The number of business valuations involving private law practices has grown steadily in recent years. The two main types of situations calling for a law firm appraisal are these:
- Transactional such as the law practice sale, merger or spin-off.
- Legal controversy. The most common reason is divorce followed by partner disputes.
Given the rising volume of law firm valuations you may wonder: what are the methods best suited for private law practice appraisal?
Methods for law practice appraisal
Law firms are a prominent example of professional service companies. Given the relatively low levels of hard assets in a typical law practice, most valuations are generally done using a combination of market and income-based appraisal methods.
For smaller privately owned and operated law practices you can do market value comparisons based on the recent law practice selling prices. Such comparisons usually rely upon the valuation multiples that are based on the firm’s gross revenues.
This value assessment is then complemented by the income analysis using the well-known Multiple of Discretionary Earnings business valuation method.
For larger law firms, the preferred income-based valuation method is Discounted Cash Flow. This valuation technique focuses on the law practice cash flow given the acceptable level of investment risk which is represented by the discount rate.
This combination of the comparative market value analysis and discounted cash flow valuation is known as the First Chicago Method.
Law practice goodwill valuation
For established law firms the value of business goodwill may be a sizable part of the overall practice value. Consider using the highly respected Capitalized Excess Earnings method, also known as the Treasury Method. You can calculate the law practice goodwill based on the so-called excess earnings – those in excess of the fair return on the capital committed.