1/14/13

What is the Market Value of a BigLaw Firm?

image [cc] KevinLouage
Answer: Zero

An old economics adage is that the value of anything is the price someone will pay to purchase it. Therefore the market value of any large law firm will be zero.

When valuing a company for a potential purchase, buyers will determine the various assets held by the target,along with their brand value, customer base and revenues. Depending on the type of industry, each factor will carry a different weight. However, revenue tends to carry the most weight since that factor has a direct monetary value. So how would a buyer value a large law firm?

Assets:
Office Equipment: Fire sale value
A/R: Maybe 75% of face value
(Although this reflects a hard value, the cost will equal the value and therefore it is just the purchase of receivables and not of a functioning firm. The only way this might have value to a buyer is if they think they can collect more than the firm would have.)
IP: Knowledge base is poorly organized and partially owned by clients. Knowledge assets walk out the door every night.
Offsetting Liabilities: Expensive long-term office leases. Possible short-term debt.

Brand:
A large firm’s brand may have some value, but since any one player owns such a small piece of the market, law firm brands are not that distinct. So the real brand value comes from being classified as an AmLaw 100 firm, versus the specific law firm brand. Most clients these days view a firm as Top Tier or not. So the brand has value only in that classification and not as a separately valuable commodity. Result: BigLaw brands will not have much, if any, market value

Customer Base:
Definite value here.
Problem #1: Per ethics rules, the firm does not own the relationship, the individual lawyers do and the client has full authority to move its business at will.
Problem #2: A customer base is specific to the individual partners, and therefore ‘owned’ by the individual to a greater degree than the firm. Therefore these are not easily transferred in a sale.

Revenue (or multiples of revenue):
Per the customer base note, revenues are tied to individual lawyers, so a buyer would be valuing the revenue based on whether the lawyers with the relationships will remain as part of the entity. And why would they? They were just bought-out of the partnership.

When valuing a business on multiples (or fractions) of annual revenue, an obvious issue is how sustainable is the revenue stream? If only a portion of annual revenue will recur year-over-year, then the multiple is reduced. The problem for large firms is that a significant portion of revenue is episodic. Large cases or mergers come and go. Therefore not much of the revenue is reproducible year-over-year on a per client basis. Typically, the on-going revenue comes from other clients having large matters appear. Accounting practices, in contrast, have very sustainable revenue, since much of the work they perform is recurring. This suggests firms that strive for Tier One work will suffer in a valuation, since Tier One work is episodic and only sustainable over a larger client base. Or in other words, BigLaw’s phobia towards ‘commodity’ work reduces their market value, since commodity work is typically repeatable and therefore sustainable.

So on a good day, the best valuation of a large law firm will be a shrinking portion of their annual revenue. I say shrinking, since the market is currently redefining Tier One work and the competition for that work is increasing significantly.

But all of this analysis is for naught. Even if you could determine a reasonable purchase value, the only potential buyers will be other law firms, since ethics rules (in the US) prohibit ownership by non-lawyers. And other law firms have no capital or a real ability to raise capital to make such a purchase. So back to our economics adage - there is no one willing or able to pay any price for a large law firm, therefore they are worth zero dollars in the market.

Imagine a company with a billion dollars in annual revenue having a market value of zero. This might be one reason why large firms struggle to act like a business.

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4 comments:

Doug Cornelius said...

The assets walk out the door every night. The firm hopes they come back the next day.

Craig Allen said...

My problem with this article is that it gets a value of Zero for the “market value” by citing the amount that would be paid by a class of investor that is prohibited from purchasing the firm. That such an investor would pay zero does not disprove that the BigLaw enterprise generates value much greater than Zero to its actual owners, its partners. It also does not support the indictment of BigLaw’s ability to “act like a business.”

Value is not just what someone will pay for an enterprise. Value in use equals the value of future net benefits over costs, discounted at the cost of capital. There are many aspects of a BigLaw firm that generate benefits to the owners greater than the costs.

While the author acknowledges that the market recognizes firms as being "Top Tier" he doesn't acknowledge the value in that distinction. Even if there is little differentiation between Top Tier firms, Top Tier status will command higher fees with less marketing effort from many clients - and that adds value to the BigLaw firm.

The author claims that commodity work adds more to firm value than episodic higher-value-added work. Yes, the multiple is higher for commodity work (it is less risky). However, the revenue side of the equation is higher for the high-value work (as it commands a premium). McDonald’s is a viable and profitable business, but so is the best restaurant in town.

The author says that the BigLaw firm’s most valuable assets walk out the door every night. That is true of Apple and Google too - yet the human resources of those firms generate great value for their owners. The ability to do interesting work, to work with expert colleagues and to be associated with the prestige of a BigLaw name attracts and retains those human assets even in the absence of contractual ownership.

DredLaw.com said...

It is always a challenge to value a service business. In researching this recently I learned that lateral partners book of business is valued at approximately 1/2 of the annual revenue. Apparently, other lawyers understand that clients and cases may not follow the partner. They may stay with a junior partner or the associate who has actually been doing the work!

Anonymous said...

How does one explain the fact that FTI, Goldman Sachs and probably others had much the same attributes of a law firm and have gone public with stock trading to all who care to own a piece of the equity?

 

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