Speaker 1: 0:00

Can you just kind of talk through high level how consumer, client oriented firms are valued? So, the very first thing, well, hello and welcome to the J Sterling Hughes show, where we share how we have built our family law firm from zero to 25 plus attorneys and 15 million in revenue all in the past 10 years, and my purpose here is to document what's working and what's not working, with hopes that you can take that and recontextualize it and have the firm of your dreams. My name is Jeff Hughes and I'm your host, and today I have a guest with me and we're going to be talking about how do you value family law firms for a sale. My guest is Richard James. Richard is the founder and CEO of your Practice Mastered and Partner Club, which my firm is a part of. We get a ton of value from that program and we've done another podcast on that.

Speaker 1: 0:46

Over the years, richard and his team have helped over 900 attorneys build and grow a sustainable predictable. The key there is predictable practice. He's also the author of four books on law firm marketing and business systems and someone that I've gone to for help whenever we've encountered problems that I wasn't familiar with and I wanted to draw on his expertise from looking at so many other firms and compare that to kind of how we are thinking about the problem. So welcome, richard. I'm looking forward to this podcast to hear more about how you value firms and how you've seen them valued.

Speaker 2: 1:16

Yeah, jeff, thanks so much and again, as always, congratulations to you and your success. I appreciate the love that you throw our way about helping you, but action kills fear and your firm is a firm that takes rapid action, there's no question. That's why you one of the key reasons why you're successful, you know, in addition to your intelligence and your hard work. But anyway, congratulations to you and to Jeff and your partners and all that you've built, because not only are you building a great firm, but I think that law firms do God's work and you're doing it at a very high level because you're helping people in some of the most difficult times. So, anyway, thanks to your communities that you serve.

Speaker 1: 1:50

Thank you, I believe that too, and I believe he's given us this business to steward for his kingdom, so we try to treat it that way. That's good Boy.

Speaker 2: 1:59

I feel like I fail every day at being a good steward, but I'm trying, boy, I'm trying.

Speaker 1: 2:04

That's our condition, isn't it Our human condition? You gave a really insightful, informative talk at our last conference with your practice master on valuation of firms. Now, this is not talked about a lot. It's hard to get good quality information on how law firms are valued and I would love to kind of turn you upside down and shake as much out as I can from your brain on this topic. So can you just kind of talk through high level how consumer client oriented firms are valued? In particular, me and my audience are, as you know, are interested in family law firms. That's where we sit. So what are your thoughts?

Speaker 2: 2:44

there, yeah. So first of all, thank you for the compliment on the presentations that was. My partner and I presented on that over the period of three hours, so we're going to do the best we can in 20 minutes to give you a high level of perspective, but I think we can do a good job. So the very first thing we have to understand from two basic premises. The first premise is you have to decide what type of law firm owner you are. So are you a level one law firm owner and you're going to keep it small and keep it all and you're going to maximize your profitability and you're going to take July and December off or whatever that looks like to you and you're just going to like? Your exit is going to be look something different than the level four investor. Who is the level four law firm owner? Who is investor, who is built as practice to the point where they no longer have to work in the business at all and they have a CEO running the business. And, of course, in between there is the manager level we call that law firm hell and then the third level is CEO level, and so understanding where you are and what you want to build is really important. And then, secondly, what does an exit look like for you as a law firm owner? And then, secondly, what does an exit look like for you as a law firm owner? Because there's a couple of options. You can die with your boots on and just once you're done, you're just going to close the practice, and that's an option, and many folks do that. The next is you could succeed it to somebody else and kind of just you're bringing up an associate and you're just going to mentor them and eventually they're going to take over and they're going to buy it from you at some level or some future pay out or whatever. And then there is this general idea that you're going to actually sell the practice. Right, and that's the other extreme In between those two. So, by the way, sell the practice means you're selling, you're exiting, you're at some point no longer involved.

Speaker 2: 4:20

In between the like, succeed it and sell it is this area that's called run it from the mountains and the beach. So you don't actually want to sell it, you're just going to let it run itself. Systems are going to run your law firm, people are going to run systems, and you're going to either go to the mountains or the beach and you're going to let everybody else kind of run the firm and you're just going to derive profits from it, and that's possible too. So you have to understand where you are and what you think you want. It doesn't matter which one of those you want.

Speaker 2: 4:48

Valuation fundamentally is the same, and the path to the valuation is going to get at all of you in any one of those four positions, exactly what it is you want, because the way we create more value in a law firm is to fundamentally create more cash. When we're selling a law firm, it's not like we're selling some SaaS company that can have negative cash flows and we're selling for future valuations. Because, a, that's not how law firms traditionally work and, b, because of the nature of law and the guidelines, there are no P companies or VC companies coming in and making agile investing, investing or acquisition at any high level, which means if we're going to sell the law firm, we have to figure out who we're going to sell it to, and those options currently are limited. They're there but they're limited, and so the liquidity of the market is going to affect all of this. You get that, I'm assuming.

Speaker 1: 5:42

Jeff, right, yeah, you've got to have a pool of buyers to drive the price up.

Speaker 2: 5:46

Yeah, yeah, the supply and demand curve is off right now because there's more supply than there is demand, not because there wouldn't be demand just because the law does not allow for there to be demand. Currently there are some players stepping up in this world and they're starting down this process of building some of this demand world, and they're starting down this process of building some of this demand. I'm watching it happen. I'm part of one of them myself, and so it's fun. It's fun to watch and I'm looking forward to the next 10 or 15 years. I feel like that's going to be my second mountain is watching all that unfold, and so I'm excited about that. But for now, when you're valuing a law firm, it really comes down to value drivers and value subtractors, and so, if I just go to the top of the page, like I have a whole worksheet for this. If you're interested in the worksheet, you can contact me outside of this podcast and I'll get it for you. But you obviously have it, jeff.

Speaker 1: 6:38

What's your email for folks to contact you on that, Richard? Like how would you get on Richard?

Speaker 2: 6:42

Jay at YourPpracticemastercom, richard Jay at yourpracticemastercom and my assistant will get it to you, but anyway, it's a worksheet that basically walks you through how to value a law firm from an attractor and a detractor perspective. So you start at the top with gross revenues and where your gross revenues are puts you in a certain threshold. So like, if you're under a million dollars or less, you're going to be automatically at a certain threshold of multiple. And what is a multiple? Well, and then we go to EBITDA right, or profit.

Speaker 2: 7:16

Said differently, owner's benefit is another way to make the statement. I'm not going to get too technical because we can't get to it right now, but just suffice it to say the amount of money that law firm makes. And so the way that law firms, any business, is fundamentally valued, traditionally speaking, is a multiple on EBITDA, not a multiple on revenue. Very rarely do any businesses get multiples on revenue. There are businesses who do, but they are typically in a tech space. In a traditional business model, it's a multiple on revenue. By the way, a great book on, just as a sidebar, richard Parker wrote a book called how to Buy a Good Business at a Great Price.

Speaker 1: 8:07

Highly recommend it. Hes, it's jsterlinghughescom and subscribe. It would mean the world to me and what I will do for you there is. I will send you weekly content to help you build and grow your practice, as well as news and developments in the greater world of family law. Thank you, and back to the show. Just for clarity's sake, so EBITDA is another word for our conversation for profit. So when you say EBITDA, you're talking profit. Okay.

Speaker 2: 8:32

If I say EBITDA or I say owner's benefit, I mean fundamentally the same thing. Okay, there are nuances that we don't have time to get into, but that's fundamentally what I mean. So for profit, we're going to have a multiple. Now the question is is how do you determine what the multiple should be? And that's where these we'll call them value drivers and value detractors come in. So, like a value driver is how much is revenue growing year after year? And then if it's growing nothing or less than 30%, it doesn't get much of a bump in valuation. If it's growing between 30 and 100%, it gets another bump in valuation. If it's more than 100%, it gets another bump in valuation. So growth does play a part in valuation, because a business that's acquiring your business is going to want to see growth. And then it's what is the percentage of profit to revenue? And if you're keeping less than 30%, then you get no bump. If you're keeping more than 30%, well then you get a bump in valuation. So you want to make sure you're as profitable as possible. So right there, if we just stop right there, a value driver is to have your firm growing and to maximize profitability. So if we grow and maximize profitability.

Speaker 2: 9:47

Regardless what level law firm owner you are, you're going to succeed. So the reason why this is so important to understand is because, even if your business intention isn't to sell your firm, understanding how to build your firm to sell means that you're building your firm to maximize profitability. Does that make sense? Yeah, and then it's future. Cash flow is another driver. So future cash flow means we're measuring and look.

Speaker 2: 10:12

Most law firm owners, to be clear, wake up broke every month. So family law attorneys wake up broke every month, which what I mean is you got to go get new business all the time. You don't have a family who purchases your services and is a client for two years, five years, 10 years, whatever. That's not how family law works. Although you all probably have one of those clients, you typically you have to go get a new client all the time and there's some sort of client value. So what is future cashflow? And future cashflow is like what is your future earnings on that case?

Speaker 2: 10:40

Because in a cash business, you have what you earned today from what they paid you as a retainer and what you build against it, and then they have what you think the case is valued at and how long it's going to take you to earn that money and being able to take all your cases and put it through that pool and go okay over time. It's going to take this long for these cases to work through. The cases are worth about this because we're putting this many hours or flat fee into it, and so my future cash forecast looks like this. It's a very important number to have as you're growing or managing a business, because if you don't know your future cash forecast, you can find yourself upside down really quickly, and so that's a main driver in valuation.

Speaker 2: 11:21

Then there's something called LTV to CAC ratio, which is basically what is your client acquisition cost and what is your lifetime client value and what does that ratio look like, and the higher that is, the more you get in valuation. And then there's deal structure and this is where really the rubber meets the road in a lot of firms. So you could take a $500,000 firm and they could be making $150,000 in profit, and in a traditional market they may be worth $250,000 or $300,000 because of their multiple, and they might think to themselves oh my gosh, that's just one or two years of profit. Why don't I just keep it open for one or two years and close the door. Three years and close the door. And yeah, that's an option.

Speaker 1: 11:54

I think that's what most of them do. Right, that's what most of them do. Yeah, yeah, yeah.

Speaker 2: 11:58

But if you're willing to take risks, so deal flow, deal structure means how much risk are you willing to take. So if you're a small law firm and you're a $500,000 firm and you're willing to say, listen, don't pay me anything today, but pay me out over time as a percentage of the future profits, well now you can set this valuation closer to $500,000 or $600,000 because you're taking the risk. So that's the extreme version of the risk. And so between the low version of the risk I sell you the firm and I leave tomorrow, I got fast exit and the high version of the risk hey, don't pay me a nickel and pay me out over time and I'm going to be part of the future deal Between those two extremes is where this sits. So again, one extreme is you're going to get a lower valuation. The other extreme is you get a much higher valuation. So deal structure has a lot to do with overall valuation.

Speaker 2: 12:45

Now the detractors are things like key man risk. Is it one person that is controlling the ship in some way, shape or form? And if it is, how do we deal with it? Is there a single channel risk? We get all of our business from one lead source, like the worst number in business is one. This is happening over and over again. So in key man risk and single channel risk, when you're starting to position your firm to actually sell, you want to diminish that risk. If you're not going to sell your firm, those risks aren't overwhelming, but there still are a risk.

Speaker 2: 13:15

And then systems risk. Do you have systems that run your law firm or do you rely on the knowledge that's in Betty's head or the knowledge that's in your head valuation and then do you have a data risk. Do you run your business by the numbers? Do you have a CEO scorecard that shows very clearly the key performance indicators of all the major numbers? And you have the data to support all of this so that you can point to somebody and show the truth about what's actually happening in your business.

Speaker 2: 13:48

And if you don't have data, then you have data risk. And if you have data risk then you reduce your valuation. So what you do is you take your gross revenues, you take your EBITDA, you take, based on those two numbers, what your actual valuation would be, based on a multiple, and then you add in your value drivers, you subtract out your value detractors and then you have your multiple at the bottom and what we did. This exercise with everybody in Partners Club and the sad truth was the vast majority of the members, despite their success from a cash flow perspective, were very unhappy with their overall multiple, and what this means is most law firms are worth a whole bunch less than what everybody thinks they're worth.

Speaker 1: 14:31

Yeah, so on these factors that are detractors or what'd you call them, ads or something I mean whatever you want to call them Adders, detractors it works right. Yep, okay. So do you in your formula? Do you put a formula or a percentage on each of these, like, okay, if you're the only person running the firm and you're retiring, that's key man risk, so you're marked down 20%, but you've got great yeah, so let's take your business You're 10 million plus.

Speaker 2: 14:59

So at the 10 million plus you automatically qualify for like a six-time multiple Of my profit. Six-time multiple of your profit, correct? So then you take revenue growth Well, are you growing at or below 30%? And then you get to add a point to that and so that would be one multiple point. But then if you have key man risk, you're like detracting three points. Like, if there's a major key man risk, it's a major detractor, right. And so if you have single channel risk, you detract a point. So what happens is you take your initial baseline multiple of six or whatever it is based on your revenue and profit size, and then you detract, you either add to that multiple or you subtract off that multiple.

Speaker 2: 15:39

I suspect, based on what I know about your practice, I suspect that you're somewhere in a seven to eight mark. That's my suspicion of you. Yeah, that's my suspicion based on what I know about your practice. I can't guarantee that. By the way, look, if we have more liquidity, more buyers, that value goes up. Like, by the way, this has happened to chiropractors, this has happened to dentists, this has happened to doctors, like all these professional practices that are out there, veterinarians, they have all their multiples. What happens is when the people who are going to buy them when the buyers enter the market, the what happens is when the people who are going to buy them when the buyers enter the market, the multiples skyrocket. Right, because there's this hunger for this, and so when this happens, there will be a massive opportunity to exit at a multiple higher than when it settles down. It's just a supply and demand curve, yeah.

Speaker 1: 16:29

We're not there yet. The dental model in particular is very instructive in this space. I've spent some time reading up on that. Oh, I completely agree.

Speaker 2: 16:36

I think that and I think, yeah, here's the difference. There is a difference. So, dental, veterinarian, those type of businesses, they have lifetime client values and clients stay with them for years. Yeah Right, that's the fundamental driving difference. So what the purchasers of law firms don't know yet that they will someday, is that there is not a lot the residual business. You always have to keep the marketing machine going. Here's the thing that currently allows law firms to succeed where these dental practices and veterinary hospitals and chiropractors don't, is that your CAC to LTV or LTV to CAC ratio. That ratio is very, very high in law firms. So, like healthy is five, I oftentimes see law firms LTV to CAC ratio as high as 15 or 20 or more, and so that is a.

Speaker 1: 17:32

So break that number down. I'm not catching that entirely. So if my long-term client value is $10,000 and it costs me $2,000 to get that client, that's a 5.1. Correct, right, you got it. That's five, okay. So obviously the higher the number the better, right, because you're Correct Okay. And the lower the number, the worse off you are. So you're spending five thousand to get to that ten thousand hour client. You don't have any money left over to service the client, so it doesn't work. Ok, all right, I interrupted you. Finish what your thoughts?

Speaker 2: 18:04

No, no. And we said we I preface this in the beginning like you and I could do two hours just on LTV to CAF, yeah.

Speaker 2: 18:13

Right Because how do you fix cost of acquisition? Well, everything we teach right. The whole PCLC and new client attraction pipeline right. How do you increase LTV? Well, it's about pricing and making sure we're getting paid and moving things through the pipelines, through the flow methodology that we teach. So that whole process of increasing LTV and decreasing CAC is a masterclass in and of itself. But generally speaking, you want to maximize your LTV to CAC ratio so that you can maximize your valuation.

Speaker 2: 18:46

But again, even if you don't plan on selling like, take Jonathan Breeden, he's not a firm of your size but he started off doing I don't know, I think Jonathan said publicly he did $30,000, $40,000 a month and now Jonathan is poised to have a multiple seven-figure year and he went from not knowing any of these things to applying all these things and taking his LTV to calculation, to where it is, and so he applied all of this.

Speaker 2: 19:12

Jonathan doesn't plan on selling his practice, but now he's able to have his practice. He's now the CEO of his law firm, has almost he only has, I think he has three cases left and makes, you know a lot of money every year as compared to what other people make or lawyers make for slugging away at doing the work, and so I can. We could read off example after example after example of people who don't expect to sell their firm, but use this framework to identify what they need to strengthen up, which pillar they need to strengthen up to allow them to maximize profitability and to allow them to raise the CEO or possibly even the investor level, so that their firm can operate without their daily input certainly as a lawyer and they can yield a high level of profitability. And that's really where we are right now, because we don't have a lot of liquidity in the market.

Speaker 1: 20:06

Richard, I know we have like two minutes left here, but I want to go down market where the majority of our listeners are sitting, and that's in that $500,000 to $1.5 million $2 million range. Again, every firm's different for all the reasons you just described. What are the general ranges and multiples someone could expect on a sale in that part of the market?

Speaker 2: 20:24

I think you'll get two times multiple if you want to stick around a little short period of time and exit. I think you can get a one-time multiple on gross revenues if you're willing to take some risk and hold some paper.

Speaker 1: 20:36

And I mean it typically looks like you stick around for two or three years and just make sure.

Speaker 2: 20:41

You might have to stick around and operate because they probably want you out of the way anyway. But you'll be the lawyer that they'll need as a backup. But then you'll hold the paper and get paid out over time, and usually that time is three to five years. So the longer you're willing to hold the paper, the higher the multiple. Yeah, and I would say you should expect the top side on that firm at one time multiple of gross revenues, right, regardless of what EBIT is, and if you just wanted to sell it and get out, you're looking at a two to 2.5 multiple.

Speaker 1: 21:09

On the profit.

Speaker 2: 21:10

On the profit, and that's, by the way, doesn't include any buildings that you own or anything like that. That's just the business, that, not including real estate.

Speaker 1: 21:16

Yeah Well, thank you, this has been real informative. I've I've appreciated, enjoyed it immensely. So if someone needs to get ahold of you, you, you want to give your email address one more time.

Speaker 2: 21:25

Yeah, it was the richardj at yourpracticemastercom. Visit us at yourpracticemastercom. Consume some of our free content. Schedule a call with us and see if we're the right fit. If you wanted a copy of that form that we talked about happy to give it to you Just email me. My assistant will get over to you. You can start filling out that calculator for yourself and have fun with it and hopefully you can see what your valuation is. And if you're disappointed, don't blame me. If you're disappointed in your valuation, don't blame me. Yeah, very good.

Speaker 1: 21:52

All right, thank you, richard. Thanks for coming on today. All right, jeff, it's always a pleasure.

Speaker 2: 21:57

Congratulations to you, to your success, to your family. Your success really is my joy. I've been fortunate that God has blessed me to the point I don't have to do this anymore, but I just I love watching you guys succeed, and so I love what your firm is doing. Congratulations and thanks, by the way, for helping everybody and putting this message out there to all those that are listening. I think it's what a great service to your fellow peers, especially in the family law realm, because many of them find themselves lost at times. So congratulations to you.

Speaker 1: 22:22

Thanks for that Awful lot of times. Thank you Appreciate it.