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Bar News - September 16, 2011


Succession Planning, Part I: Solos and First-Generation Law Firms

By:


William E Howell
 

Arthur G. Greene
If you are the founder of a solo practice or small law firm, chances are you think about the long-term future of your firm on a regular basis, yet the day-to-day demands keep you from taking steps to address it in any proactive fashion. Developing a plan is not as hard as you may imagine and the benefits from the effort spent are well worthwhile.

The goals of a succession plan should be (i) to make sure your clientsí on-going needs are well taken care of, (ii) to provide you with the flexibility to enjoy some personally rewarding retirement years, and (iii) to maximize the value you receive for the law practice you have built through years of hard work. It is only through a process of planning that begins well in advance of the time for the firm founderís retirement that these goals can be achieved.

First generation law firms are usually founded by lawyers who are both strong leaders and exceptional rainmakers. If the firm has grown over the years, the founderís focus in hiring additional lawyers has been for the purpose of servicing their clients and performing legal work, without succession in mind. As a result, the supporting lawyers frequently do not develop the skills necessary to generate business on their own and successfully lead the firm. Without a successor type lawyer in place, the retirement of the founder will challenge the very existence of the firm.

In this respect, every solo practitioner or small firm has a succession issue. Even those lawyers who say they love their work and have no plan to retire may be surprised to find that, over time, their feelings may change to, "I want to work when I want to work." Sometimes, this feeling can creep in unexpectedly. By the time most lawyers reach their sixth and seventh decades of life they no longer want the demands of a full time practice. In many cases, the future of their practice or their small law firm ends dismally, forced by immediate events, like illness, disability or death. Lack of any forethought in retirement planning results in some lawyers winding down their practices and closing the doors, an unfortunate finale to what could have been a lasting legacy.

Every founder of a solo practice or small firm needs to consider what they want for a retirement plan and whether the alternatives include transitioning the law practice to a hand-picked successor. Making the decision may seem daunting and implementing it may seem formidable. In many instances, this is the cause of inaction. But many who take the steps say they wish they had done it sooner.

The first thing to recognize about succession planning is that it is a process, not an event. If your firm has ever created a strategic plan or long range plan, the approach and work involved are similar. The process should begin at least five to ten years before the solo practitioner or founder of the firm intends to begin a transition. Identifying a successor and developing a step-by-step shift takes time. In most circumstances, if you are in your mid-50s, now is the time to set a plan in motion. Waiting until you reach 60 or 70 is waiting too long.

Elements of a Succession Plan

There are several aspects to a long range succession plan. They include:
  • Generational Spread of Partners - Some aspects of succession planning are pretty simple. For example, as you grow your firm, make sure you hire from different generations. You would be surprised to learn how many small firms grow by adding lawyers from the same generation as the founder and end up with all the partners in the same age group.

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  • Leadership Requirements - Rarely do we see a successful firm without strong leadership, which therefore becomes a critical succession planning issue. Some believe leaders are born, not developed. Others embrace the concept of leadership training. We wonít solve that debate, but the point to take away is that successful succession involves identifying or developing one or more effective leaders to succeed the founder.

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  • Management Responsibilities - Management is unlike leadership and involves different skills. Every law firm needs individuals who are organized and have the ability to carry out policies and effectively implement new plans. As firms grow, the majority of the management duties can be delegated to an office manager.

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  • Entrepreneurial Spirit - Lawyers who are founders of a small law firm have an entrepreneurial spirit. Without it, they would not have embarked on becoming business owners. Unless you focus on this factor in your recruiting process, you are likely to make hiring decisions that surround you with lawyers who are not and never will be entrepreneurial and therefore not the firmís successors.

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  • Transitioning Clients - Clients are not commodities that can be easily transferred from one lawyer to another. They are not like mortgages that can be transitioned from one lending institution to another, with minimal notice to the consumer. The lawyer/client relationship is intensely personal. The successful transition of clients to successor lawyers takes more effort than most lawyers appreciate.
These elements need to be part of a comprehensive plan that will include recruiting, training, career development and sharing of clients. For some the effort may seem burdensome, but for those who can implement such a plan the financial rewards and lifestyle benefits will be well worth the effort.

Alternative Approaches

Most small firms are unprepared when the founder wants to retire. At that point, what are the possibilities? Fortunately, there are still a number of approaches to take. For example:
  • Recruit a Successor - Solos and small firms with no apparent successor may consider engaging in a process to hand pick a successor. The successor can be an experienced younger lawyer that can be groomed to become the owner of the business. There would likely be a fast track to partnership and an exit strategy with an appropriate compensation arrangement for the retiring lawyer. This succession approach covers a five to ten year period.

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  • Merger - Solos and small firms can consider merging with another small law firm. This type of arrangement usually involves a two or three year period to execute. Often, the retiring lawyer is provided an Of Counsel arrangement with appropriate compensation and benefits. The duties of the Of Counsel may vary, but a critical component is continued involvement with the clients as matters are transitioned to one or more other lawyers. Experience has shown that some continuing involvement of the retiring lawyer is critical to the new firm retaining the clients.

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  • Acquisition by a Large Firm - Solo practitioners and small boutique firms with a highly specialized practice, strong revenues and a solid client base can be attractive to some large firms. There have been numerous instances where large firms have brought in successful solo practitioners and offered a mutually advantageous exit strategy for the solo. It must be noted, however, that only a few solos have practices that would produce the revenue necessary to be attractive to a large firm.

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  • Sale of a Law Practice - Rule 1.17 of the New Hampshire Rules of Professional Conduct now allows for the sale of a law practice, provided certain conditions are met. The Rule is of recent origin, so we have limited experience upon which to evaluate the effectiveness of a sale of a law practice, but for most solos an abrupt sale to a third party is fraught with problems, including client retention issues. As a result, the better course for a solo is entering a process of bringing in a successor and planning a transition over a comfortable period.
These approaches involve an analysis of the marketplace and identifying the most appropriate candidates for confidential inquiry. This process can identify firms that may have an interest, but, like so many lawyers, they are so caught up in day to day business that they havenít found the time to focus on what may be good ideas.

Advantages of Two-Tier Partnerships

The advent of two-tier partnerships came in the 1980s, at a time when many large firms found they had become partner heavy and, therefore, needed to slow the growth of partnership ranks. In recent years, more small firms have begun to adopt two-tier partnerships for different reasons. The primary advantage in small firms is that it allows for a gradual transition into partnership with the founder more easily maintaining control of the most critical decisions for a longer period of time. The time also allows for development of the younger partner.

Under a two-tiered partnership, the second tier is made up of non-equity partners (sometimes called "income partners") who are salaried, not responsible for firm debt, not required to buy-in, and they have no opportunity to share in the profits, except for the possibility of an employee-like merit bonus. While the more significant decisions are reserved for the equity partners, the firm can be structured so that the non-equity partners participate in practice management issues and other routine decisions required by the firm. It represents an internal distinction; to the community and client base, they are "partners." The non-equity status provides time to groom lawyers and prepare them for the responsibilities of ownership.

Compensation Issues

A proper succession plan requires the successful senior lawyer transitioning clients to younger lawyers three to five years prior to an anticipated retirement. For this to work, the firmís compensation system needs to be structured so that the senior partner is rewarded, not penalized, for sharing his clients with the next generation of lawyers. While compensation is a major hurdle, there are a number of techniques that have been employed by innovative firms to protect the compensation of senior partners during such a transition.

Creating Value

Financial considerations are always in the picture. How much value have you created? What is the value of the firm for the purposes of selling your ownership interest in the law firm? Valuing the law practice or the firm for purposes of selling an ownership interest to the next generation of lawyers is deferred and will be addressed in Part II of this article which will appear in the next issue of the New Hampshire Bar News.

Exit Plans

When it comes to structuring the exit plan, Of Counsel arrangements or consulting agreements are excellent vehicles for providing the retiring partner with a reduced role and appropriate compensation, based on a variety of factors which may include the value of the business being transitioned. Lawyers structuring such an arrangement have great flexibility. Only lack of planning will stand in the way of developing an innovative approach for succession from one generation to the next and creating for oneself a beneficial wind-down to retirement.

Conclusion

Succession planning involves several specific considerations, which every firm should address: 1. Making sure the ages of the firmís lawyers are balanced across more than one generation.

2. Making hiring decisions are based on the eventual future need for leaders and rainmakers.

3. Educating all lawyers in the business of law; that is, how the financial model works and what is necessary to attract clients and lead to financial success and stability.

4. Looking for opportunities to involve all lawyers in some aspect of management, in order to evaluate whether they have the skills to become future leaders of the firm.

5. Making sure the evaluation of the firmís lawyers includes contribution to the culture of the firm and its shared values, in order to reinforce the importance of those qualities in the future leaders of the firm.

6. Having a valuation process that can be employed to set a realistic value on the firm, for purposes of supporting the transfer of ownership interests in connection with the plan for succession.

7. Developing a client transition plan which involves the next generation of lawyers participating with the firmís most important clients, while protecting the more senior lawyers on issues of compensation and status.

But back to the critical point, which is that small firms and solos need to plan for the future. Make decisions about growing the firm and move beyond hiring for the short term. Instead, create a firm identity and an institutional approach. Address succession planning and have an exit strategy that will allow clients to continue to be well represented and, at the same time, will permit the founder or other senior lawyers to retire gracefully, achieving rewards for the value of the firm they have created.

Arthur G. Greene Consulting, LLC provides consulting services to law firms, with focus on the needs of small and mid-sized firms. He can be reached at agg@boyergreene.com.

Bill Howell, ASA, CPA/ABV/CFF provides business valuation services to closely held and family owned businesses. More information is available at
www.williamehowell-llc.com and he can be reached at billhowellcpa@comcast.net.

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