This article can be broken down into two sections. The first section is a brief overview of the effects of becoming a partner, and the second section is the practicalities.
The cost to you personally of becoming a partner of a law firm will be sleepless nights, very long hours, stressful situations dealing with colleagues, limited income for a period of time, and lots of hassle from the SRA (potentially).
I am guessing though that the person who asked this question was not actually referring to the physical costs of being a partner but rather the actual finance involved in joining the partnership of a law firm.
The usual cost of buying into a law firm is the price that the other partners put on the cost of purchasing a share of the equity.
Salaried partner – more of a title
It does not usually cost anything to become a salaried partner, other than the acceptance of quite a lot of stress and responsibility. A salaried partner has no link to the actual capital or profit of the business, but instead takes a salary and gets to call themselves a partner. In most cases there is very little relevance to being a salaried partner other than the street cred it gives you, but it does mean that the firm can inform lender panels for conveyancing that they have more than one partner, which can be a pre-requisite.
Fixed share partners have a specific share of the profits every year but don’t own the capital of the business.
Equity partners are the full version of a partner – they own the equity in the business and they are responsible for everything that goes on within it.
How much to spend?
The price of buying into a partnership is the figure everyone in the deal is comfortable with. There is no set way of defining the value. Quite often existing partners have very little idea as to the actual figures they should be quoting to someone looking to buy in. Some firms will use their accountant to work out what the current value is and then divide that by the percentage share the new partner will receive.
Consider the valuation
If you are that new partner, I would recommend not agreeing to this because in our experience, the vast majority of the time the figures the accountant will come up with may well be a fair and reasonable valuation of the practice, but in reality it will not be the figure the existing partners could get if they were to put the firm on the open market for sale.
We would usually recommend asking if you can get a valuation done based on current deals, which can be obtained (apologies for the shameless plug) from jonathanfagan.co.uk. Other providers are of course available.
The figures you will get for an accountancy valuation will be the figures they have managed to put together by using a formula which is usually something along the lines of 1-2 x net profit, or 3 x turnover divided by net profit etc.
Most partners will look at their accounts, speak to their accountants and then come up with a figure that is reflective of this. So, for example, if they come up with a figure of the practice being worth £300,000 and there are five partners, then they would probably expect a new partner taking over one of those existing partner spots to pay one fifth of the £300k by way of investing in the practice. This would then give you an equity share in the business of one fifth, which would mean that every year you would get one fifth of the profits either as dividend or drawings, depending on the firm’s structure.
This is the advantage of being an equity partner rather than a salaried partner, although if your firm is not making any money then being an equity partner is not really going to do very much for your bank balance.
You must insist on being able to check out the finances of a firm in full before you invest into it, and we usually recommend requesting a full set of accounts from the firm, and as much information as you can get hold of, including current salary structures of all the staff. I have heard of horror stories where existing partners have refused to release the accounts to potential partners, and this should set off a huge alarm bell.
Will I make a profit?
You need to essentially work out whether or not the practice is profitable, and use this to determine whether or not you want to invest. If a practice is running at a loss or at very little profit, then there is little merit in putting any money into it and you would probably be better off requesting a salaried partnership or staying as you are. If there is plenty of profit and it’s pretty obvious the partners have been drawing good amounts for a number of years, then it sounds like that would be the type of practice that you should definitely consider investing in.
Rather than have to stump up the whole cash payment up front, some firms will instead pay it by way of salary deductions over a period of time. This means that you do not then have to go out and find large amounts of money, but instead can have the amounts deducted from your salary and to buy into the practice effectively over a period of say three or five years. This then means that you don’t run the risk of having to borrow money in order to buy into the practice, but similarly it does leave you with a debt that has to be paid and ties you into that particular business. Yet again another reason you need to be absolutely sure that the practice is one that you want to be involved with, because as soon as you take partnership you are tied up with it over a substantial period of time.
If you would like assistance with any partnership proposals, details of a commercial finance adviser, or if you are a retiring or outgoing partner or somebody thinking about buying into a partnership, please give us a ring on 01824 780937 and we will be happy to assist.