Next exit

Many law firms have not given full consideration to the exit of their owners, planned or otherwise, and the impact this may have on the firm, as well as those left behind. This is an industry-wide problem, with small to medium-sized law firms affected the most.

The exiting owner has a right to exit the firm. The remaining staff need a strategy to follow that ensures a smooth transition in what could be a challenging period.

In this article, I look at how to plan succession effectively in your firm.

Why it matters

An ineffective plan can result in a number of issues.

The first is loss of staff. An unplanned exit which results in a dispute will quickly reverberate around the firm. The staff will know, and they could feel vulnerable, and split into political factions. If they feel threatened and that their security is at risk, they will look for alternative employment. This loss of staff will further damage the business. The firm’s reputation will also be at risk if employees begin to approach your competitors.

Make sure your firm has a clear path to equity

The second is loss of experience and knowledge. If the business doesn’t plan ahead, expertise and skills may vest in just one person, making them virtually irreplaceable. This issue is particularly common in smaller firms where owners have specialised, or the firm does not

have the need or finances for other staff in that specific area. This is a huge challenge, and the business may need to recruit two or more people to cover the deficit, which will put additional stress on finances.

Finally, failing to address succession and exit planning may constitute a breach of the mandatory principles of the Solicitors Regulation Authority (SRA) Handbook (principle 8 – run your business or carry out your role in the business effectively and in accordance with proper governance, and sound financial and risk management principles).

Effective succession planning culture

For succession planning to be effective, the culture must be appropriate and receptive. This means three things: openness, understanding, and planning.

Openness

When owners are honest about their intentions (which may change as time passes), the firm can plan and respond. From the outset, owners should discuss and be honest about their personal exit plans, requirements and expectations. It may be uncomfortable, but it will enable all the owners to understand the intentions of the others and plan for their eventual retirement.

However, it needs to be understood that each individual’s plans must remain fluid, as everyone has a right to change their mind or priorities.

Understanding

When discussing future plans, ensure everyone has a clear understanding of both the plans and their context. What is driving a decision, and what is the chance of this be coming a reality or being subject to change? What are the implications of an owner’s exit? What skills and experience will the firm lose if and when they leave? A full understanding and appreciation of the exiting owner’s plans will allow for detailed planning and the removal of surprises that could have a negative impact on the firm.

Planning

With understanding, a plan can be built. When a new firm is set up, these conversations should take place during the initial phases. This will be the easiest time to achieve a meeting of minds and agree a sensible plan. As a firm becomes more established, this becomes more complex. If you are in a firm that has not addressed succession and exiting, a plan should be implemented sooner rather than later.

In the rest of this article, I look at how to draw up effective succession plans.

What to address in your succession planning

The path to equity – internal and external

Make sure your firm has a clear path to equity, both for existing people and external appointments. This shows staff what they can do to elevate themselves, and provides them with an incentive for high performance. It also helps with retention, which is critical for success.

Include in your plan:

• the steps to follow in the firm (for example, trainee, associate, partner, senior partner, equity partner)
• any minimum periods expected at each step
• the technical skills, business skills and qualifications and training required
• what training the firm will provide, how and when
• when, why and how the firm will consider a new entrant to ownership
• the financial considerations of becoming an owner, what is involved and how the firm can help.

You should also establish a set of principles to ensure that any lateral hires are right for the firm. Unwinding from an equity appointment is a tumultuous journey. Making it clear what is required at entry will ensure both the firm and the entrant understand expectations. These principles should cover certain issues.

• How long must an individual have been with the firm before ownership is offered? If immediate, what are the conditions and expectations?
• If the individual is bringing clients or people with them, in what time frame are they expected to arrive? Are covenants likely to be breached? What are the implications of this?
• If financial targets are to be met, what are they and when should they be achieved?
• If there is a requirement to purchase equity, how much and on what terms?
• How does the partnership agreement provide for a new entrant, and will they be given advanced sight of the requirements and documents?
• In what circumstances would the firm not proceed in offering equity, and what would be the consequences of this?
• What are the expectations and requirements of new owners? How must they conduct themselves and represent the firm? What decision-making powers and corporate responsibility will they have?

Finally, you should think about business continuity following the exit.

l What would happen if a fee-earner or business developer with key relationships left? If the relationships were handed over to someone else, would the client have the confidence to stay?

• If an owner were moving to a new firm, what could be done to stop their clients following? Does your contract include a non-compete agreement?
• If owners had not discussed their future retirement plans, or retirement were brought forward prematurely due to illness or a change in circumstances, would the firm have time to find, recruit and train a replacement? What would happen if no replacement could be found, or internal staff were not ready or willing to become owners?
• What would happen if an exiting owner wanted to continue as a consultant without the risks of equity?

Financial planning

It is likely that a firm will expect any person seeking equity to provide a financial commitment to acquire shares. How will that be provided, and what support can the firm offer, either itself or through third-party funding? Would the firm be willing to consider salary sacrifice or will it expect the individual to raise the capital personally? Many banks and finance houses are willing to provide loans to an incoming equity owner, but what are the terms of such a loan and would the firm need to act as guarantor?

Funding in today’s financial environment can be a major issue or barrier to bringing people in as equity partners; all options must be fully investigated and addressed.

The plan also needs to consider the financial implications of the owner’s exit.

• What could happen if an exiting owner wishes to receive a monetary reward for the goodwill and value of the firm generated over the years? What could happen if the firm cannot meet that reward?
• If, as is likely, money was put into the firm to obtain equity, has that been protected in a high-interest saving account or (as often happens) has it been used as working capital? What is the state of the capital account? Could an exiting owner be owed more money than has been accumulated through the years?
• Does the firm use the money from a new entrant to pay out an exiting owner? If so, would a new entrant always be available and willing to invest money into the firm, and would that sum meet the requirements of the retiring owner?
• If it is the requirement for an owner to leave with only their capital account, has that been fully documented and understood?

Partnership agreement

Ensure the partnership or shareholders’ agreement has fully addressed the firm’s requirements when an owner exits. Importantly, revisit the agreement every two to three years, making sure it is up to date, relevant and keeps pace with the individuals and the firm. The agreement should typically cover the following questions:

• How is an owner removed and on what grounds?
• What is the impact on staff and clients when an individual is removed?
• What is the notice period, and is it sufficient? What are the restrictions and covenants? If there is a sudden or immediate exit, how will this be addressed?
• Are there to be special considerations for ‘founding owners’? For instance, can a founding owner be removed by a non-founding owner?
• What are the financial considerations – what is an exiting owner entitled to and when?
• Is consultancy an option after stepping down? If so, what terms will apply?
• What could happen if an owner wishes to reduce their hours or responsibilities?
• How will disputes be dealt with?

Regulation

If an exiting owner holds a regulatory position, will there be a qualified person available to step into the role? Does this leave a gap somewhere else in the firm?

Merger or sale

If your firm’s succession strategy involves merging with another firm or being taken over, do the owners want immediate value? Would they want an ownership status in the new firm, and if so, on what terms? A poorly planned engagement strategy will waste time and is likely to fail. Both sides of an acquisition or takeover will have requirements; these must be set out, discussed and agreed at the start of the process.

Closure

How will the firm approach closure? A law firm that is approaching closure may need to spend up to two years planning. There are significant financial consequences to be considered, the most notable being run-off cover. Other factors will need to be budgeted for too, such as redundancy, archiving, and closing or transferring client files. If closure is a long-term strategy, careful planning is essential, and the firm must consider the financial, regulatory and operational requirements.