What Determines Your Law Firm’s Value with Michael DiGennaro

Michael: I was going to say this thing comes full circle to that. It's like their identity is gone. It's like, "Oh my God, I'm in a business role with free time." Like, what do I do?

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Melissa: I mean, I don't know. We were talking about psychological stuff. So some people, too, just want to grind it out till the end.

Melissa: Welcome, everyone to the Law Firm Owner Podcast. Today, I have a special guest who I'm especially excited to talk to for a bunch of reasons that we'll get uncovered. Michael DiGennaro. Welcome to our podcast.

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

Melissa: When someone is going to reach out to you guys, they do want to find a buyer, and they want to find the match. You guys will help with the deal. What other professionals will they need that is outside of what you will provide?

Michael: That is an exceptional question, and I'm glad you asked. And I think, I think case in point was the transaction we were describing and how that went south. Buyers and sellers will need advisors, and just from the get go, like, if you're looking to buy or sell a law firm and you're not willing to spend money on, you know, you're looking to be very cost-shy on advisors, I advise you to stay away from it right up front. You should think I need $25,000 for my advisors, and I'm talking about the lawyers, the deal consultants, etc.

If you're not willing to spend that kind of money, you can have a really poor transaction and risk losing lots of money by doing a deal. And so I'll tell you the advisors that are needed. So, at the Law Practice Exchange, I'm a former practicing attorney. Tom is a former practicing attorney, also an accountant, but we don't practice law, and we don't act as fiduciaries. But what we do is a lot of heavy lifting, deal dynamics, deal structuring, reviewing letters of intent, reviewing asset purchase agreements, or stock purchase agreements. We do a lot of the deal mechanical work.

Ultimately, both buyer and seller will need an M&A attorney in the jurisdiction in which the transaction is going to happen. They will need an ethics attorney, because there are ethics rules surrounding the sale of practice. Rules 117, ABA's Rule 117, and Rules 5-4 govern the sale of a law for practice. There are a lot of duties that get involved in there. There will be due diligence. And due diligence means that you will be reviewing client materials. So what the rules are surrounding that are very important, that you're complying with your bar's ethical rules.

Those would be the two attorneys, I would say. And the last would be a fiduciary. Making sure you have a CPA or some other type of fiduciary that's signing off on a deal as in your best financial interests. And that will also walk you through tax implications of a deal. If you structure a deal as an asset purchase versus a stock purchase, that has a whole array of different tax implications, that your and with your unique financial situation, you need to know what is an optimal structure.

If you're a seller, do you really want a lot of cash at close? What is your tax bill going to look like in that year? I don't know. I'm not I'm not in your personal financial material seller, right? So like, you need to talk with a tax advisor that can advise you like, what is an optimal structure? When, if you can get the payments in a most tax optimized way, what should we ask for if we're representing you for instance? But those are really the advisors that you want to have in addition to a deal advisor are M&A counsel, legal ethics counsel, and some sort of fiduciary.

Melissa: And I would imagine, you know, let's say you find an M&A attorney, and they probably can point you to some other professionals that are going to be needed within the deal that you could have consults with. Is that correct? I mean, I think this could seem overwhelming to people to vet and find the right fits for them and, you know, a team that they really trust. So, I don't know. Tell me where I'm wrong. And also, I'm cognizant that there may be some conflict of interest here that you needs to be thoughtful about. Do you recommend professionals, or no, that's not something you can do? 

Michael: So we work with trusted partners. We have a page of trusted partners. Those partners are for everything from recruitment professionals that are willing to work with the smaller law firms, not just get the giant fees that the AM Law 200 firms pay for the giant salaries they pay their associates. It's deal financing.

So, have you SBA prequalified for purchase of the firm? Have you SBA qualified your sale? Like, will SBA lender grant the loan under certain terms to any buyer of the firm? We have uh referrals to lawyers. Yes, there's ways you can find corporate lawyers um through our trusted partners, operations consultants, pretty much anything that we don't do, we have links to individuals that can help with that.

And I think it would be great, yeah. I mean, we're building out our network now. And one of the things that our clients come to us asking for is guidance on MSO structuring, MSO, LSO structuring of deals, because it's the way in terms of non-lawyers and lawyers of foreign jurisdictions acquiring law firms. So that's one of the big asks that we've had recently in terms of legal services.

Melissa: Okay. Now that's great. That's good. You do have trusted partners. And I would imagine that Law Practice Exchange, once a foot is put forward with you guys, that you will point them in the directions of how they need to line up, get their ducks in a row, so to speak, to move forward. that you'll be as a part of the, you know, structuring the deal and advising where you can, that's part of the role is that you will point them and make sure, like, check these boxes. Some of these we can do, some of these we can't do. Is that correct?

Michael: That is correct. Yes. We set clear boundaries on what we are capable of doing and not capable of doing. And I will make those recommendations for the same sets of advisors all day and every day. Don't want good deals to go south for not having the right advisors in place. And there are deals that should go south, and they deserve to die because they're bad deals.

And we act as intermediary for most of our deals. We're only representing a very select handful of clients on full representation. So we do about 10 to 12 full sell-side representations at any one time, just because of the bandwidth we have. I told you our advisory team is myself, Tom Lenfestey, and Brenda. And so we're working all of those deals. That's our current deal team. It will expand.

But other than that, our participants in our marketplace, we are not representing any of those. We only will do representations on an à la carte basis, meaning you will counsel you on your letter of intent and whether you should be renegotiating your deal, or we will renegotiate your deal for you. We will take segments of the transaction. That way, we are freed up to be act as intermediaries for the most part of the time, trying to bring together good deals for both parties and making sure that really bad deals don't happen, because that would be horrible for both our buyers and sellers if, you know, a deal falls apart. 

Melissa: So, let me see if I understand correctly. The Law Practice or the Exchange is really, am I understanding correctly? It's really for smaller firms. And then they can, you can provide pieces of the puzzle to them almost à la carte, it sounds like. Bigger firms will come to you and hire you for full, full boat of services. Is that correct?

Michael: That's exactly right, Melissa. So, we set up the marketplace, which is the name of our exchange, specifically with the firm of $2 million in revenue and under in mind as a value-oriented, cost-effective means of transacting. We've set it up that way for a variety of reasons. So first of all, when you deal with a conventional business broker, they may ask you for, let's say, we need $25,000 to get started for you, marketing the firm, doing all the stuff we need to do to prepare it to market, etc.

And then that arrangement will be exclusive. So, you know, wherever your buyer happens to come from, we're still getting paid our fee. And then they'll get 10 to 13%, perhaps, of total deal value for the deal that happens. And it is full representation. And it and that might be suitable for certain candidates. We just don't find it very helpful for many candidates. And simply because that's a traditional representation from other service industry spaces. And many of which where deals will be all cash at close and buyer and seller won't have much to do with each other afterwards. We find more of a collaborative arrangement works seems to work a lot better with law firms. And so hence the exchange. You enter the exchange, you're not in an exclusive arrangement.

So you enter, and your fee is the greater of $5,000 or 1.5% of the seller's revenue. You know your fee going right into it. So if you're a million-dollar revenue law firm, your fee is going to be $15,000 at the end of the day for your sale. So it's a very transparent fee. We're not so we're there trying to get deal, we will help on an à la carte basis too, so that instead of paying this large sum of money to get your deal done, when you don't need us to do all the things.

So where we've taken ourselves out of, we're not chaperones to your dating anymore. We want you to date more. Have more conversations. Don't let my calendar dictate when you speak to a prospective buyer. By all means, speak to buyers there. And also, which may seem against our interest, also have conversations outside of our exchange. Have conversations at cocktail parties, bar association meetings, etc.

We will still help that individual or that law firm owner get their deal done, whether we get a success fee from the exchange or not. And it's simply because we're an advisory first entity, which means we make a substantial amount of our fees through advising on deals, both deals that happen through the exchange and deals outside of the exchange. We work for uh I've been approached by law firm buyers that had nothing to do with The Law Practice Exchange that had their deal presented to them from another broker somewhere else, and they just pay us service fees to help consult on their deals. And so this way,

Melissa: That's smaller firms too that can that can be the case with a smaller firm.

Michael: Yes, absolutely. Yep.

Melissa: Okay. People that come to you, let's say they skip the marketplace, they're above a two-million-dollar firm. Which, is that a rule or that's just a guide? People can post there and be a part of the marketplace if they are higher than $2 million in revenue.

Michael: They can. So there's no restriction on, you know, entering the marketplace by revenue size. It's just what we find is that sellers, as they're as they become larger players, they generally want even more discretion and selectivity. So they don't… they want a chaperone. In other words, they want that chaperone today. They want us to be curating and vetting the date before the date actually happens, right?

They don't you know, we want to be bought by private equity, but, you know, we want to make sure it's private equity that's done these types of deals before, or, you know, we only want certain we want you to vet, like if it's another large, you know, if I'm a personal injury law firm, and I you have other personal injury law firm buyers, I want you to run them by me one by one before presenting me because there's sharp elbows in the market. So, so it's a it's a it's a degree of discretion and involvement, and they want us, they typically, the larger the firm is, the more they want our involvement on an ongoing basis in the deal at all times.

Melissa: Okay. Yep, that which makes sense. If you have thoughts or anything you can offer with, you know, often when you're hearing of buying and selling businesses, there is a multiple that's talked about that a lot of people hate talking about that are actually in the world.

So I imagine that's you as well, because it just varies so widely and you cannot just you can't really give a straight answer. But part of that, I think for education purposes for people listening, you know, if maybe you could explain the multiple, and I know a lot of times it's based off of EBITDA, but is that true also for a law firm or is it a real number for a law firm or most firms or is it actually, I don't know, EBIT, you know? I don't I don't know what to, I think I think people listening should hear about this and about these terms and about how to think about these things.

Michael: Yeah, great points. Um, and yes, the answer is yes, and yes. So, yes, we do, a lot of valuation is keyed off of an EBITDA figure, or, you know, given the somewhat more simplistic transactions, the two-million-dollar and below transactions, what we call true net. And the way we get at a true net or an adjusted net is by, you know, we, typically owners run a ton of things through their law firm for tax purposes, right? It makes their margins look a lot smaller than what they actually are. So we handle a lot of owner perks, costs that effectively a new owner will not will not be facing when they take over the business, right? And that adjusts the margin appropriately.

Two, we check to make sure that lawyers are actually taking a salary for the legal work that they do, and a lot of them do not. They're just we just draw. Well, that's not, you know, that's not your net then. What's left over is not your net. It's the net benefit to owner, and that's not what value is calculated on, net benefit to owner. It's calculated on true net.

So what we also do is we look for a market-based salary for any legal work that the owner is still doing, and many owners are still doing legal work. They haven't gotten to the stage where they've put themselves in the pure owner seat yet, and we adjust that, which will then shrink the margin. 

But once we get there, we generally can look at valuation multiples off of that figure. I guess the, you know, what is it? Well, there's there's textbooks out there that say the number is 3.5 times earnings, which is actually preposterous because I mentioned before that the guy dancing on the truck who, you know, does the PI stuff, that law firm, the revenue model is just completely different than the corporate law firm we talked about before or even the criminal law firm that we talked about before.

And so the multiples can vary pretty substantially. I think like for instance, and I'll give you the difference. So, like in the personal injury law firm space, right now, we're seeing multiples anywhere between like 2.5 and 4 times earnings. And I expect those multiples will get driven up because private equity is quite interested in and actively acquiring in the personal injury law firm space right now. And so I think the expectation is those multiples will get driven up as sales to private capital becomes more normalized.

In most other, you know, non-contingency type spaces, you're seeing multiples more of like in the 1 to sort of 3 times range, which can probably disappoint a bunch of your listeners, but yeah, you're not you're not this isn't you're not in the laundromat business, right? You're not in the HVAC business. This is, you know, it's hard to transfer the value of your law firm to a new owner. The easier you make it for a new owner to take over your practice, and you de-risk that transfer of goodwill, the more valuable you will make the law firm, which is I guess where you come in, Melissa. Like, you are making law firms more valuable because it will de-risk the sale for a purchaser.

Melissa: I mean, and the crazy thing is, and I think about a year ago, I talked about this on the podcast. It is about creating more value in the firm, um as an asset, but also that very thing gives you more freedom. So, every everybody wins. The value of the asset goes up, so you give yourself the opportunity to have a better exit, whatever that looks like, you know. But also in the meantime, you aren't grinding it out until you decide to make those steps into exit.

So it just seems like a, it's hard work. It's hard work to get yourself out of the center of everything, but it's work worth doing because, you know, who wants to just I mean, I don't know. We were talking about psychological stuff. So some people, to,o just want to grind it out till the end.

Michael: I was going to say this thing comes full circle to that. It's like their identity is gone. It's like, "Oh my god, I'm in a business role with free time. Like, what do I do?" I'm not practicing this super sexy area of law anymore.

Melissa: So funny. Okay, so 1 to 3 for firms that, well, basically are not PI and getting bought by private equity.

Michael: I mean, we have done law firm valuations for the over the last 14 years of our existence, and we've valued over 400 of them in that time. Where we come out, generally in terms of revenue, we come out anywhere between 0.45 and 0.95 annual revenue, and where we generally come out, I'm talking about just averages here, is anywhere between 1 and 3.5 times earnings.

We have done a significant amount of work in the personal injury law firm space um in the last few years and multiples are, you know, well-run personal injury law firms can easily command multiples of 3.5 to 4 if they're doing everything right. If they have the right margins, the right software, you know, the you know, the right case management software, there's KPIs, SOPs, all of the ability to measure performance of the firm, ability to press a button and see what the financial, you know, finances of the law firm are at any given time. Those have a lot of value and a lot of value for a new owner. So.

Melissa: Will you speak just to give a sentence or two on why, like for instance, when you say push a button and be able to see the finances at in any moment that you'd like to look and you get a full snapshot in a way that matters. Why is that important?

Michael: So first of all, when you're thinking about getting your business ready for sale and commanding value, you have to put yourself in the shoes of the new owner. It's like, do they come in and are they wading through paper documents, or do they come in and are they able to press the button and to see where things stand? And a lot of that comes out in our due diligence process with clients.

We have folks that want to sell, and we tell them, get ready, buckle up because, you know, when the PE guys come in and take a look at you, everything is going to be sliced and diced. And so front-loading that and getting all of those responsibilities taken care of prior to actually trying to effect of a sell will not only make your life a lot more pleasant in the sales process, but it'll also make your law firm more valuable because you can substantiate everything that you are saying about the firm rather than making someone wade through paper documents to get there. And so it also shows that you have a finger on the pulse of your firm, you know what's going on, and you really everything can be substantiated by numbers. And ultimately, that an investor buyer is looking for that, everything being substantiated by numbers.

Melissa: You know, you mentioned 1 to 3, maybe 1 to 3.5. Is there something about the three and a 3.5? how rare is that? And is the reason for whatever rarity you'd put on that to get there, is it something that is it luck, or it wasn't luck?

It's that they were pretty committed to getting all the things that you've mentioned, for example, right? SOPs, KPIs, the firm is run as a business. And, you know, there's other things, but is it a pipe dream for people to think, okay, I'm gonna I'm gonna get 3. I am going to get t3. I'm going to do all the work it takes to get 3. Is that the wrong way to do this, or is that a smart way to think about it?

Michael: No, that's the exact right way to think about this. And it and there's no dumb luck involved with this. Maybe it's dumb luck that you decide that you want to start a personal injury law firm, and that happens to be a very lucrative practice versus something else. But when you get to the like beyond for two firms that are in the same practice area, right, can look very different with valuation walkers. And I can tell you the one with effective processes, systems, and procedures in place, any day of the week is going to command more value than the one without them.

And so part of this is owner mindset. Does owner see themselves as lawyer first, and business is just it happens to be a business, or do they see themselves as business owner first and lawyering is one of the things they do as a business owner of the firm? That's one of their functions. And so it is a very different mindset. And I can tell you that there's a lot of lawyers that don't see themselves as business professionals. They see themselves as lawyers or what they think of traditionally as a lawyer.

Melissa: Yeah. No, that's true. Yeah. I mean, I feel lucky. The people that usually we end up working with, they're already on a good track of they've they've flipped out of just being a lawyer. Maybe we're their first step in doing that, but most of the time, they've been thinking in those ways, trying to chip away at things, and then we get to come in and help and hopefully speed that up for them just to start to get things organized and situated.

Is there an example that you could think of where look, on paper, they were doing everything right, but there was something about the firm that knocked it down in terms of the multiple or the value that they were going to get? 

Michael: Yeah. So, I mean, basically, you still need to keep, you know, you could have these KPIs and SOPs in place, but you still need to be doing all of the um conventional things to run a law firm. You still need to be doing those well as well. And when it's it's not like, oh, because I have these KPIs and SOPs and all these things, I can stop doing this other thing that's very important to a specific law firm to do. You need to keep doing that.

Like, no, you need to keep ad spending in order to get, you know, these clients in the door. You need to maintain that. You need to be doing these, you need to stay on top of that. You need to be looking at that and what the results are, right? Just because there's processes and systems in place, doesn't mean um that frees you up not to do those things that you were doing before. It's something that's uh added on top of that, I would say.

Melissa: Yeah, that's super interesting. We do have people that come to us that they just naturally get more business than just keeps coming. So they and they aren't spending on advertising at all. And it is interesting to think, you know, because they're they're try they're handling the growth. They are needing to adjust to the growth. There's things internally they have to do. Their processes need to be down. They're being very responsible and being a good a good steward of the business, which means taking good care of the clients and throttling if they need to, the people who are coming the new clients. 

But at some point, if they are interested, it sounds like, so tell me where I'm wrong. If they are interested in selling their firm, they are going to need to um focus on marketing, because it's going to be an important maybe yes, maybe there's some organic stuff happening that's enough for them. But if they want to sell, they're probably would be a good idea to actually focus on marketing and not just let it all roll in as it as it does. Is that true, or if they have enough history of organic growth, then they really they don't need to focus on marketing.

Michael: I would say they do need to focus on marketing. So we work with very profitable law firms, law firms that are more profitable than those that actually advertise. And the problem is that the means by which they get their um clients uh is sometimes um let's say concentrated referral sources, right? That's that's a big red flag for buyers when they come in and they're like, "Wow, you don't do any advertising or marketing, and that keeps your cost really low. That's great, but like and you have all these great clients, but you've gotten them through these five referral sources." And what happens when you leave?

Like, what happens to those referral sources, right? Like, like tell me I know things are really good. Like, you're riding this big gravy train right now of awesomeness. But what happens when you leave, right? Like, why haven't you done SEO? Why haven't you done PPC? Why haven't you done these other things?

And a lot of the answer is bandwidth. I haven't had enough staff. I haven't had enough attorneys to do all the work we have. And I think that's one of the biggest common denominators I have I get faced with clients right now is they're like, "Hey, things are really good. I have so much business. I just have never been able to be effective at making hires." And it's a shame that there aren't more effective talent solutions out there for these firms because they could be even more profitable and be doing a lot more revenue than what they currently are, but for the fact of not having um the ability to deploy talent to the new clients.

Melissa: I just appreciate you so much for being here today. I'd love to have you back on if you're willing. I have more questions in my head I was going to ask until I realized what time it was. 

Michael: I'd love to come back. I really enjoyed being here, and I really appreciate you having me on the show. I enjoyed all the questions. We live for this stuff at Law Practice Exchange, and it sounds like, you know, what you're doing for your clients has, you know, immeasurable impact because you are what's going to get them ready to be sold later on at values that will be attractive for the sellers and, you know, take care of their financial future and that of their families. So.

Melissa: Yeah. Well, that's my goal. And I, you know, I think I'd love to develop the relationship further and set our people up as best as we can and, you know, push them your way so that you can help.

Michael: Sure.

Melissa: Well, again, thank you for your time. And yeah, everyone listening, there's a we'll have him back, because I have lots more questions. Thank you.

Michael: Excellent. Thank you, Melissa. I appreciate you.

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