Succession planning: Creating a seamless strategy for personal injury practices

This article was produced in partnership with BridgePoint Financial

Stephen Pauwels, Co-Founder and Principal at BridgePoint Financial, sat down with Canadian Lawyer to discuss the unique challenges law firms face when it comes to succession planning, the trends he’s seeing in the space, and the role BridgePoint’s innovative solutions can play in smoothing out the transition process.

CL: How do legal practices differ from other businesses from a succession planning perspective? 

SP: One distinguishing feature affecting Canadian law firm succession planning is the regulatory restriction on alternative business structures, or ABS, which precludes ownership by non-lawyers. As a result, the options available to retiring lawyers looking to sell their practice to a third party are limited relative to other businesses. Having said that, we are starting to see foreign firms from jurisdictions where ABS are allowed, and who have access to broader capital sources, making investments in Canada.

CL: What other trends are you observing in the legal profession that affect succession planning for lawyers?

SP: Market consolidation is certainly happening in Canada.  Law firms, like any business, can benefit from economies of scale and the growth opportunities that mergers or acquisitions can offer. Merger activity has been quite active amongst the larger, full-service firms over the past decade as size very much matters in winning the major corporate business these firms covet. But we are now also witnessing consolidation within the litigation boutiques who have historically been more local or regional in focus. A few of the larger personal injury firms, for example, have now expanded across multiple provinces. Some have acquired an established local practice to gain an immediate foothold in the new market, while others have pursued a more organic expansion strategy. Either way, these firms have been able to leverage the large investments they’ve made in their systems, in professional management in some cases, and major marketing programs. There is also the benefit of market risk diversification as it pertains to provincial motor vehicle insurance legislation, which is a perennial lingering threat for these firms.                

CL: Are there differences in succession planning processes depending on the size of a firm?

SP: Succession arrangements for the full-service, multi-partner firms are much more formulaic. Each partner buys into the firm at the outset and holds their shares until retirement when they are re-acquired by the firm at or around book value. It’s a perpetual torch passing exercise that provides a stable capital base to the firm, if no meaningful upside to the partners for their investment. By contrast, smaller firms with one or few owners contend with the far more impactful change in control of the business upon succession. This involves finding a suitable successor(s), valuing the practice, managing inevitable cultural change, and often the largest in the process - financing the deal.     

CL: Can you elaborate on the financial challenges these boutiques typically face?

SP: Well, amongst other factors, the absence of a non-lawyer, third party buyer’s market means that most succession plans at boutique practices are internally oriented. That means the retiring owner typically sells his or her interest to continuing lawyer(s) from within the same firm, who may even be a family member. Whomever the succeeding lawyer(s) is, they are rarely in a position to write a cheque for the entire purchase price of the business. Bank financing, meanwhile, remains elusive when most required, and can’t be relied upon as a source of succession deal financing. In fact, the firm’s existing bank line is often secured by the personal guarantee of the departing owner, who will understandably be looking to take that with them when they go. As a result, the only option in many instances is for the retiring lawyer to finance the deal themselves by agreeing to staggered payments to the departing owner for years after they’ve left. It’s the legal market’s version of a vendor take-back mortgage, and not an optimal end result for an owner who in any other business would benefit from more immediate monetization opportunities.   

CL: Does the nature of the practice influence the financial challenges faced through the succession process?

SP: In my experience, the most significant financial challenges are faced by contingency practices, and not just relating to succession planning. Banks have no real appreciation or appetite for the contingency-based business model, as any plaintiff injury lawyer can attest, yet these firms require the most onerous capital commitments of any legal practice type. As a result, they rely on the owners’ continuously re-invested capital to weather their cash flow fluctuations, and to fund the significant disbursements on each client’s behalf. Many owners refer to this retained capital in the firm as their “nest egg” since it typically remains captive within the firm until their retirement. And even then, as noted, it can be a serious challenge to extricate.     

CL: What role can BridgePoint play in the planning process of practice transitions to alleviate these challenges?

SP: We have played an active role in many practice transitions over the years acting as both a matchmaker and a source of deal funding. We offer a much more satisfying solution than the status quo, vendor take-back financing. 

Most commonly, we finance most or all the disbursement portion of the buyout price. We also become the ongoing source of future disbursement funding for the firm. By relieving the new owners of this burden, we liberate the firm’s future fee revenue and bank credit for more productive business investments — for example, additional staff or marketing, or expediting any staggered payments owed to the prior practice owner.   

Our funding can be brought in to help close the succession deal, or pre-emptively well in advance of it. Practice owners who adopt our disbursement funding years before their succession can break the captive re-investment cycle and start the withdrawal (and enjoyment) of their “nest egg” that much sooner. Gradually replacing their disbursement capital for BridgePoint’s also lowers the eventual cheque size from the succeeding lawyer(s) — potentially broadening the candidate base and the vendor debt the departing owner would be forced to take back. It’s a win-win scenario.     

CL: Can you explain a bit more about how your services work, and the cost to the law firm?

SP: Our disbursement funding solutions are provided through two main vehicles. Our Expert Access program allows lawyers to obtain med/legal assessments from our broad network of medical, engineering, and financial expert partners across the country, deferring payment of the account until settlement. This alleviates what is typically the most onerous portion of the disbursement pie for any personal injury practice. Our complementing File Funder program is a dedicated source of financing for pretty much any other disbursement the firm would otherwise be carrying for their clients.    

There is no cost to the firm associated with the Expert Access program so long as the expert’s account is repaid within a specific period — typically two years — as our expert partners are willing to share some of the savings our program affords them (in administration costs, marketing and bad debts). Our File Funder interest is typically paid by the client and is therefore of no cost to the firm. The interest rate varies somewhat depending on the size of the facility, but is very much in line with the interest we’ve seen firms charge their own clients on disbursements in jurisdictions where that is allowed. 

On that last point, there is a prevailing belief in Ontario that lawyers aren’t allowed to charge interest on disbursements. It’s true that lawyers can’t themselves charge interest, at least not without a very impractical, thirty-day advance account rendering process. However, there is no restriction where the financing is provided by a third party, so long as the arrangement is disclosed and consented to. This is a game-changing revelation for many of our law firm clients — especially in the current environment where the cost of experts and other disbursements is escalating far more rapidly than their fee revenues.   

CL: What advice would you give to practice owners who are starting to think about succession planning?

SP: Firstly, I would say that your law firm is not only your place of employment, but also a part of your legacy. You need to create a transition structure that reflects the years of hard work and the value of the brand and business you have created — value that the next generation of lawyers will inherit and benefit from. There are multiple methodologies that can be used to determine the theoretical value of what a business is worth. The services of a financial professional (with experience valuing legal practices of a similar nature) such as a Chartered Business Valuator is always a good place to start. But there is truth in the mantra that ultimately, a business is only worth what the buyer is willing to pay. In the case of legal practices — disadvantaged by regulatory restrictions and the banks’ rigid lending criteria — that mantra might more accurately be “what a succeeding lawyer is able to pay.” To avoid the fate of many other retiring practice owners who were sold short on their succession deals, I would simply say — explore your options. They might be wider than you think.