Partner Buyouts: How to Determine a Fair Multiple for Your Firm

One of the biggest hurdles in succession planning is figuring out a fair valuation multiple for the equity buy-in, or buyout. This can be tricky for everyone involved, especially when it comes to niche markets like law firms, where the usual valuation methods don’t always fit. Getting an agreement on valuation and setting realistic expectations for both buyers and sellers is the first step to any partner succession plan.

Take, for example, a prominent law firm nearing the final stages of a merger where a partner is going to be bought out and another is going to roll into the new merged firm’s equity plan. They’re looking to pin down a fair multiple for their partner buyout provision. After the merger, their annual revenue is expected to hit $25 million and an EBITDA of $5 million (Earnings Before Interest, Taxes, Depreciation, and Amortization), with exciting plans for growth alone, or post-merger.

For firms this size, the typical valuation multiples are usually higher than other smaller firms and range between 3 to 4 times EBITDA. But this number isn’t set in stone and may be highly dependent on the type of practice, the nature of client relationships (and how secure they are in a merger), the funding and compensation structures of the merged firm, and others — so, it can shift depending on a variety of market factors that need to be carefully considered when structuring buyouts or mergers.

Here are a few of the factors that influence the valuation multiple.?

1. Market Maturity: Law firm M&A is still relatively new, with limited historical data compared to other industries. This creates uncertainty, making buyers cautious, which can sometimes lower valuation multiples.

2. Buyer Profile: Most buyers in this space are lawyers who tend to be more risk-averse. Many rely on self-funding or loans, which adds personal financial risks. As a result, they often look for higher returns, capping the multiples they're willing to pay.

3. Private Equity Interest: Private equity (PE) firms are slowly stepping into the law firm market, but they're cautious. PE investors want clear exit strategies, which can be tricky in the legal industry, making them selective and further limiting capital availability.

4. Funding Requirements: For larger law firms, securing private equity or family office funding is key. However, the pool of investors interested in law firms is still growing, so options may be limited for now.

5. Buyer Challenges: Even with solid financials, finding a well-funded buyer who understands the legal industry’s risks can be difficult.

6. Market Evolution: As the market matures, more deals and data will likely drive valuation multiples up over the next decade.

For law firms looking at mergers or buyouts, it’s important to understand the unique market dynamics to set realistic expectations. With market immaturity, cautious buyers, and limited capital, law firm valuations can be quite different from other industries. Working with a knowledgeable team that understands these factors is crucial for making sure both sides get a fair deal.

Do you have questions about mergers or buyouts? The LPE team can help! Click here to book an intro call and get the answers you need.?