Partner leaves law firm

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Partner leaves law firm

We advised a partner leaving a law firm.

The exit process negotiated

We were instructed by the partner, and as a result:

  • Negotiated a fair value for his share, based on the current valuations.
  • Resisted allegations of negligence thrown up in an attempt to reduce our client’s leverage.
  • Valued the goodwill in the firm, which increased the global valuation of our client’s share.

Partner leaves law firm

The partnership deed was very old. It lacked many provisions typically found in modern, well-drafted partnership agreements. The partnership deed was silent on how partners could be removed from the partnership. It contained no clause dealing with a return of capital when a partner left.

The problem with an outdated agreement

The partnership deed frustrated the six on-going partners. These six partners could not easily force our client to leave without dissolving the partnership. Dissolving the partnership was not commercially attractive.

Our client was head of a department. The partners had decided our client’s department was no longer a profitable activity. Our client accepted that he would leave. Resolution depended on the value placed on his partnership share.  We advised our client not to resign until the value was agreed.

Law firm valuation

Our challenge was to propose a method of valuing our client’s minority equity share upon which everyone could agree. The remaining partners engaged a specialist to advise them and negotiate on their behalf.

Valuing the share of a business

The partnership had enjoyed year on year profit. However, the previous year had been weaker than other years. Nevertheless, profitability had been regained during the current year.

Our client then instructed us to prepare a valuation. Our valuation accounted for multiple factors, e.g.

  • A historic review of profits, averaged out to dilute the one poor year, i.e. increase overall PEP;
  • The percentage of recurring fee income;
  • Cost-cutting measures recently implemented to improve profitability, we further outlined how cost-cutting could be exercised in the future;
  • Net margins in comparable law firms;
  • The likely value of goodwill.

Goodwill

Goodwill was the most valuable asset. However, goodwill was the most difficult asset to value, it was not apparent on the balance sheet.

We valued goodwill based on gross fees received, to which a multiplier was applied. The multiplier figure caused considerable negotiation. In effect, this figure dictated a large proportion of our client’s share value.

Defending negligence allegations

In these cases, it is fairly common: the ongoing partners attempted to undermine our client by raising allegations of negligence. Note:

  • These allegations had not been previously raised.
  • The ongoing partners tried to attribute bad business decisions, that were taken by the whole partnership, personally to our client.

We knew these tactics. We dealt with these allegations robustly. Our past experience enabled us to advise our client, that whilst stressful, such allegations must be ignored if they are unfounded.

Thanks to our advice, our client did not feel compelled to resign before concluding the share value negotiations.

Outcome

After a long period of negotiation, we achieved:

  • A capital payment for our client worth approximately four times his average annual earnings;
  • A 10% rate of capital gains tax, as it was a capital payment.

In addition to the lump sum payment, our client received full drawings for the period of negotiation.

A new legal partnership agreement

Our client secured a position with a new partnership. He asked us to review the LLP agreement. The new business was:

  • Structured as an alternative business structure (ABS); and
  • Regulated by the Solicitors Regulation Authority.

We took our client through the obligations he would inherit. We drew his attention to the risks he was taking on. This knowledge empowered our client to negotiate better terms right from the start of the new relationship.

A partnership is a relationship between individuals sharing a common view to profit. That view does not usually change, but the size, shape, and structure of the vehicle carrying on the activities will. We assess the true position upon an individual’s exit. Alex Kleanthous is a partner in the dispute resolution team at Gannons, and has extensive experience of acting for both the exiting partner, and those remaining in the business.