By - Jeremiah Grant
Last Updated - March 14th, 2024 7:00 AM
Mar 14
Law firms are among the most valued businesses in the country, thanks to the consistent profitability they’ve been able to maintain. And this trend is only set to increase further as more businesses and individuals look to spend on legal services.
Now, if there’s one new normal that this boom has created in the legal industry, it’s the historic increase in sales, mergers, acquisitions, and investments.
For owners and partners at law firms this calls for one thing: You should be equipped with an up-to-date law firm valuation. After all, you never know when a big shot opportunity may arise for you to either cash in or scale up.
But you might have that one big question, i.e., how to value a law firm in the first place?
As someone who works closely with law firms and has valued multiple such businesses, I know one thing for sure: Law firms aren’t easy to value.
That said, valuing a legal business isn’t rocket science either, especially if you know which methods professional business appraisal services use and when.
So, read on as I’ve discussed the ins and outs of law firm valuations, along with my own expert tips.
Let’s start with the basics first, i.e., what law firm valuations are all about.
As you’d have figured out by now, valuing a law firm involves establishing its dollar value or fair market value. You can think of it as an amount that a willing buyer will readily pay to acquire your legal business.
Now, in order to determine this dollar value, business appraisers will follow various business valuation methods like asset valuation, cash flow estimation, earnings multiples, etc. You see, these are universally accepted valuation methods used across businesses and entities for accurate value estimation.
However, evaluating a legal enterprise can be entirely different from other businesses. That’s because, unlike other businesses where tangible assets, earnings, future projections, etc., are crucial, law firms are more about their goodwill, legal experience, accomplishments, etc., to name a few.
So, while valuing a law firm, I always factor in all these elements for an accurate value projection.
We will discuss more of this later. First, let’s understand how you can value a law firm.
Whether you’re planning expansions, considering investments, or preparing for sale, our specialization in law firm valuation will provide you tailored insights.
Now that you’re acquainted with the basics of law firm valuation, let’s shift focus on its practical aspect, i.e., how can you go about one such valuation.
For starters, valuing a law firm involves the same methods that are used to evaluate any other business. Take the asset-based valuation method, for instance, which is used across industries, including legal services.
Nevertheless, the valuation approach is different for law firms since business appraisal experts like myself look for the finer and more complex details.
For instance, even if a highly reputed law firm has a lesser number of clients presently, it is likely to acquire more clients in the future.
So, I will put a higher dollar value on such legal enterprises. After all, these details signal a higher value to buyers, investors, lenders, etc.
Curious about the different law firm valuation methods and their unique valuation approaches?
Well, continue reading as I’ve discussed how exactly I value a law firm accurately and how you can do the same.
If you’re acquainted with the how and about of business valuations, I am sure you already know about asset-based valuations.
But for those who don’t, an asset-based valuation determines the value of your business by calculating the total value of all its assets and subtracting this value from liabilities. Herein, business appraisers like myself will factor in all the assets that your business may own, including the intangible ones.
Talking about law firm valuations, an asset-based approach will factor in the value of all the assets that your legal enterprise might own. And this will include everything from tangible items like properties, furniture, and electronic gadgets and intangible items like trademarks, copyrights, patents, and goodwill.
How to value a law firm using the asset approach?
The math of asset-based valuation is very straightforward, and here’s what it looks like:
Value of all assets – Value of all liabilities = Net asset value
For instance, suppose the value of all your law firm’s assets combined is $6.9 million. Also, let’s assume its liabilities in the form of loans are $1.8 million.
In this case, the new asset value or fair market value of your law firm will be $5.1 million.
Another popular approach to valuing legal enterprises is the law firm valuation rule of thumb. In fact, this is one of the simplest and most reliable ways to evaluate a law firm since all you need is your business’s gross revenue from the last year.
You see, the rule of thumb approach takes your enterprise’s gross revenue and multiples it by an applicable multiple.
For instance, as per a Lawyerist Podcast, the multiple for law firms range anywhere between 0.5 and 3.0. And the exact multiple applicable to your law firm will depend on factors such as its location, size of clientele, demand for its niche, etc.
Now, let’s suppose that you own a corporate law firm which generated a gross revenue of $768,900 in the year 2023.
So, to determine the value of your firm using the rule of thumb approach, I’ll take a multiple of 2.3, given the high demand of corporate lawyers. Thereafter I’ll multiply the gross revenue of $768,900 with 2.3, thus deriving a valuation of $1,768,470.
Annual gross revenue x Applicable Multiple = Total business value
$768,900 x 2.3 = $1,768,470
#3. Valuing a law firm using discounted cash flow
For those of you who’ve just started a law firm and are stepping into the world of legal businesses, discounted cash flow is the perfect valuation method.
And this is for a simple reason: The method evaluates your business based on future revenue projections rather than present-day earnings. After all, like any new business, you likely lack a major cash flow at the moment.
So, how do you value a law firm with discounted cash flow?
Well, valuing a law firm using the discounted cash flow method is not complicated at all if you have the following information:
Your total upfront investment to open a law firm.
Discounted cash flow projection for the next five years.
For instance, let’s say you invested a total of $489,000 to start your law firm. This includes the cost of property lease, office furniture, trademark, staffing, etc., to name a few.
Similarly, going by the standard legal industry assumption, I can project a cash flow of $1,129,000 over a period of five years.
Now, if the operational cost of your legal enterprise is 31 percent of the projected cash flow, this will also be the discount rate. So, I’ll take this discount rate and discount it to the projected cash flow in order to obtain a discounted cash flow.
Total discount – 31 percent of $1,129,000 = $349,990
Lastly, to determine the fair market value of your business, I’ll take the discounted cash flow of $779,010 and subtract the upfront cost of $489,000. This will provide us with a valuation of $290,010.
Discounted cash flow – Initial investment = Fair market value
A yet another business valuation method that you can follow for your law firm is the market multiples method derived from comparable businesses. In fact, this is one of the most commonly used methods for businesses such as gas stations, trucking companies, car wash facilities, etc.
Herein, you need to first determine either the EBITDA ( earnings before interest, taxes, depreciation, and amortization) or the SDE (seller’s discretionary earnings) of your business. Thereafter, you can multiply the EBITDA or SDE with an applicable multiple, which is based on the value of recently sold comparable businesses.
But there’s a catch with market multiples
You see, when it comes to law firms, there are a couple of problems with market multiples that you should be aware of.
Firstly, law firms, notwithstanding their size, prefer to keep the total value of sales confidential. Moreover, even those who’ve acquired the business follow the same principle.
Secondly, the size, scale, and area of expertise differ for different law firms. So much so that it is difficult to find a comparable business that has sold in the last year.
Simply put, these factors make it nearly impossible for valuators like myself to find a relevant valuation multiple. And using an irrelevant multiple to value your firm can provide an inaccurate valuation.
As such, I suggest you do not use this method to evaluate your law firm.
Whether you’re planning expansions, considering investments, or preparing for sale, our specialization in law firm valuation will provide you tailored insights.
While the methods that we discussed provide a practical guide to law firm valuations, there are other nuances involved, too. And the most important of all is the general goodwill that your legal practice has in the public eye.
You can think of it as the brand value of your law firm, which will also influence its final valuation.
Herein, regardless of the method that I am following to value your law firm, my focus will be on the general goodwill your practice has generated over the years. This will include both the goodwill of your firm and the personal goodwill that you and your partners or colleagues have generated.
You see, a law firm’s goodwill is an essential intangible asset that determines its present and future earnings.
For instance, suppose you own a small law firm with a huge clientele. Here, it is your personal goodwill that brings more people despite the small size of the operation.
So, I will factor in your personal goodwill while valuing the firm.
Similarly, for large law firms like Kirkland & Ellis, it is the goodwill of the practice that matters. After all, they’re the biggest law firm in the country and are considered the best brand in the legal industry.
As you can see, law firm valuations are not complicated if you have the right data such as its revenue, earnings projection, asset value, etc.
For instance, all law firms are aware of their gross annual revenue. So, to know the value of your firm using the rule of thumb method, you can simply pick an applicable multiple and multiply it by the gross revenue.
At Arrowfish Consulting, we are seasoned valuation experts with specialized expertise in law firm valuations. Our valuations are backed by 200+ years of combined experience. In short, we’ve got your law firm’s valuation requirements covered.
Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.
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