A common question in recent times has been how to calculate net profit when working out the price of a law firm and in particular relating this to the situation where a seller is also working as a fee earner and taking drawings or dividend out of the business.
The key question is usually whether or not to deduct some or all of the drawings/dividend/salary of a partner or owner, and any family members, in the overall net profit calculation.
In terms of a valuation this needs to be adjusted according to the replacement value of the seller and any family members. This is because the vast majority of owners don’t take out an equivalent sum to the level that they would get if they were a normal fee earner in their role.
So, for example, if you have an owner of a law firm taking out £90,000 per year and they undertake conveyancing work and are head of conveyancing, then the calculation ought to be based on the estimated salary you would be paying a fee earner to undertake that work as a head of conveyancing and a conveyancing fee earner, which will probably be more around the £65,000 mark in most cases.
These are the sorts of figures that come up in law firm valuations which we undertake on a regular basis, but we don’t think you can simply deduct the money paid to the owner of the firm and expect to have an accurate figure.
It is an incredibly complicated calculation to make, because you do need an idea as to the sort of salary levels and payments that need to be made to a fee earner to replace the money paid to the owner. This is not a simple calculation to make, and one that you will probably need assistance with. Fortunately, we can provide that assistance through our valuation and deal structure reports, and if you require our help please get in touch.
However, we think it is wrong to include the money paid to the owner, simply because in law firms, the money paid to the owner rarely reflects the income they are generating.
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