What’s a law firm worth? with Bharat Kanodia

Episode Notes

Transcript

[00:00:00] 

[00:00:27] Bharat: Hi, Karen, how are you? Good to see you. I appreciate you having me on your show. Hopefully, uh, we both can make a fool of each other together.

[00:00:40] Karin: thank you so much for being here today. This is going to be a very interesting and valuable, uh, episode where we are going to talk about. Money and finances. And we’re the big question that we’re going to get to is what is a law firm worth? And I know this is something that you’ve talked about a lot.

[00:00:59] You’ve got a YouTube, a video on this. You’ve got some blog posts, so you’ve got, you’ve got the info. You’ve kind of gone through this exercise of figuring this out, but how did, how do you even start? Where does, where does a, a firm owner start with trying to figure out valuation on, uh, 

[00:01:21] Bharat: Yeah. The first question to ask is why would you need evaluation for, you know, nobody wakes up one morning and says, I’m going to get an appraisal today.

[00:01:30] I don’t get too many of those calls believe me or not. And that’s why I gotta be really charming. So this is me being charming. Um, most people need evaluation if they have some kind of a pending transaction. Okay. Or if the need to file taxes on their firm or their practice, um, or they’re under some kind of fee litigation, maybe getting a divorce or something under the rule of law.

[00:02:02] Yeah. Um, otherwise nobody says let’s get evaluation now. I do have a conflict of interest when I say this, but that does not mean I’m wrong. Everybody should be getting evaluation on a yearly basis. And that is because why do you get a report card at the end of the year after you’re done with school or a semester that tells you.

[00:02:27] So if you are an attorney or a partner at a law firm and you’re working 80 hours a week, or you’re making at least other people work 80 hours a week, um, you need to know that, Hey, have we really added value? Um, and you can only do that, not just by counting the billable hours or by the revenue you have made, um, by getting a valuation and believe it or not, just because you have made additional revenue this year, or your revenue is high.

[00:02:57] That directly does not translate into a high valuation. That’s what most attorneys think. And that is incorrect. 

[00:03:06] Karin: Okay. So let’s back up to the first part of your w your answer was, why do you even need evaluation? And my initial thought was none of those answers that you provided my initial thought was that they’re getting ready to sell the firm.

[00:03:21] And so they’re trying to figure out, okay. I, I I’m done. I feel like I either am done being a lawyer or maybe approaching retirement or ideally. You aren’t approaching retirement. You’ve kind of built it up. You’ve got this whole plan and you’ve, you’re at a great place in your career where you do want to sell it and then go on to whatever that next phase in your life is.

[00:03:44] And you have to figure out how much it’s worth. So, so that that’s another scenario where ideally, uh, law firm owners are planning for that and then trying to figure out, okay. What’s it worth. So, so wa so where do they start with that? And then what’s the difference between, like you said, the valuation and the kind of profitability profitability of, of that from 

[00:04:10] Bharat: great point.

[00:04:11] Um, so one of the reasons I said for evaluation as a pending transaction of some kind, now that could be. The thing that, Hey, they’re looking to sell the business in a law firms case, a partner buyout or transferring shares to a junior partners, or what have you some kind of a transition plan. It’s what.

[00:04:33] And when I say, just because you have revenue that does not necessarily mean profit or does that, that is not a one is to one equation to a higher valuation because in evaluation, I am looking for revenue. That is sticky. Okay. 

[00:04:50] Karin: What does that mean? 

[00:04:52] Bharat: So I am looking for revenue. From customers that write you checks on a monthly, weekly, quarterly basis, 

[00:05:01] Karin: recurring, 

[00:05:02] Bharat: recurring revenue, precisely.

[00:05:04] So in criminal defense attorney, that’s a hard practice attorney. That’s an easy practice to buy, um, a family attorney. That’s a hard practice about, you know, people, I mean, yeah. I mean, you might have some recurring customers, but you know, somebody can only get divorced twice, maybe thrice. I mean, if a lot of family problems like, okay, my God, um, you know, so, so in, in the law arena, um, this is most important because you know, some lawyers really do need to find new customers on a daily basis.

[00:05:44] Yeah, and that makes it difficult. Um, so practices that have recurring revenue. So say if you have a practice in venture capital or some kind of a corporate practice, those are fairly straightforward because it’s recurring revenue. Um, so law firms are usually valued anywhere between 0.5 to 1.2, five X on revenue and the spread between 0.5 and 1.2.

[00:06:13] Really varies on the stickiness of that revenue. So it’s a very, if it’s very sticky revenue, like a corporate practice, um, corporate practice also, you know, if it’s coming from say B2B clients or institutional clients, that’s very bad. Yeah. 

[00:06:29] Karin: So let’s say that you’re a new newish lawyer and you’re starting your firm and you’re thinking, okay, I down the road, I want this to be a ten-year plan.

[00:06:41] And so in 10 years, uh, I want, I want to be set up with a firm that is going to do one of those transactions you described. I’m either bringing up. Uh, partners, which I think actually that should be a shorter term plan. That’s maybe three to five years, or maybe in five to eight years. I’m um, can starting the process to sell the firm.

[00:07:05] So how do you get started with that? Uh, that kind of a thought process in terms of the way that you set up your firm to make sure that you have the numbers and that sticky factor that you’re talking about. In a more valuable way so that when, and I mean value in terms of valuation, not just kind of in terms of an adjective, but in terms of the actual numbers of evaluation of affirm, 

[00:07:33] Bharat: uh, great questions.

[00:07:35] So

[00:07:39] if you have, if your business model is set up in a way where you have the same customer writing, you check. Recurringly that, um, form or that business model is very valuable. Okay. So, um, say for example, a trademark attorney trademark attorney, um, might get paid on a per trademark basis, or they might have a, I dunno, minimal monthly fee of say a hundred bucks or 150 bucks to maintain that trademark.

[00:08:15] That 150 bucks a month on a dollar to dollar basis. Right? So say if the charges say, I don’t know, $3,000 for Wiley, the trademark and 150 bucks to maintaining the trademark from on a dollar to dollar basis at 150 on a monthly basis is far more valuable than the $3,000. That’s one time, 

[00:08:40] Karin: because it’s more of a higher lifetime.

[00:08:43] Correct. 

[00:08:43] Bharat: Yeah. It makes you that check on a monthly basis, no matter what. And a potential buyer is not going to look too kindly on that $3,000 because they probably never will see it. Right. It will look very, very kindly. Did I say very on that $150 on. 

[00:09:02] Karin: So if I’m following you, which I, I think I am this whole idea of subscription business models in terms of law firms, which it really seems to be the hot topic that most firms are trying to find a path into this.

[00:09:20] It’s not just because you have a better work-life balance, which you do. Like that’s a great, you know, bonus in that whole idea. You have a better kind of mental health, because you know, from one month to the next, you have a baseline of income that you can count on so that you don’t have to start from scratch on the first of every month, but long-term, you’ve got a much more solid and valuable foundation of this firm so that when you’re going to sell it, you have this idea of whether you’re going to take on project by project versus.

[00:09:56] Finding a way to monetize that client interaction as a subscription is, is the, the path forward that that’s what you have to focus on 

[00:10:05] Bharat: very much. So. 

[00:10:07] Karin: Yeah. Okay. So if you take that $3,000 transaction, and let’s say all the other guys down the road are doing that because that’s, that’s, you know, it’s a traditional way of doing, uh, uh, I’m going to stay with the patent attorney idea.

[00:10:20] Um, and then you break it up. And initially that initial transition between that, uh, upfront costs and then taking it as a monthly cost, it’s hard to get over that hurdle of. Of getting used to that feeling of those small bites instead of big chunks. Um, but then you have a longer interaction with that client 

[00:10:47] Bharat: very much, so very much.

[00:10:48] So you, you got to look at valuation from a potential buyers perspective, right? A potential buyer only wants to fix. Really only two things and people make this so complicated and they really do not need to. Um, and you know, somebody might say, oh no, they need three things. And only they need five things.

[00:11:09] All shit. They need two things and that’s it. If somebody tells you otherwise Coldwell chewed on them and those two things are one they want consistent. Is in recurring revenue, same customers paying you money on a monthly, weekly, quarterly basis. You don’t have to go out and hunt for a new customer daily, as you said, you don’t have to start over every month.

[00:11:34] Yeah. Secondly, they don’t want to do anything to service that customer. So if a nearby. Automate or have layers of management. There is a management are expensive, so automation is favored. Um, but in law firm, not everything can be automated. If everything could be automated, there would be no attorneys. Um, 

[00:12:00] Karin: imagine that world,

[00:12:05] Bharat: wait, who are you audience again?

[00:12:11] Now not everything can be automated, right? I mean, you know, if you have to write a brief, you can’t use, you know, software to write a brief. I mean, you know, maybe nowadays you can, but you still need somebody to 

[00:12:20] Karin: come again.

[00:12:24] Bharat: So start with what can be automated. You know, people always come back to me and say, hell no, no. I run a law firm. I run an accounting practice. This can’t be automated. Well, I understand not a hundred percent can be automated, right. Even a 7 47 running on autopilot still needs a captain or a pilot sitting on the seat watching what’s happening.

[00:12:43] So it’s still not a hundred percent auto. Um, so think about what can be automated start with those things. So simple things, the account receivables, payables, payroll, um, digital marketing, email solicitation, you know, sending birthday cards, greetings, you know, those things can be. With those and then move on to the bigger things.

[00:13:07] You know, don’t just start by saying, oh no, I’m too important for my business. My business can’t be automated because then you’re not really creating value. What you’re doing is you are creating a job for a new or a potential buyer, and nobody pays big money for a job. People paid big money for a business that gives them cashflow.

[00:13:28] Karin: So the summary in my mind is some kind of subscript. Some, some plan, some subscription plan that keeps your clients active and paying and automation, 

[00:13:42] Bharat: that’s it? Yeah. All layers of management that helps you service that business more efficiently. I shouldn’t say 

[00:13:51] Karin: more. Okay. But ideally automation, because it’s.

[00:13:56] Bharat: It’s far cheaper. Yes. In the a hundred bucks, 150 bucks, 200, even $500 a month on some software is so much cheaper than even hiring somebody in the 

[00:14:06] Karin: Philippines. Yeah, of course. Uh, okay. So then coming back to this idea of then how you figure out the worth and the value of a. So they started looking at, um, let’s assume you’ve done all these things.

[00:14:17] Well, you’ve got your subscription subscriptions. You’ve got your clients that are kind of on that recurring revenue model. You’ve automated as much as you can, and you’re getting ready to go sell the firm. And so how do you start to have some sense, uh, around how much it’s worth. When you’re looking at those subscriptions and you realize, okay, I’ve got a bunch of subscriptions.

[00:14:39] These are worth more than just these one-off clients that my neighbor has. How, how much more, how do I figure this out? Where’s the valuation? How do I, uh, put a dollar sign on this, to this guy over here who want, who might want. 

[00:14:54] Bharat: So a rule of thumb is your revenue is worth anywhere between 0.5 to 1.2, five X of your revenues.

[00:15:03] So say if it’s a dollar from your forum could be worth anywhere between half a million dollars to about 1.2, $5 million. Now that’s a pretty wide range. So, what I would do is if I were you as a quick and dirty calc, I would take all the customers or the revenue that’s on a recurring or a monthly basis.

[00:15:23] And put that in the one to 1.2, five bucket. Okay. All the one-off revenue ad hoc revenue, and put that in the 0.5 bucket. And then.

[00:15:38] Karin: That’s that’s the part that I feel like a lot of lawyers didn’t want to hear that there was going to be math involved, 

[00:15:44] Bharat: already business, but somebody has got it. 

[00:15:47] Karin: You just get a big calculator or you find somebody with a big calculator that can put the numbers in and hit the plus sign or the minus sign or whatever the case might be.

[00:15:59] Okay. So they’ve got this number and they’ve got this kind of valuation. And so does that, does it usually work out that way, where you present your valuation to the market? Um, is it kind of like listing a house where here’s the price we’re going for? Let’s throw this out to the market and see what happens or, or what comes next.

[00:16:21] Bharat: Um, great question. So, uh, you know, it is similar to, um, selling a house, but not entirely, but yeah, fairly close. So first thing they need to do, they need to have some kind of a range that, Hey, how, um, how much will I access? At the low point that if somebody offers me or what is the ideal number that I want, you know?

[00:16:44] So the range could vary anywhere between $200 and $50 million. Okay. Well, right. I mean, and then you come up with, um, you talked to a business broker who specializes in, um, selling law firms and you talk to them, or, you know, there are coaches who help special sell firms or. Partnerships within the firms.

[00:17:09] Um, and you talk to them that, Hey, this is what I’m thinking. This is what my evaluation is. What do you think this thing is worth? Or how much can you help me sell it for? And then you list your business. Okay. Biggest problem people have is they say, Hey, I can’t list my business. I don’t want my clients to know that I’m going to sell my book.

[00:17:27] Well guess what you’ll find plants are going to find out

[00:17:34] is going to have happen. 

[00:17:35] Karin: It’s like saying I don’t want people to know I’m pregnant. Like at some point it’s going to be visible. People are going to know 

[00:17:43] Bharat: that’s how this works. Right. You didn’t know. Th the only question is, do you want to be ahead of the ball or do you want to be chasing. Yeah. So it’s better to be ahead of the ball.

[00:17:53] You know, let the clients know, Hey, um, this is what I’m doing, but also tell them why. 

[00:18:00] Karin: Yeah. Yeah. That matters a lot. It’s not like we’re in a desperate situation. We’re trying to, you know, run from, you know, we’re just barely keeping it together before we go bankrupt. Um, because people assume the worst when, when they hear things like that.

[00:18:16] And as far as, um, when they, when you were talking to. Talking to a coach and kind of approaching them with your, your hopes for what your valuation is. Um, before we started recording, you were saying that you thought, uh, MBA was a waste of time. So I’m going to use my MBA phrases and we call that a BATNA.

[00:18:35] So you go in with your best alternative to a negotiated agreement. That’s the BATNA where you say here’s basically here’s my bottom. I’m not going to take anything below this, and it’s basically your plan. So you don’t walk into any kind of negotiation and, um, you know, and get swayed and kind of walk away thinking, oh, that was not what I wanted to have happen.

[00:19:00] So you figure out what your best alternative, you know, you have your hopes and then you have your BATNA and you go in and, um, figure out kind of what the market will bear. 

[00:19:12] Bharat: Yeah, and, and very much so. And you want to be very honest with the clients. Look, I’m trying to sell, because look, I’m 66 years old.

[00:19:20] I’m done. I have a few years of Manny. I want to send, to spend time with my daughter or my wife, or, you know, my mistress w what have you, right. Or, you know, you just say that look, um, you know, I want to go try something else. But you want to be ahead of the ball and also let the clients know that what the plan is, look, I’m going to transition to this new owner or this new partner, but I am still around.

[00:19:45] And guess what? We’ll be around. Nobody’s just going to take the keys of their truck and let you walk away and oblivion, right? Not like selling a house. Right? Many people think selling a farm or selling a business is like selling a house where you get to walk away instantaneous. Yeah, something, a business doesn’t work like that they will be some strings attached for at least a year or two.

[00:20:07] So that buyer or the new owner is, um, doing all that needs to be done or is aware of all that needs to be known about your business and your clients. Yeah. There’s some, uh, And there will be issues in client transition. There will be a need for knowledge transfer. There will be need for. Um, you know, working through staff attrition and all these things matter.

[00:20:38] And that’s why, you know, if you want to sell your firm for say $5 million, don’t expect somebody to just write you a check for $5 million 

[00:20:47] Karin: and have you go off to a beach somewhere. 

[00:20:49] Bharat: This is work like that. This is, you know, this is not the movies. You know, this is not a novel 

[00:20:55] Karin: well, and, and anyone who’s been through a merger acquisition, Knows what that feels like.

[00:21:01] And you’ve, you know, anyone, maybe you haven’t, but your cousin has, or, and you see that logical sequence of events. New company comes in, they get rid of some people, and then they keep on a bunch of the employees for that knowledge transfer. And those people I’ve been through a acquisition where I was kept on and it’s like, ah, I don’t know.

[00:21:26] I don’t know how I feel about this. Just kind of being here to kind of be milked for all of my value and then, and then be, you know, being dismissed after. So recognize that there’s, there are challenges in that whole thing, especially from a staffing perspective, it’s really complicated to make everybody feel okay about that because they all see the writing on the wall.

[00:21:50] When, you know, there’s, there’s people coming in, people going out, some people being laid off and, um, that whole process, but you have to maintain a certain level of the, the business for it to survive. 

[00:22:04] Bharat: Very much so, very, yeah. So, um, you know, so you’ll have some kind of employment contract and some kind of a earn-out that, Hey, you we’ll pay you a certain percentage off your price or the next two years, or, you know, whatever you have promised because you know, one thing I’ll always see in transactions is like, okay, today my revenue is a hundred dollars, but next year my revenue was going to be 150 bucks.

[00:22:30] I’m sending you 150 bucks and you know, buyer comes and say, okay, fine. I will give you you this money next year after you achieve the $150 avenue and then all hell breaks loose, like, oh my God, I can’t believe the guy said that he doesn’t trust me. I don’t want to sell my business to them. Like, okay, dude, just calm down.

[00:22:53] Wow. Seriously. I mean, you know, say your revenue is a hundred. And next year you say the revenue is going to be 150. Don’t you think the person should have. Healthy doubt. Right? All that person is going to get to 150. And they’re not saying you won’t and I won’t pay you for that. All they’re saying is I will pay you your price based on the 150 after you achieve 150.

[00:23:21] Right? Right. I don’t see anything unfair in. 

[00:23:24] Karin: Yeah, I’m just thinking of shark tank. Um, and I’m imagining a lawyer walking into the shark tank and that’s basically what we’re talking about. And, uh, lawyers walking in. You know, there’s the lawyer, his ego, his, you know, law school experience, like all of this stuff, that’s on his shoulders and he walks in and he’s got the sharks in front of him.

[00:23:51] And you I’ve watched enough shark tank to know that you can’t pitch them on future potential earnings. Cause no one you’re you’re you’re trying to predict the future. And so. 

[00:24:05] Bharat: Especially in a law firms case because it’s very difficult to scale. I mean, this is not like selling, you know, zoom subscriptions where you can go from a zero to a million in two days.

[00:24:17] You know, it’s difficult to scale billable time. You gotta add people, you got to hire people. You’ve got to train people, you know, it’s, that’s not 

[00:24:25] Karin: doable overnight. Yeah. So if you’re imagining that lawyer in the shark tank, uh, how is this different from that kind of a presentation when you’re thinking about selling that firm or your putting together that valuation and trying to present it to a potential.

[00:24:43] Bharat: Very different. As I said, scalability is very different. 

[00:24:46] Karin: Okay. So you have to think in terms of your staff and the kind of, all of those costs, I’ll 

[00:24:54] Bharat: give you an example. Um, few years ago, people were being hard on Elon Musk. Um, because the analysts on wall street were saying, well, they’re not growing fast.

[00:25:11] And I was laughing because that really explained to me how little the analysts know about the business. Elon Musk is in, um, Tesla is not a technology company. Tesla is a auto company and an auto company to make cars. They need factories. Yeah. Make factories. They need to acquire land. To build on that land.

[00:25:39] They need to work acquire permits. They need to acquire labor. They need to acquire material. They need to, um, lay down cement and founding and cement takes 48 hours to cure sometimes 24 hours. I mean, and there’s nothing wall street or U R I R Ilan can do about. And if these analysts are saying that they’re not scaling fast enough while they’re stupid, because they don’t know.

[00:26:12] So the same thing that if somebody says that a Yolo forum is not skating fast enough, that person has, is either not an attorney and doesn’t know how to a law firm works or has never run a professional services for. Um, you need to hire people and if you hire the wrong people, guess what’s going to happen to your professional services phone, right.

[00:26:34] Um, where are your biggest assets, you know, walk out and go home. All it every day. That’s. 

[00:26:40] Karin: Yeah. Yeah. And they get hit by buses and things happen. And then, you know, we have a global pandemic and all of a sudden everybody’s life goals change and they walk out the door and then they don’t come back or whatever the case might be.

[00:26:54] I mean, there are people, so it’s not just like a number on a spreadsheet. Um, so. So the, the big difference you’re kind of describing in terms of pitching to an investor, like the shark tank thing really just comes down to the people and the staffing and the, the kind of knowledge transfer and the knowledge base is where your value is.

[00:27:15] And so it’s hard to, uh, hard, it’s more, it’s difficult, difficult to put numbers on that and to it in the same way that they do for like a cupcake company that they do on shark tank or whatever. 

[00:27:29] Bharat: If you were to pitch your law firm to a shark tank, I would focus on two factors and those factors are how sticky is your current revenue that Hey, these clients write me a check on a monthly basis, no matter what.

[00:27:44] And second, how are you going to increase that sticky revenue using your reputation or whatever you want to use? Marketing, how are you going to make that sticky rice into more sticky rice? 

[00:28:06] Karin: Yeah. Big pot of sticky rice honesty. Okay, awesome. I think that’s super valuable. So, um, no smooth transition into our book review at this point, I feel like we’re just going to go jump right into it.

[00:28:20] So, uh, As you know, our audience is full of lawyers. And thank you so much for holding up your book so we can get the visual cue there. Um, so what’s the book that you just held up that you’re going to recommend to the audience? 

[00:28:34] Bharat: Never split the difference by Chris boss. And, uh, I, I like this book because, um, I have a very sensitive bullshit meter when somebody tells me.

[00:28:51] It gives me sermons. Caryn. You should do this. You can’t not do this when you go to China, speak Chinese. Oh fuck. Thanks for sure.

[00:29:05] Um, this book is no BS. These are all stories and these are all practical things that he talks about. Um, we’d um, you know, maybe a couple of nights after dinner you’re done. Um, so 

[00:29:19] Karin: that’s why giving you advice about like, what is, what does he mean by never split the difference? What is he, uh, kind of giving you the advice about kind of interactions?

[00:29:27] Bharat: Well, say for example, if you know, you’re selling your law firm and I’m a buyer and you’re saying a million dollars and I say half a million dollars and you know, most people will say, all right, fine, let’s split the difference. Let’s make any saying, don’t do that.

[00:29:45] Because there are better ways of negotiating. There are better ways of bringing people to your sides and he talks about those ways. And that’s what this book is giving you the how to, I mean, there are many books that tells you, you know, You know, like there’s sermons, it’s kind of like going to church.

[00:30:01] It’s like, you know, you do this, you do that. Well, nobody tells you how to talk to people. Or I only believe advisors or coaches who tell you the how to, because without that, Hey, I could be giving sermons all.

[00:30:18] Karin: Yeah. I always kind of question those guys who just feel like they could jump in and give you all that advice about a life that they they’ve only known for five minutes or, or maybe they don’t even know it at all. And it’s like, ah, I feel like that’s a little more complicated than that. Awesome. We 

[00:30:33] Bharat: will link to, I will tell you, right.

[00:30:35] Oh, um, Karen lose weight. Won’t get angry current. You should be kind to your sister. I know 

[00:30:45] Karin: how, right. Right. Okay, awesome. We will link to that book. That sounds like a great resource that has a lot of actionable tips and you know how to do all those things, not just don’t split the difference, how and why, and all of those things about, you know, all those up questions that are so important.

[00:31:05] Um, so brah, what’s one big takeaway that you would want listeners to get from this.

[00:31:12] Bharat: Um, the big takeaway is look for sticky revenue. 

[00:31:19] Karin: Yeah. Make a big pot of sticky rice, 

[00:31:23] Bharat: a lot of sticky rice and keep it and keep making more and more don’t. And most people, you know, are looking for that. Uh, Uh, balloon payment, right? Yeah. Don’t look for that balloon payment. Look for that recurring revenue type of 

[00:31:37] Karin: clients.

[00:31:38] Awesome. Berat Ken Odilia, which I have a hard time pronouncing is the founder and chief appraiser of very Strat the it’s a technology company, and we will link to your. Website your YouTube channel, the blog post about how to evaluate, how to evaluate a law firm and all of your social media accounts as well.

[00:32:02] So it brought, thanks so much for being here today. I really appreciate your time. 

[00:32:05]