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Episode 72
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Practice Management and Business Skills
The Great Succession: The Decline of the Financial Harvester and Rise of the Legacy Leaver
Law as stated: 20 January 2023
What is this?
This episode was published and is accurate as at this date.
Succession Plus CEO Craig West returns to Hearsay to interrogate changes to the goals of exiting leaders and to ideate best practice for exiting firm partners.
Practice Management and Business Skills| What area(s) of law does this episode consider? | Exit strategies for business leaders and law firm partners. |
| Why is this topic relevant? | For those starting out in the legal profession the world seems wide open with possibility; lots of infrastructure is devoted to transitioning young law students into professionals. But the other end of the legal career spectrum is less well catered for and the possibilities can seem much fewer. Exit planning, or business succession, tends to be little more than an afterthought for many firm principals and business leaders. This episode looks at exit strategies, maximising returns from exit, and how to measure the success of an exit plan. |
| What are the main points? |
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| What are the practical takeaways? |
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| David Turner:
1:00 | Hello and welcome to Hearsay the Legal Podcast, a CPD podcast that allows Australian lawyers to earn their CPD points on the go and at a time that suits them. I’m your host David Turner. Hearsay the Legal Podcast is proudly supported by Lext Australia. Lext’s mission is to improve user experiences in the law and legal services and Hearsay the Legal Podcast is how we’re improving the experience of CPD. Hearsay The Legal Podcast first looked at succession for law firms back in 2020 in an interview with Craig Osborne from RMB Lawyers, and we’re revisiting the topic again today because succession for law firms continues to be a perennial problem. Exit planning and business succession tends to be a little more than an afterthought for many law firm founders and new principles of law firms. And the perception that the value of a law firm is often tied up in the client relationships with individual principles often leads to low valuations of law firms on exit or sale. Returning to the show today to talk to us about exit planning and succession for law firms is Craig West of Succession Plus. Today we’ll be looking at some different segments of the legal profession, including how to measure the success of an exit plan, how to maximise return on exit, and the impact of technology on the future of law firm sales. Craig, welcome back to Hearsay, the Legal podcast. |
| Craig West: | Thanks for having me. |
| DT: | If any of our listeners have heard your earlier episode, they might know a little bit about your career and your background and why you founded Succession Plus. But in case they haven’t, tell us a little bit about your journey to starting Succession Plus |
| CW:
2:00
3:00 | Yeah, sure. Look, I was an accountant in public practice. I worked with a lot of business owner clients. My practice was almost entirely business owner focused, and I saw during that period, lots of owners preparing for exit and what I actually saw was them not preparing for exit. Them ignoring it, leaving it too late. They made lots of mistakes around valuation. I saw people sell the business for less than what it was worth. I saw people sell to the wrong buyer. Take on hopeless terms in terms of earnouts and guarantees and warranties and so on, that actually cost them in the end a lot of money. And I really thought this whole question around succession and exit needed to be examined and there needed to be a process and a system that people could follow to actually successfully exit. Now, in doing that research, I found nothing. There was nothing around that actually did that. There was no structure or process in place. And a lot of people just – including advisors – bumbled their way through an exit, they got there in the end, but it wasn’t quite right. It wasn’t successful. It didn’t really get the outcome they wanted. So I went away and did a bit of study. I went to the States. I read everything I could find, exit planning’s actually a big profession over there. And so I joined up with a group called the Exit Planning Institute. I did their education program and then on the way back in the plane, literally it’s a 15 hour flight, so I had plenty of time. I actually documented what I thought was a step-by-step process to achieve a successful exit. At that point, I think I started with nine steps. It’s now 21 steps. It’s divided up into five stages, and it is literally a process from start to finish to exit a business. That’s what we use with our clients, I’m no longer doing accounting work. Whilst I’m still an accountant – you can’t get out of that. I’ve always been an accountant, I guess, now my business is purely focused on succession and exit planning. We’ve got 20 advisors around the country and we work with business owners specifically to help them do two things, maximise the value of their business and successfully exit whatever that looks like for them. |
| DT: | We’ll talk about what that means, what that looks like for them, and some of the different motivations that you might have on exit and some of the different goals you might have on exit a bit later. But first, I get the feeling, I know the answer to this question based on your previous one, but who needs an exit plan? |
| CW:
4:00 | Look, I think everybody that goes into business needs an exit plan. It’s a little bit ridiculous if you went and bought an investment property, but you had no prospect of ever selling it or getting out, no one would ever do that. But people go into business all the time without knowing what the exit looks like. And ultimately people go into business for all sorts of reasons. But ultimately it’s about building an asset. It’s about building equity in your business. Over time, yes, you’ll get an income on the way through. You’ll probably, hopefully pay yourself a salary and you’ll get some dividends. And overall though, it should be about building an equity value under that business, building an asset that at some future date you can sell and fund your retirement or do the next thing, or whatever it might be. I always tell people, Steve Covey Seven Habits of Successful People. Habit number two is: begin with the end in mind. So I reckon you shouldn’t go into a business without knowing what your exit strategy is going to be, and you should be working on it the whole time, all the way through. |
| DT: | It’s interesting you say that the goal is to build an asset. I think a lot of small business owners, and I’d say this especially of small professional services firms, tend to think about it as an activity rather than an asset. |
| CW: | Absolutely. |
| DT: | Really focused on the income rather than that kind of asset value. |
| CW: 5:00 | Yeah and we’ve worked with just over 800 clients since I started Succession Plus, so it’s 12 years. If I look at the most successful of those 800 clients, they have realised a substantial value for their business, treated it as an asset, worked on it as an asset and then developed it to a point where they could successfully exit that asset and realise that capital that’s ultimately what’s made them successful. You know that yes, they make money on the way through, and that’s important. You’ve got to do that. Otherwise you won’t be there to sell anything. But ultimately it’s about, treat it as an asset, build it up and successfully exit at some point. |
| DT: | Now you mentioned before that you help your clients achieve their goals for an exit plan, and of course maximising the capital gain on exit is not the only goal that you can have… |
| CW: | Correct. |
| DT: | … when exit planning, when you are meeting with a client to talk about how you are going to help them plan for their succession, what are some of the goals that you might talk about? |
| CW:
6:00
7:00
8:00 | Yeah, I think it’s a really interesting point. So what we are seeing now is a real change in the marketplace. Twenty years ago, people were focused on selling the business for maximum dollars to fund retirement, that was basically 99 out of a 100 clients. That’s what they wanted. That’s no longer the case. So I think two things have happened; that sort of financial focus – or financial harvest we call it – has changed a lot with baby boomers. If you think about most baby boomers in Australia, if they bought a house in the seventies in Sydney or Melbourne or wherever they live if they’ve been in business for 20 years and they’ve been making good money and taking out salary and dividends and investing it and so on, they’re probably already wealthy. They don’t need to sell the business to fund their retirement. Now, what that does is then change their focus from financial harvest to what I call legacy or stewardship type exit strategies. So we now get lots of clients come into us and their goals are not maximum dollars. Don’t get me wrong, they’re happy to take the money. If you sell it for X $10 million, happy to take it. But it’s not their main goal. Their main goal is things like, how do I look after my staff and hence employee share plans become interesting. And so people are changing their focus, so legacy becomes important. Now that could be legacy in the traditional sense of, I’ve built this business up and I want to pass it on to my two kids, or keep it in the family. So that’s one sort of legacy strategy, and that’s all about family business succession and how you manage that succession through family, which has got its own traps and trips and interesting sort of problems to deal with. But the other side of legacy might be people that want to look after their employees, people that want to look after their suppliers, their customers, people that are really focused on, I want the business to continue after I exit. That’s a real legacy. TIP: That body that Craig mentioned earlier is the Exit Planning Institute – a US-based group focused on the exit planning industry. The EPI, as it’s also known, conducted a survey of 128 business owners in the US, not the largest sample size but let’s work with it, and found that 47% of respondents to that survey expected to transition to some form of an internal buyer, whether that be a family member, an employee, management or partners and shareholders. Now, interestingly, 58% of respondents to that survey also expected to have some form of continuing role in the business after they exited. Essentially, strolling rather than running into retirement. Echoing Craig’s sentiment earlier, that same report also found that approximately half of the business owners who responded to that survey didn’t have an exit plan at all. What that means is the strategy and the plan has to be slightly different because success for them is not, “get me 10 million.” It’s; make sure the business continues for the next 10 years. I’ve got a client at the moment who literally said to me just two weeks ago, he said, I asked him, “what’s success look like? If we successfully achieve this exit, what does it look like for you?” And he said, “make sure my two sons don’t bugger it up” – those exact words. So what we’ve done there, it’s an interesting strategy because it is about an exit and he wants to get some money out of it, but he’s really focused on making sure the kids look after the business. So we’ve said, “okay, let’s go and recruit a general manager. Your sons can run it, but let’s put someone next to them with a bit of gray hair, a bit of experience whose only job is to make sure they don’t bugger it up, make sure that they’re safe and they’re not going to do something silly, or they’re not going to invest in something that’s going to waste a lot of money.” So for him he’s already got that outcome. We’ve recruited someone, he’s now looking at: who do we put in there and how to make sure that outcome is achieved. |
| DT: 9:00 | As a bit of an aside, what you just said reminded me of a case I worked on a few years ago. It was a litigation matter and it involved a family business with something like an 80 year history. |
| CW: | Yeah. Wow. |
| DT: | And while I was working on that matter, I heard a bit of a saying that with family businesses, the first generation builds it and the second generation grows it, and the third generation, as you say, buggers it up. |
| CW: | No, that’s right. |
| DT: | Is that something you tend to see a bit in your succession practice and you talked about family business succession as this kind of special category of succession planning really? What do you see as the unique aspects of family business planning? |
| CW:
10:00 | I think the biggest problem in a family business, and it’s probably every single client I’ve worked with in family business, is that people are wearing multiple hats. So if you think about a family business, you know the example I just gave you, Dad passing it on to his two sons. There’s obviously a Mum there somewhere. She doesn’t work in the business, but she’s a shareholder, so she’s got that hat on. Dad actually works in the business, he runs it, he’s the CEO, if you like. He’s the major shareholder. So he’s not only an employee. He’s a shareholder and he’s a member of the family. So he’s now got three hats on. And the decisions he might make as a family member might be different to the decision that he makes as a CEO. So therefore that creates quite complicated dynamics. I often ask them have you got a corporate governance structure? Have you got a board? “Yeah. Yeah. I talk to my wife over dinner about decisions all the time,” and you go “no, that’s not a board, that’s your wife, that’s a family.” Now you can have that conversation because that’s a shareholder conversation. You and your wife own the shares. You need to have that conversation. But it’s a different conversation to what you would have with an independent director, for example, on a board. So I think the biggest issue with family business is people are wearing multiple hats. Sometimes two or three. Those can always get confused and then the communication gets confused as well. Are you talking to me as the CEO, the shareholder, or a family member or all three? Because that becomes quite complicated. |
| DT: 11:00 | Now we’re here today to talk about succession for law firms. Law firms have, historically, not attracted very high purchase prices, relatively low multiples of EBITDA, for example on sale. Can you tell us a little bit about the returns on exit from a law firm or professional services firm compared to some other industries? |
| CW:
12:00
13:00
14:00 | I think the biggest problem for law firms and a lot of professional services firms is the value of that business is largely tied up in an individual. If you’ve got a two or three partner firm, then typically, people go and use a particular lawyer. They’re not loyal to the particular brand. If John Smith moves from XYZ law firm to ABC law firm, the clients will probably go with them. Now what that means is the underlying business itself doesn’t hold a lot of goodwill value. The lawyer themselves do. Now that’s a problem because in most other businesses, if you think about it, even if there is a key person in there, the loyalty’s actually often to the brand or the product, not to the individual. So the best thing law firms can do firstly, is recognise that. Now that problem’s universal to most professional services firms. And even lots of small businesses, they’re key person dependent, and that key person is normally the founder. So if you’ve got a business that’s entirely related to the founder, I often tell people, that’s actually not a business, that’s a job. And unless you’re a soccer player for Manchester United, you can’t sell your job. So it’s a real challenge for lawyers and other professionals to get their head around, how do I take that value away from me and make it about the firm? It’s about recruiting good people. It’s about bringing more people into the meetings with you. It’s about encouraging the client relationship not to be held by one person, but to be held by multiple people. And therefore, if that lawyer leaves, the chances are the client may not leave with them. The client may stay with the business, and then you’re creating some goodwill value. TIP: E-BIT-DA or EB-IT-DA or EBIT-D-A, there’s a little bit of controversy about the pronunciation, I fall into the E-BIT-DA camp if you’re at all interested, is a concept that might be familiar to you if you work in commercial law, especially in M&A. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation. It’s a way of measuring the performance of a business agnostic to the way it’s financed. For example, a business that’s financed primarily with bank debt might have a high EBITDA but low net profit because of all of those interest expenses. In the hands of another owner, however, who plans to finance the business primarily with equity or cash that they have on hand, it wouldn’t have those interest expenses and so it’s EBITDA, not net profit, that is the best measure of the underlying performance of the business – the business’ ability to turn its assets into income. A multiple of EBITDA is a very common way to value a business, including a law firm. It’s not the only way, however, some other valuation mathods used include net asset valuations and the super profits methods which we’ll hear a bit more about later in the show. Of course, the other method of valuing a business is net present value, forecasting all of the future cashflows of the business and then discounting them for their value in the present rather than the future. This might be the gold standard of valuing a business but isn’t always psossible if a reliable forecast can’t be made. |
| DT: | Tell me a little bit more about how we create goodwill value in a law firm particularly around creating that relationship with the firm as a whole or multiple lawyers in the firm rather than that single key contact because I think so many lawyers do have this fixed mindset about the value of their businesses and the value of their practices, that it really is a one-to-one relationship between the client and the lawyer. |
| CW:
15:00 | Yeah. And I think that’s always been the biggest trap. If you think about some more personal type relationships. So think about your dentist or think about your GP, it’s a personal relationship. I couldn’t care less what business my dentist worked for, what brand was on the door or anything else. I’m going to go with him, because I know him. I trust him. I’ve known him for 20 years. Therefore, there’s no value in that business other than that individual. Now, law firms are just an extension of that, but you see some law firms now starting to change that a lot. There’s lots of law firms now that are operating largely online, so there’s a bit of digital disruption there. That’s actually a good thing because I’m no longer relating to an individual. I don’t even know who’s answered that online. I need a shareholders agreement drafted up. I go in, I get it. It’s online. And I know a lot of lawyers aren’t in favor of this kind of practice, but it’s a really interesting model because I no longer have a relationship with an individual lawyer. I have a relationship with a brand, and I’ll stay with that brand if it works well. I don’t know who’s drafting the documents in the background. I’m not meant to know. So that’s a different type of relationship. My business, we’ve got a relationship with our lawyer. I know them well. I go out to lunch with them every now and then. We refer each other clients. I won’t change law firms. Now that’s – he owns that firm, so it’s a small firm. That’s a really good example though. Those guys, at some point, they’re my age. At some point in the next 10 years they’ll retire. What do I do then? Who do I go to? Then? It’s a really interesting problem to think about. |
| DT: | There’s almost a succession problem for the client there, isn’t it? |
| CW: 16:00 | Correct. Correct. In 10 years time when the two brothers actually, when they retire, I’m going to have to go, okay, now where do I go? Because they’re not there anymore. I know a couple of staff in their firm, but it’s a different thing. It’s a relationship driven thing. So I think the challenge for law firms, to come back to your question about goodwill value is to try and create goodwill value outside of one individual. Now that can be a problem, because it can be expensive, do you need two lawyers in every meeting with a client? No. One lawyer can do it. The ideal thing though is to have two lawyers so my relationship’s not with one, therefore it’s with the firm. But that’s expensive. Now I’ve got two people in the room charging me $500 an hour. I don’t know if I want that. |
| DT: | That’s right. |
| CW: | Is that a good outcome, maybe? I think law firms need to think about how they service clients and what the relationship looks like with the firm, not with an individual. |
| DT:
17:00 | Yeah, absolutely. And it’s interesting that you mentioned that digital disruption or that kind of software as a service approach to law delivering documents online, for example, or providing advice through digital channels because I think there’ll always be a place for that close relationship with your lawyer and there’ll always be a place for that bespoke work, but having a business line or a revenue that does involve an automated or digital approach to some of that more repeatable work. Does sound like a way to improve the goodwill value of your firm. And I think we know that subscription businesses, there are some law firms that operate on subscription models now, subscription businesses and software as a service businesses typically attract quite high multiples, don’t they? |
| CW: | Massive multiple compared to a law firm. It’s quite common to see multiples of five to eight times monthly recurring. So if you think about a subscription business where a law firm might bill, I don’t know, let’s say it’s $100,000 a month, that’s $1 million a year, right? Roughly. You are talking about a multiple there of $5 million, $8 million in value. Now, that’s much more than you would get for a law firm that builds $1 million in normal fees. It’s just way more. |
| DT: | What are the multiples that you usually see with law firms? Traditional law firm businesses? |
| CW: 18:00
19:00 | I think there’s a real change, a bit like accounting firms. It used to be the rule that dollar for dollar revenue was about what a law firm was worth or an accounting firm. Now banks are starting to focus on profitability, and they’re starting to focus on the types of, as you said, subscription recurring revenue is far more valuable. TIP: Now, putting a value on goodwill is really difficult. But one method to calculate goodwill that we’ve discussed a little bit earlier in the show is the super profits model and this is an appropriate model for the sale of relationship-driven businesses like accounting firms and, yes, law firms. Now, the super profits method calculates the value of goodwill in a business. It does that by first taking the actual average profit of the firm that’s up for sale and then deducting the normal or expected profit of a like business in the same industry. The difference is the so-called ‘super profit’. Goodwill is then the value of the super profit multiplied by a number of years that profit could be earned after the sale, a bit like an EBITDA multiple. Have we got clients, for example, on fixed monthly retainers? If you have that, your law firm’s more valuable than a firm that just does time-based billing. So it’s really about identifying what are the value drivers. In professional services and how do we actually get our law firm down that path? |
| DT: | Now, something that we talked about the last time you were on the show was employee share option plans and employee share option plans in small businesses that aren’t marketable that an employee share option plan can be a good way of selling down shares in a business that there’s not necessarily a market to sell. I guess what I’m asking, when it comes to law firm succession, who is your buyer? Because it can be difficult to find a buyer out in the open market, can’t it? What are some of the things that law firm principles can do to prepare their successor? |
| CW:
20:00 | Yeah, I think there’s sort of two levels of potential buyer for law firm. The obvious one is other law firms who are looking to grow. And there’s been a lot of consolidation in the industry already, and that’ll continue where you can buy either a particular client base or, set of fees basically you buy, or a particular niche. If you’ve got a small law firm that’s expert in a particular area, that might be a very attractive acquisition for a large firm. So that’s obviously one option. It’s basically a trade sale. The other option though, is to look more internally, and that’s where the employee share plan type stuff comes into play, where you’ve got employees that are probably, they’re interested buyers, as long as you’ve got enough time to implement it. One of the issues with an employee share plan, if you like, is it’s not a quick exit strategy. If you want to get out of your business in the next three months, employee share plan’s not going to work. |
| DT: | No. |
| CW: | But if you’ve got 10 years, if you’re smart enough to think, okay, I’m 50, let me start thinking about how I sell, maybe my employees would be an option. If I can find a way to help them fund it and buy in over time, that might work very well. Be a really good exit strategy. |
| DT: | You know that brings to mind the question of when you start planning for an exit, because it might be the case that if an employee share option plan is your exit strategy, then maybe it does take 10 years. When should a law firm principal start thinking about their exit? Is it the moment they become a principal? |
| CW: | Yeah, I think absolutely. I think all business owners should think about the exit strategy when they start. |
| DT: | As you said, start with the end in mind. |
| CW: 21:00 | Absolutely. Begin with the end in mind. You really should be starting to think about what you’re doing. If your goal is to build up an asset, then you have to have a strategy to get out of that asset or to turn that asset into cash at some point. And the earlier you start, the more options you have, the more time you’ve got to implement it, the more time you’ve got to pivot if something goes wrong. If you’re doing it in the middle of a GFC or COVID hits the year you want to sell, then you have to change that strategy. The more time you’ve got to make that happen, the better outcome you’ll get. |
| DT: | Certainly. So far we’ve really been talking about small law firms or at least implicitly we’ve been talking about small law firms, individual principles, law firms with four partners or so. But the equity principles in a very large law firm probably face similar exit challenges, don’t they? If not, in maximising their return then certainly in terms of achieving some of those other goals we talked about before, like making sure that their clients are well served, making sure that their employees or their staff continue to develop in their careers can you tell us a little bit about what principles in a much larger professional services business might think about it in terms of exit planning? |
| CW: 22:00 | Yeah, I think there’s a real issue there because I think a lot of the younger generation looking at that option of becoming an equity partner in a large firm and saying, “I don’t know if I want to do that, actually.” There’s a real change, where people are saying, “yeah, I’m not sure I want to work 70 hours a week and earn that much money and buy in and have a debt and do all that sort of stuff. I’m happy to just be an associate and earn this much money. And I’m going to work from home two days a week and I’m going to spend more time with my family.” And that’s actually changed quite dramatically. And I think that’s a real challenge for principals. I spoke to a firm a couple of months ago in Adelaide where there’s a couple of older principals and they are set on the fact that their practice is worth X and I’m going to get one of these young people to buy it. Now they’ve started that process. The reason they called me in is the young people, basically all as a group said, “no thank you.” |
| DT: | Wow. |
| CW: 23:00
24:00 | Blunt like that. No thanks. Not interested. That price is completely wrong, and even if it’s right, I’m not paying that. I’m not interested. So now the older principal is sitting there, 70 years old with a problem going, okay, now what do I do? His view was that was always going to be the succession strategy. I’m going to sell that for this much money to the young people that work with me because they’ll always want to become a partner. And I think that’s changed a lot. TIP: Now, just as the COVID-19 Pandemic changed people’s expectations of remote work for jobs which have limited proximity requirements, so too did it change perceptions and attitudes to work more generally – something we’ll touch on in just a moment. And closely related to this change in attitude was the so-called phenomenon of “quiet quitting” – the idea that to make more time for work-life balance, personal pursuits an projects, workers should do no more than the absolute minimum requirements of their jobs. But without even going that far, as Craig mentions, high performance workers are also not necessarily looking to repeat the journeys of those in positions of leadership today, preferring instead to pursue greater flexibility or work life balance or even their own side projects. So then you’ve got to get a little bit smarter, little bit more creative. Maybe you look at the employee share plan because maybe it’s not about one person becoming that partner. It’s about four. So you’re actually diversifying that across a broader group of employees. But I think as a business model, you know that traditional partnership succession role, not just in law firms, accounting firms have got the same problem. There’s a lot of accounting firms that have got large numbers of equity partners and younger people coming through and buying that, is not the option it used to be. It used to be a given, I worked in an accounting firm 30 years ago, that was the pathway. That was the obvious path. That’s what everybody did. It’s what had been happening for a hundred years. It’s changed now. That’s not going to happen anymore. |
| DT: | Yeah, absolutely. |
| CW: | So therefore you need a different plan because that plan’s not going to work. You need a plan B. |
| DT: | Certainly there’s definitely more young professionals choosing different paths. I wonder, do you think that creates a bit of a succession problem for these large professional services firms long term in the sense that there might not be that pipeline of partners to replace the current partnership. |
| CW: 25:00 | Yeah, absolutely. Look, I think there’ll always be some that will go ahead and go down that path, but I think that’s a gap. If you’ve got a 50 partner firm and you’ve only got 10 partners coming in, what are the other 40? It might be a 10 year problem because they’re not all going to retire at once, but there needs to be a pathway and a strategy. And again, as we said earlier employee share plan is one potential strategy, but that’s not always going to work. It’s not always the right solution for every firm. So I think they do need to think about what does that pathway look like |
| DT: | For sure because, there was a time not so long ago, when there were always more people vying for that partnership role than there were roles for partners. |
| CW: | Correct. |
| DT: | Much the same way that there were always more senior associate positions than there were roles for senior associates. And I suppose the shape of that pyramid is starting to change. |
| CW:
26:00 | Yeah, it is dramatically, and it’s not just in law, I think it’s in lots of other areas as well. Accounting firms are the obvious comparison. That’s starting to change, I think, people working from home and COVID has had some serious impact on people’s sort of career planning and pathway where, as I said, there are lots of people now that are quite happy. I spoke to someone the other day in an accounting firm, quite happy to work three days a week. Understands they will make less money, understands that means they’ll probably never become an equity partner. No issue at all. Very happy. Great person, brilliant accountant. And would ideally would love to be the right person to pick if you’re going to choose someone to succeed you as a partner. That option’s not there. |
| DT: | Yeah, absolutely. I think so many people have rethought, reexamined what they want out of a career as a consequence of this time we’ve had… |
| CW: | Correct. |
| DT: | … working from home, working in lockdown. Now as we said earlier, there are a number of different goals. An exiting principal might want to achieve, and only one of those is maximising return. Let’s start with that goal and then we’ll move on to some of the others. But if a law firm principal came to you today and said, “I really want to maximise my return when I sell my practice, I’m going to sell my practice in the next five to 10 years, and I want to get as much for it as I possibly can.” What’s the one thing that you would say to them now, do this? |
| CW: 27:00
28:00 | I think there’s a few things to say to them. The first one is in, the main one is treat it like an asset. People are very emotionally attached to their business. Particularly if you think about someone who’s been in a law firm for 30 years, maybe they founded it, maybe they started out with their mate from uni 30 years ago. It’s now built into a practice. They’re very emotionally invested in that, and therefore they make emotional decisions, not thinking decisions. And I often talk about the comparison. If you replace the carpet in your lounge room at home, you spend a lot of time, effort, and money working out which carpet you want. If I own an investment property 20 kilometers away and the real estate agent says you need to replace the carpet in the lounge room. That’s a ten second decision. No problems. Do it. Get something durable. But I don’t want to spend a stack of money. It’s easy, right? Because it’s an investment. I’m treating it unemotionally. Just make the business decision and get on with it. In our own businesses, we often don’t do that because we’re so emotionally invested. So the first thing is, treat it like an asset and start to make business thinking strategic decisions. The second thing is you’ve got to think about what makes that business attractive to a buyer. So in a law firm, clients and client relationships, can we change 50% of our clients onto a monthly retainer type type model? Now, if we can do that, that alone will make a substantial difference in value. Can we attract and lock in good people around us? Maybe we look at an employee’s share plan to do that, can we look at the definition of our services? Do we become a niche firm where we’re specialists in intellectual property law or some other area of law? There’s obviously a stack of them, but that also makes us more attractive. And then it’s the basic stuff that we tell every business owner. Systems, processes, policies and procedures, risk management. Make it as attractive as you can by getting all those basics right, systemisation, technology, all those things you can do to improve efficiency, all add value. |
| DT: | Often, those sorts of things, those business management tools are often overlooked. By professional services principals aren’t they? |
| CW:
29:00 | They’re often overlooked by all business owners, because let’s face it, you go into a law firm because you’re really good at the law. Not because you’re really good at running a business, and that goes for an air conditioning mechanic as well. They go in there because they’re good at air conditioning, not because they’re good at running a business or supervising 20 people. So I think you do either have to have a partner or partners in the firm who focus on that kind of stuff, how do we become more efficient? You see now a lot of the larger law firms are putting in place a CEO or a general manager who’s not a lawyer. But they know how to run a business. |
| DT: | Do you think there’s a place for the professional manager… |
| CW:
30:00
31:00 | Absolutely. If you look at businesses generally, there becomes a point where at a certain size you need someone that knows how to run that business. So you bring in a CEO. I run two businesses, Succession Plus and a software business called Capitalize. They’ve both got their own CEOs. Both of those people are better at running a business than I am because that’s what they do, right? One’s an engineer. So systems and processes, his thing, he loves it. I hate it. I couldn’t think of anything worse. But that’s why I’ve got him there because that’s what he does and he’s really good at it. And our business is at a size and a scale where that’s what it needs. It doesn’t need me out there doing what I do and generating new clients and doing marketing and doing podcasts like this and so on. It now needs someone to say, okay, that’s all cool. We’ve got it sorted. Let’s get the business systemised and processes and to make sure we can manage the growth that we’ve got. Now, law firms are exactly the same. Those people are in there because they’re really good lawyers. Doesn’t necessarily make them good managers. Some of them are and they can run their own firm. The problem is do they spend enough time doing that or do they spend their whole day practicing law? If they’re practicing law all day, they haven’t got time to be a manager. So that’s where maybe you want to bring in an external CEO or manager. TIP: Now, Australia had a slightly bumpy start to this trend. There was one large Australian law firm that notoriously fired its non-lawyer CEO, after she emailed a firm-wide apology to staff after it came to light that one of the firm’s partners was representing a client accused of historic sexual offences. Now, this kicked off a very public round of hand-wringing about whether non-lawyers in law firm management could possibly understand the ethical duties that lawyers held to their clients and the court. Now, while a handful of national Australian firms have non-lawyers as CEOs, most of those top positions in Australian law firms remain partner-in-charge. However, professionally trained accountants, MBAs and others, are increasingly working in senior management roles within law firms. |
| DT: | Training from years and years of legal practice is usually that if the client calls you, take the call, whatever you were doing before you put aside |
| CW: | You’ve gone into law because you like practicing the law, you might not necessarily like managing HR for 55 people, that’s not fun. So you know, that’s where you start to say, okay, either I’m going to go and manage the practice and I’ll become the CEO or the general manager and I won’t practice law. But if you actually really want to practice law, then practice law. Get someone in who loves doing the other stuff so they can do it for you. |
| DT: | Now we were just talking about the things that we would put in place if we wanted to maximise return on the sale of our law firm, implement processes and procedures adopt a niche specialisation… |
| CW: | Yep. |
| DT: 32:00 | … convert one off sources of revenue from clients to recurring sources of revenue, whether that’s retainers, whether that’s subscriptions. If that same principal came to you and said, “I’m independently wealthy. I’ve earned a lot of money in my many years of legal practice. The sale price I don’t care so much about, help me make sure that my clients will be looked after I leave.” What’s the advice that you would give to them? |
| CW: | It’s a different problem altogether and it’s then about, who’s going to manage those clients after you leave? And how well trained are they? Not so much in the law, we’re assuming they know what they’re doing, but how well trained are they in how you manage your clients and how you want them managed. And one of the greatest examples of that is in the sales. Now people don’t think of lawyers as salespeople, but we are, if you’re a lawyer in practice, you’re selling all the time. |
| DT: | Absolutely. Yeah. |
| CW:
33:00 | So the problem with that is that, I talked to principals of both law firms and accounting firms, and, I spoke to one not long ago, their principal sales I asked them about the CRM, their social media, their website, their Google ads, and they looked at me like I was some kind of lunatic. He said “no, no, no, no, no, our managing partner plays golf three times a week, and every time he plays golf, he brings in a new matter.” I go, “okay, that’s interesting. That’s sales.” But it’s not going to happen the day he stops playing golf. You are in big trouble. Yeah, it’s works well now. Cool. It’s that he’s having a great time playing golf and bringing in clients, but what happens when he stops? |
| DT: | It’s that very traditional. I think I heard it described by by someone as the finders, minders and grinders kind of mindset from 40 years ago. But that digital channel is often overlooked, isn’t it? |
| CW:
34:00 | Absolutely. And that’s a great example of something that we can do that will ensure the practice continues on. Where do the clients come from is a big question from a buyer’s point of view. Now if your answer is, all the buyers come from my personal network, my golf club, and whatever. You go that’s a bit of a problem actually because as soon as you stop I’m not getting any new clients, so we need to think about a sales and marketing engine, not just a partner who plays golf or does lunch or whatever they do. Now, I’m not saying you should stop doing that, if that works for you, keep doing it. But you’ve got to have a backup plan, where else do clients come from? Have you got, do you take other partners in the firm out to golf with you so that the relationship’s not just with you, it’s with other people, for example. There’s lots of things you can do, but I think you have to approach it from a very business sort of strategy. And again, that takes a lot of time. You can’t start that six months before you retire. This is a five year project to put absolutely that sort of stuff in place. So in terms of passing on clients and relationships, you’ve obviously got to get other people involved. Now, the problem with that is there’s a cost attached to that. So if one partner goes out and plays golf and picks up a client, that’s cool, but now you’ve got three people doing it at $800 an hour. That’s a very expensive game of golf. The firm’s looking at it saying, my God, I’ve got thousands of dollars an hour playing golf. Great. How does that help me? |
| DT: | Yeah. It’s interesting. We had another guest on the show recently, Demetrio Zema from Law Squared. They’re a firm that doesn’t use any kind of time-based billing, and he said that removing time-based, charging from your mindset, not measuring time in dollars is such an important step in enabling yourself to do things like that. |
| CW: | Absolutely. |
| DT: 35:00 | To invest in client relationships and to put in that time up front that you might not be able to charge for, because whatever you think in terms of that opportunity cost of, oh, I could have charged $800 for this hour. It’s always going to seem so unattractive to do it. |
| CW:
36:00 | Absolutely. We don’t have time sheets in my business. I’ve never had them since 2009. And look, I think it’s a very liberating thing to do, but you talk to some partners in law and accounting firm, they are terrified of that idea. How do I know what that person was doing on Thursday morning at 9:00 AM. Well, you don’t, clearly. But I think there is, that, that guest you were talking about, I think they’re absolutely right. Get rid of time sheets. Absolutely. And that therefore forces a bit of a change in how do I build people and what’s the relationship with the client look like? Is it project based fixed fee quoted up front, or is it a recurring retainer, which as I said, is more valuable. There’s an opportunity there to not only change the model and save yourself a lot of time and grief with bloody time sheets. I used to work in an accounting firm where time sheets were the bane of my existence. I used to hate it. Every Friday, the managing partner or the admin manager would be on my case, where’s your, you haven’t done time sheets for yesterday? And you go, oh my god. But I think there’s an opportunity not just to get rid of the time sheet, but to change the whole business model to say, is it fixed fees? It retainer? How do we actually make something that’s a bit more valuable? |
| DT: | Yeah, absolutely. That frustration with time sheets is definitely one that a lot of our listeners will will find familiar. And there are a lot of good reasons to move away from time-based billing in and of itself. But it sounds like it’s also quite a clever step towards a good succession plan. |
| CW: | Absolutely. If you can use it to change the revenue model with clients. Absolutely. It’s a great strategy. |
| DT: | Now something we’ve been talking about throughout our whole conversation really is key person risk. And some of the techniques used to manage that in a sale agreement might be conditions on the sale price, whether that’s an earnout. That might involve the seller remaining in the business for some period after ownership changes so that they can transition those client relationships over. But as you said, earnouts can be a little bit risky, can’t they? Can you tell us a little bit about what an earnout is and what our listeners should be looking out for if that’s proposed as part of a sale agreement? |
| CW: 37:00 | Yeah, and I think, there’s an easy way to avoid that and that is to plan early, so that it’s not about you have to stick around for two years after you sell to make sure the clients all transition. Imagine if you knew that the sale date was 2038 and that you started working now on transitioning all the clients. So by the time you get anywhere near that, there’s no issue at all, and you don’t need to stick around. That’s the first thing to do. Get rid of it altogether. The problem is with an earnout, there’s always going to be performance related metrics, whether it’s retention of clients, whether it’s the dollar billing that’s attached to the client base you’ve just sold, or whatever it might be. There’s always going to be risk in that. And you don’t hear many stories of earnouts being spectacularly successful, particularly from a seller’s point of the seller normally says, I ended up getting ripped off because, they did this, they did that, they changed the model. They overcharged my client and they left, and therefore I didn’t get paid the earnout because the client left the business even though it wasn’t my fault. |
| DT: | Such a common complaint, isn’t it? |
| CW: | That it’s always the case. |
| DT: | After I was not in a decision making role anymore, the buyer made a decision, right? Deprived me the earn out. |
| CW: 38:00 | They changed something and that deprived me of $100,00 or something, which is a really, it’s a negative way to do it. So I think ideal. Whatever the buyer’s concern is that they’re trying to protect by the earnout, as in retention of clients. Fix it before the sale. Have all your clients hand it over to someone else before the sale. There’s no discussion then about how do you retain them. |
| DT: | That’s such a good point because in that example where the earnout is designed to cure this issue about transitioning client relationships, all of that work can be done before the sale. |
| CW: | Absolutely. |
| DT: | The fact of that term existing is really indicative that we haven’t done the work. |
| CW: | We haven’t done the work. That’s exactly right. And it’s almost every term that you see in an earnout, whatever the terms are, it’s because that work wasn’t done before the sale, and it should have been. |
| DT: | It’s probably much the same as an earn out that’s conditional on one big key client staying around because we’ve got this revenue concentration problem that we could have solved early, again by diversifying our clients. |
| CW: | Exactly right. That’s part of the reason that you really need to start this three to five years before you exit, not six months. It’s not enough time to do that in that timeframe. You really need to make sure you’ve got enough time to make it happen. |
| DT: 39:00 | Something that I’m getting very clearly from you, Craig, is that you can’t plan for your exit one or two years out from doing that. You really have to do that over a longer period of time. We’ve talked about five years, ten years throughout the course of this episode, but one of the challenges with that is that working towards a goal over a decade, it can be quite difficult to know if you are moving towards that goal or if you’re moving towards it fast enough, or even if you’re moving away from it. So how do you think business owners and especially law firm principals can measure their progress towards their exit planning goals. |
| CW: | Yeah, I think there’s a couple of key things that you can do, and I’ll use my business as an example, so I’m still the largest shareholder by a reasonable sort of amount, but on our board meeting agenda, every meeting is succession and exit strategy. |
| DT: | Wow. |
| CW: 40:00 | Now I’m only 54, right? I’m not going anywhere anytime soon. But it’s on the agenda. Some meetings that’s a 10 minute conversation. Where are we at? What are you looking at? What have you done about this? Where’s that project up to? Who are we recruiting? Which, as I said, I appointed a CEO nine months ago. So that was a large conversation that went on for six months. We actually ended up appointing that person earlier than we thought. So they’re putting that on the agenda, for example, for a board or a partner’s meeting, it should always be on the agenda. And you should be starting to look at, okay, we’ve got six partners here, two of you are over 60, where are you at? What are you thinking? What’s it starting to look like? Have you done any preparation? |
| DT: | You are talking about succession and exit planning for everyone in the business. Really. Every employee. |
| CW:
41:00
42:00 | Absolutely. And so I think, making it top of mind by putting it on the agenda for a board meeting or a partner’s meeting is one step. Just start having the conversation regularly, because ultimately we’re all guilty of it. We’ll put that off and go, okay, I just said to you, I’m only 54, so I’m not worried about it yet. You got to start thinking about it now because at some point I’m going to want to exit. Therefore it’s got to be on the agenda and it’s got to be talked about. And we’ve got to start to have a bit of a plan. And I would hope and certainly the case in my business, my board would be saying, Craig, we need an exit strategy are you retiring at 55, 60 or 65? Because that makes a big difference, if you come back and said, I’m going to retire at 55, that’s 12 months away. Bloody hell. What are we going to do now? Secondly, I think you, you should be looking at monitoring and managing the goals of that exit plan. So if I said I want to retire at age 60, that’s six years away from me. And I want to get $10 million when I do. Okay, great. That’s cool. How? What has to happen between today and six years time for you to actually realise that? Is your equity worth 10 million today? Maybe not. How do you know? Let’s get a valuation done every year. So in my firm, we actually use our own software. I’m having a meeting this afternoon actually with my head analyst to go through our financials so he can produce a valuation, which is what we do for our clients. But I’m doing it for myself so I can look at it and say, okay, if you think you’re going to exit in six weeks time and get $10 million, you are kidding, because the firm’s not worth that. Or maybe I’m already there so I know that box can get a tick. So I think you have to have put it on the agenda regularly, review it, and use some tools so that you’re dealing with facts and research, not with garbage, not with your own inflated opinion of what the practice is worth. Or looking at it and saying, okay, we’re on the pathway to get to that valuation. What are the things we need to do to make sure we get there? |
| DT: | Now is your succession and exit planning on the agenda for your board meeting because the exit plan is an internal one that you want the employees and partners to come up and take over, or would you say that’s important to have on the board meeting agenda, even if your goal is an external one? |
| CW:
43:00 | Both. So I’ve got an employee share plan already in my practice. Most of my employees are already in it, but that’s probably not going to be our exit strategy. We’re probably going to sell externally. Now that’s easy to say, but there’s a lot of work to be done between today and that day when we do that, and my employees are involved in this as well. See, I just said I’ve literally got a meeting this afternoon to go through and update the valuation. So where are we at? Now, if you are an employee who’s in our employee share plan, that updated valuation is of interest to you as well. TIP: Now, Craig joined us on a recent episode of the podcast on the topic of Employee Share Option Plans. That episode is actually the one right before this one – Episode 71. Definitely check that one out if you’re keen to understand how Employee Share Option Plans work, how they can be used to attract and retain staff, and even how they can be relevant to law firms. So I’ll be sharing that with my staff. But if our strategy is to sell externally, there’s a lot of, we’re not ready to do that today. Buyer would come in, they won’t pay what we would like to be paid because our business is not ready for sale yet. Our CEO’s only been in place for six or eight months, so that’s the first point. We’re two years away at least to let that all evolve through and get me out of anything to do with day-to-day operation of the business. Now, we’re not there yet, but we’ve started down that path and I, my view is I don’t think we’re going to get there unless we constantly review it and look at it. That’s why it’s on the board agenda. How are we going? How much time is Craig still spending day to day in the operations of the business? If that answers more than zero, we’re not there. |
| DT: 44:00 | It sounds like from a project management perspective, planning for an exit’s a bit of a walk in the fog you don’t really know when you get there, and that’s why it’s so important to continually monitor it because you it’s difficult to tell exactly how far away you are from the goal. |
| CW: | Absolutely. And I think there’s a couple of things. We’ve got this 21 step process that we use with clients. So theoretically if I start at step one, two years later, I end up at step 21. We are ready. But some of those steps in the middle of that are things like unplanned events. So I can do all the planning I like, but if I get hit by a bus tomorrow, what happens then? Is that covered? Now in our case it is. We’ve got a shareholders agreement, we’ve got a buy seller grant, we’ve got insurance. It covers that. It’s all very clearly documented. But a lot of people don’t have that. |
| DT: | That’s right. |
| CW:
45:00 | Even a lot of lawyers, I can tell you because we work with some of them that just, I know. I haven’t got around to that. And I think that’s one of the big traps people in professional services are so busy “doing the doing”, servicing, clients, writing letters of advice, conducting litigation or whatever it is that you do in your practice. They don’t set aside time to work on this. So I think that’s one of the key things. That’s one of the reasons it’s on the board agenda because it makes me set time aside to actually go and do it. Otherwise, it’s not urgent. I’ll do it later. It’s not urgent for me. It’s not happening very soon. So therefore I can push it aside and go, I’ll work on something else. I think you need to make sure it’s a priority and I think it needs to be at the board or partner level that it’s actually discussed. There are law firms around that have got people that are 70 year old and no one’s talked about what the exit or succession plan is. Theoretically that person’s just going to keep working until they drop. That’s not a great strategy. |
| DT: | No. That’s not the sort of exit you want. |
| CW: | Exactly. |
| DT:
46:00 | It sounds like that if we were looking for an example of a professional services firm that’s done everything it can to maximise the return for its current owners by implementing some of the steps we’ve described throughout this episode, whether that’s creating products in the digital channel, creating software products, implementing an employee share option plan. Professionalising the leadership of the, of the firm. Moving away from the founder leadership to a CEO. And I should also say the recurring revenue aspect that so much of your revenue is recurring for the employee share option plans that you manage on behalf of clients. It sounds like Succession Plus is that professional services firm. Are there any other steps that you’ve taken? Is there anything else that you’ve done in your business that you think would be useful for law firm principles to know about as a way of maximising the return to them on sale? |
| CW: | Yeah. Look, I think the biggest lesson there is, and we are not there yet. Like I haven’t successfully exited yet, so we’re not a hundred percent of the way, but we’re well down the pathway. I think the biggest lesson is we practice what we preach. So if I tell clients, go and put a CEO in to run your business so it’s not dependent on you. I’ve done that. Now a lot of people won’t do that. You go and talk to people about putting a CEO in to run a law firm, let’s say there’ll be partners in that room that no way we’re not doing that. That, firstly that’s going to cost $200,000 that’s going to come out of my earnings. That’s not cool. So that’ll be the first argument. The second argument will be, it’s not a lawyer. How on earth can they run a law firm if they’re not a lawyer? I’ve heard people say that to you as well. |
| DT: | Oh yeah, I’ve heard that as well. I think it’s still a novel structure. It’s not a novel structure, but for many lawyers it’s seen as one. |
| CW: 47:00 | It is, yeah. Absolutely. So I think it’s really about, yes, we’ve done some things in our business or my business ready for succession. We’re not there yet. As I said, the CEO’s only been in place for months, not years. I’m still involved day to day in several parts of the business, far less than I was 12 months ago, but I’m still involved. So I think there’s some lessons in just following the process. We’ve got a process that we use with clients. We are using the same process with our own business, and I think that’s an important thing. It’s very easy for, I would say, without any doubt, the worst prepared industries for succession and exit are accountants and lawyers who should actually be the best, but they’re not. |
| DT: | It’s plumbers with leaky taps. |
| CW: | Absolutely. |
| DT: | We we spend a lot of time advising clients about these very issues and certainly seeing them operate in practice but we don’t often think about them for ourselves. Craig we’re nearly out of time, but if any of our listeners have heard this and decided that they want to learn a bit more about exit planning, either for themselves or for their clients, where can they go for some more information? |
| CW: 48:00 | I think the easiest place is just to go to our website there’s a stack of resources on there. There’s actually a white paper around succession for professional services firms which will be applicable for lawyers. It’s just www.succession.plus there’s a stack of resources there. And we’re happy to help. |
| DT: | Fantastic. And we’ll include the white paper in the further reading for this episode as well. |
| CW: | Yeah. Cool. |
| DT: | Craig, thanks so much for joining me on Hearsay. |
| CW: | Pleasure. Thanks for having me. |
| DT:
49:00 | As always, you’ve been listening to Hearsay the Legal Podcast. I’d like to thank our guest today, Craig West from Succession Plus for being on the show. Now, if you’re an Australian legal practitioner, you can claim one Continuing Professional Development point for listening to this episode. As you well know, whether an activity entitles you to claim a CPD unit is self-assessed but we suggest this episode entitles you to claim a practice management and skills point. Hearsay the Legal Podcast is brought to you by Lext Australia, a legal innovation company that makes the law easier to access and easier to practice and that includes your CPD. Finally, I’d like to ask you a favour. If you like Hearsay the Legal Podcast, please leave us a Google review. It helps other listeners to find us, and that means we can continue creating the great content that you love. Thanks for listening and we’ll see you on the next episode of Hearsay. |
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