in EBITDA, and other performance indicators of the firm. There are more complex types of deal structures. There is a very conventional deal structure that goes on in the law firm world all the time, which is an absorption of another law firm. Maybe the target law firm owner has equity, and if there's no cash exchange in the deal, it's a share-for-share exchange with the target equity and the buyer, there will be a conversion factor. And the seller will now get equity in the buyer in a certain proportion for the shares that they currently hold in their own firm.

So that's a share for share. Some of it is cash and share, so they're going to get some is cash and some is equity. So that's another sort of conventional type of law firm acquisition. Some of it is earn-outs. We call it an of-counsel earn-out. So you bring over this partner, maybe it's a solo to your law firm, and you will pay them some sort of tail origination credit. So come to our firm, start handing you over your clients to a junior who will manage those relationships on a going-forward basis. And then after you retire, we will be giving you earn-out payments. We will be giving you performance-based payouts on your client portfolio over a period of time.

And that's one of the simpler transactions that we advocate for solo practitioners. It saves a lot of deal resources, transaction costs, and deal advisors and M&A experts and all of that. Just come to the platform and you get an earn-out. Unfortunately, a lot of law firms are unwilling to do that. What they talk about is how come to our law firm and with the cross-marketing, all these exceptional opportunities, you'll be earning a lot more than you are now for however long you stay here. But that's not true compensation for your practice. It's not the purchase of the equity in your practice, per se.

And then even more sophisticated transactions may include where there's MSO or Management Services Organization present, you may get rollover equity in the MSO. If you did a firm-to-firm merger and you get equity in the law firm, instead of doing that, you get equity in the Management Services Organization. Another type of transaction we're seeing. I've just had my first transaction or letter of intent written where there is no earn-out. It's all cash and MSO equity. So this is the first time it's been saying that. And of course, there's all sorts of ways to structure the earn-outs. So we have names for each of the types of structures we use for the earn-out, but that's probably beyond the scope of this conversation right now.

Melissa Shanahan: One question I have is, when you start talking to a buyer or a seller, how do you know what deal structure to go towards? Is it just in one conversation you can get a sense of what's going to make sense? Do you lay all the options out to them and then let them say what they're drawn to for their set of circumstances that they're in? You see all kinds of deal structures, and how do you get there? What can you say to that?

Michael Di Gennaro: Well, that's a great question. Typically, a lot of the times I'm on the sell side, I also work on the buy side, occasionally. Operating from the sell side, I would say the first thing that I ask sellers going into a potential sale is, what are your personal, professional, and financial goals? And the reason why I ask that question is a lot of it has to do with the structure of the deal that they want. In the law firm transaction world, as odd as it may sound, headline valuation or total consideration that you might get in a deal is not the number one priority. And for sellers that think that it is, I guarantee you that when you tease things apart, it will not. It will always be a third priority.

The first priority in any deal for most law firm owners will be stewardship. Who will be taking over this firm? Because I'm going to still live in this community. People know me. I don't want to put this in the hands of an owner that's going to not treat my clients well. I don't want the taint of that in the community. Who's the steward of my firm going to be? The second is structure of the deal itself. The reason why I'm selling is because I'm torn doing multiple roles. And after the sale, I only want to be doing X. Is the structure of the deal going to permit for that? That's important. And the third thing is consideration for the law firm. Knowing that second element, what roles and what duties do you want to do and not want to do depends on in part what the transaction will be.

Melissa Shanahan: That is interesting. I think when I entered into this conversation with you, I'm mostly thinking about buyers who want out of all three hats that they may be wearing. You may buy a firm or you may sell a firm. The seller wants to reduce the hats that they're wearing. Is it a sale or is it a merger? That's super interesting. I haven't thought about that before for clients is that they don't have to be out entirely, but they can structure a deal so that they just get to do what they want to do, which I would imagine has its own set of struggles. 'Cause if they're only going to do what they want to do and they're not the owner anymore, I imagine that could create friction down the path.

Michael Di Gennaro: I love flipping buyers to sellers. There are these buyers that think if I just acquire another firm, certain things are going to change. They're not really looking at what their pressure points are. The growth strategy for them is not the buyer. There are a lot more sophisticated buyers than out there than they are. What they really need to do is they need to their time freed up to be doing things that grow revenue and grow the client base. The reason for the growth constraint is because they're wearing too many hats, some of which they're not wearing well and they shouldn't be doing. Maybe they're not good at operations or management or whatever it is. They're good at lawyering. Well, or they're great at marketing, more likely. They're great at marketing and they love marketing.

I love driving clients to the firm, maybe more conventionally called an origination role. A lot of attorneys as they go through their career arc tend to start to like the origination role even more than practice. Being freed up to do that role that you do well and enjoy is the way to grow the firm. This is not a sale of everything, not all of the equity of the firm. It's a partial sale of equity to tap into private capital resources and superior operational systems, techniques, state-of-the-art, best-in-class, back office, technology, all of which you need to power the growth of your law firm. That's why I say my best sellers are buyers, because those growth-minded buyers, rather than going it alone and doing it themselves, will actually probably realize more for rewards financially for themselves if they partner with experts doing these other things that they don't do as well.

Melissa Shanahan: Do you stay in tune with people enough beyond that to know if there's struggle with this newfound partnership that they are in?

Michael Di Gennaro: We all know that lawyers can tend to be control freaks and perfectionists. A lot of the stereotypes that are in the profession, there's certain personalities. It's a self-selecting profession for the most part. I like to not put myself into that bucket simply because I went to law school for very different reasons. This is a common phenomenon that we see, and losing control can be frustrating. But what I would say is that in a lot of these growth projects that I've talked about, you really are becoming an investor partner. You're an investor, and you're an investor actually in MSO equity or rollover equity. And so you both have a common goal of growing the value of the equity in the MSO in these types of growth-driving transactions.

And entrepreneurial-like lawyers tend to like that. Losing control of the day-to-day management operations of the law firm is a worthy trade-off for being a sort of consultant voice in an MSO project. You lose control some things and you gain a bit more, if not outright control, but at least be a voice in other things. And so that can be a very rewarding trade-off for a lot of buyers turned sellers.

Melissa Shanahan: Yeah. Yeah. Okay. That makes sense. It's good to know that there are different ways of doing these deals. If someone is interested in learning more about what their path might look like if they're going to buy a firm, of course, and sell a firm, is the best thing to do is to reach out to you guys through your website? You probably have a path for them to go down the rabbit trail that they need to go down to get some answers. Is that correct?

Michael Di Gennaro: Sure. We make a lot of resources available to both buyers and sellers. We have a wealth of podcasts, presentations, resources on our website. The real entry point at Law Practice Exchange is becoming a member of the actual physical exchange. We have an electronic exchange where buyers and sellers can transact directly with each other. We call it the marketplace. Entering into the marketplace is a great first step 'cause you'll learn who are the buyers, who are the sellers? What do they look like? And you'll also be able to avail yourselves of a lot of free resources that we have there. By all means, reach out. We'd love to hear from you and what your interests are and look forward to guiding these clients to achieve what they want to achieve.

Melissa Shanahan: Yeah. Yeah. In summary, for this episode, is that it's not off the table for you even if it feels too far-stretched, too out of reach. You think you don't have enough capital, you think you don't have enough knowledge about how to do it. It's not too far out of reach. And you can secure the capital you need, especially considering it's 20-ish percent down on some deals. You're going to need to do the things to get organized inside, but that's true no matter what. You should be doing that anyway. There are other reasons to consider buying a firm. If that is a lever that they would like to consider pulling for growth, it's a great option to look into to determine what might make sense, what type of deal, what level of deal. This is all really helpful for people that just don't have this kind of knowledge at their fingertips or experience. I'm really, really grateful that you're here and chatting about it.

Michael Di Gennaro: Thanks so much and glad to be here, Melissa. I'm happy to help listeners with whatever their needs are.

Melissa Shanahan: And so, you're going to come back and we're going to talk about MSOs. I mean, I think there's such a knowledge gap there for our listeners, and me too. I know a bit, but I don't know what you know and what you see. And I'm so curious to learn more and to share it with our audience because it should be a very real part of the conversation, especially if you're considering buying, selling, and understanding that they exist.

Michael Di Gennaro: In all fairness to yourself, MSO acquisitions of law firms, while they've been happening, they haven't been happening as readily as they have been in the last year. And I think a lot of that is because we've been having conversations with private capital for years about potentially entering into the legal services space and doing acquisitions there. But I think the comfort around the ethics of doing acquisitions law firms, that comfort only really was gained in the last year to year and a half by most private capital players that I now see taking a dip into it. So it is a brave new world for a lot of us. For those that are familiar with transactions in other spaces, dental, accounting, they've been familiar with those types of acquisitions. It's now just happening in the legal services space. It's a big event. I'm very always paying attention to.

Melissa Shanahan: Just to tee people up for our next episode, DSOs had a bad rap for a while. And now it's not the case so much anymore. Things are designed in thoughtful ways. And there were, I think at the beginning, I don't know if it's the same here, or if it was in its early days with MSOs, which is still early, but DSOs, those were mostly sharks just pulling up and not caring in the ways that they should care, but it was about the profits. It's not the same conversation in that landscape. I'm still connected to it by proxy. So I'm wondering if it's the same. The very beginnings were just opportunistic. I don't know, it's legal though. So ethics are a little more on the table than and it's easier to be on the table. So just a quick comment about that. What do you think?

Michael Di Gennaro: There are good ethics advisors out there that can give you guidance about these MSO transactions. I give a shout out to Trisha Rich and Josh Port at Holland & Knight. Also our trusted partners. We refer a lot of clients to them for guidance on MSO transactions. As far as the types of players that are engaging in these transactions, it's like, yeah, there will be sharks doing this. The fortunate thing is, I think a lot of those sharks won't be successful in their transactions simply because of the nature of law firm transactions.

Private capital is at its best when it is supporting, not leading, supporting a MSO project with a savvy and proven business operator. And hopefully in partnership with a lawyer, not just writing MSO documents up, but one that has business acumen and strategy to do these deals. Those are the ones that I see succeeding. I think a lot of private capital direct acquisitions will fail simply because there's a lot of translation that needs to be done on how to behave with lawyers. Lawyers are savvy individuals. They're trained to read personalities and read people well. And law firm transactions are very much goodwill-heavy transactions.

The buyer and seller will be in bed together, for lack of a better term, for years after consummation of the transaction. The relationship matters probably more than any other aspect of one of these deals. The relationship between the buyer and seller matters in order to make the transaction successful. Because it's not just cash at close, I hand a suitcase of cash over and the keys and the buyer hands a cash a suitcase to the seller and the seller hands the keys over. Because it's not that type of transaction, I think we will see less of that here than your observation in the DSO space.

Melissa Shanahan: It does seem, especially after listening to you, legal law firm owners or lawyers are a little less vulnerable than doctors and dentists with some of this stuff. So that may be true as well. I love what you said, private capital supporting, not leading. That's the difference, is they're supporting, not leading. I can't wait to have you back for MSO conversation, dig in, have you give us some examples of what you're seeing, and just educate our listeners.

Michael Di Gennaro: Thank you, Melissa, for having me.

Melissa Shanahan: Absolutely.

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