A question of values
‘Business
as usual’ is not a phrase many of us have been lucky enough to use
for the last couple of years. The downturn has touched almost
everybody – including professional services firms. A fortunate few
have found a bit of minor cost-cutting has been enough to remain
stable, but many others have had to make much more fundamental
reappraisals of their operations.
A time-honoured way of bolstering weakness is to join forces with someone else to create a stronger entity, and there have indeed been noticeable amounts of M&A activity in the legal sector. But the announcements one sees in the press tend to mask a fraught process of negotiation, with many issues centring on the question of value.
It goes without saying that a purchaser wants to pay as little as possible for an asset, while a vendor wants to get as much as they can. This is where expert input can make all the difference.
‘One of the first things to consider would be goodwill,’ says Diane Elliott, Director of Share and Business Valuations at BDO. ‘Any firm looking to merge or be taken over wants to maximise and preserve the worth that its partners have worked to build up. So you would look to see whether the name of the firm retains any value either in its local region or in terms of specialism which could be distinguished from individuals in the business.
‘Goodwill can command a premium, but there are no hard and fast rules for determining it, so it will always come down to negotiation – and the buyer will, of course, want to keep this premium as low as possible.’
The second factor in valuing a firm is easier to quantify. ‘You look at its recurring fee base,’ Diane continues. ‘What types of ongoing business is the firm involved with? Does it have longstanding contract work with corporate clients, or a solid legal aid franchise which could be transferred to an acquiring entity? There’s a huge gulf between work that effectively comes into the firm automatically, and work that you have to go out and win each time, and any valuation will reflect this ‘
The final key factor is people – ultimately that’s where the value of a law firm usually lies. And you can’t sell people, as Diane points out. ‘There may be scope to transfer employees under TUPE,’ she says, ‘but what about the partners? Some may be really good, and others may have got the firm into difficulties in the first place. In any case, people can behave atypically in hard times – fixed assets are one thing, but the ongoing worth to the business of individuals is much harder to quantify, particularly if they are free to leave at any time.’
People who may not be on board with merger plans can also further complicate questions of value by, say, leaving and taking key clients with them, or setting up a rival firm. Employment issues are critical, and Diane notes that restrictive covenants and service agreements should be carefully considered when making plans involving personnel.
But many firms in merger situations don’t have the luxury of time to reach a fully thought-through and wholly satisfactory valuation. ‘When a firm is in dire straits, partners may need to do a deal in a limited window of opportunity,’ confirms Diane.
‘The further ahead that firms can plan, the better. There is a major difference between a carefully planned strategic merger and a last-ditch effort to save a business. That said, nothing is risk-free: you’re signalling possible vulnerability even by raising the subject of a merger, and once due diligence work begins then you’re opening your books to your rivals. The key is to stay as much in control of your own situation as you can, and not let things like short term cash flow problems drive long term decisions over your future.’
Interestingly though, and to end on a note of cautious optimism, BDO have been doing increasing amounts of valuation work on behalf of new partners entering partnerships. ‘There is actually quite a positive feeling in the market at the moment,’ Diane observes. ‘Although if someone comes on board promising you the earth, make sure they prove their own value before you commit to giving them a share of yours.’
Thankfully, that kind of value is more straightforward to pin down.
