Does anyone really do their due diligence on a firm before buying in? If you are like nearly every other person in professional services, the day you get offered partnership will be one of the best days of your career. What you won’t be thinking about when the offer comes through is, “how solvent is the partnership I am joining? Is it the right firm for me?” No, instead, you will be so pleased that you have been accepted into an exclusive and private club that you’ll probably just sign on the dotted line.
While this ends up working out okay for some people, not everyone is that lucky. Here is why you must do your due diligence on your firm BEFORE buying in and what you need to look at.
*This blog is an excerpt from chapter 2 of the 3rd edition of Poised for Partnership. This chapter focuses on ‘Direction’ and helps you to work out whether partnership is right for you and if it is really what you want. Download the full chapter for free here.
Why do your due diligence on your firm?
It’s a great feeling being asked to join the partnership. However, before you agree to become an equity partner, whether fixed share or full equity, you need to do your homework on your firm. After all, ‘buying-in’ is just a fancy term for buying a stake or slice of equity in the business. If your firm folds you could be left with a large amount of personal debt, which may impact your ability to practice (particularly if you are lawyer) in the future!
On the day you are admitted to the partnership, you will:
- Resign and become self-employed,
- Sign the Partnership Agreement (i.e. how the partners agree to run the business),
- Make a significant capital contribution to your firm,
- Leave the firm’s pension scheme,
- Lose your employment rights,
- Tie your personal reputation to the firm’s reputation,
- Stop receiving the benefits you were entitled to as an employee of your firm.
When you see it in a list like this, that’s a lot to lose all on a ‘promise’ that you will receive significantly higher financial rewards and greater influence on your career and firm than
you do now!
Yes, none of these rewards are actually guaranteed. Do you now think doing some basic due diligence on what you are really being offered may be a wise thing to do?
What level of money will I be asked to put into my firm?
Every firm is different and will be capitalised differently. There is no set amount of money needed to buy into a firm. However, expect to be paying a minimum of £30k and up to potentially £250k to buy into your firm.
Whilst most firms will organise a bank loan on your behalf to pay for your stake in the firm, you will still be liable for any interest or capital repayments. This is immaterial if your firm is doing well. However, there are no guarantees that your firm will be profitable in any one year and that you, as a partner and owner of the business, will actually be paid anything…
What due diligence should I do on my firm before buying in?
The more you know about your firm before signing on the dotted line, the better. For a full list of questions to ask, download our free due diligence for partnership checklist!
As well as these questions, you also need to know the answers to these 4 key questions:
1. When will I need to contribute capital? (and what will my money be used for?)
When you do your due diligence on a firm, the first thing you need to do is to be clear on exactly what you’re signing. The partnership agreement is a pretty important document and you need to know what is contained in it. For example, you may find out that until you have been an equity partner for five years, you will be working your butt off to line the more senior partner’s pockets. So it is very important that you find out how are your partners are remunerated.
When you look through your Partnership Agreement, you will need to establish:
• How quickly do you get your capital back if you leave?
• Do you get your capital back in full when you leave?
• What your capital is being used for.
You may not think these are that important but just bear with me while I give you some example scenarios.
What happens if you’re not clear about what will happen to your capital when you exit the firm.
- If you make a lateral move to a new firm and your old firm is slow to repay your capital, it could prevent you from accessing a new line of credit to buy into your new firm.
- If you exit your firm on a whim, you may not be entitled to your capital back. (Unlikely, but if you haven’t read the partnership agreement, how would you know?)
What happens if you don’t know how you’re capital will be used by your firm.
- If your firm is not profitable and financially sound, your capital contributions may be used to keep the business afloat. The result when the firm goes bust is that you’ll still need to pay back your partnership loan – just without an income!
The last thing that you want is to find out that your capital has been used to give an unsustainable business model a few extra months of life before it falls over. If your partnership is wound up, the partnership liabilities are paid first and then any remaining assets distributed to the partners. However, there are unlikely to be any remaining assets to distribute as most firms’ value is in their client list. And trust me when I say, you can expect any goodwill to disappear very quickly when a client finds that their professional advisor is in financial difficulty.
Moral of the story here? You will need to be absolutely clear about what your capital is used for and what will happen to your capital when you exit the firm.
2. Is the firm solvent?
As mentioned above, there is a very real and present danger that your capital contribution could be used to prop up an ailing firm. As well as risking your own money in this situation, and leaving you with hefty personal debts, you could also face a large reputational risk. Being a partner in a firm that goes bankrupt is often seen to be a huge black mark on your own reputation and character.
To get an idea of how solvent your firm is you need to have sight of, ideally, the last three years of annual accounts and the most up-to-date management accounts the firm has. Sadly, you are unlikely to be given access to any sensitive financial information about your firm until you have been offered partnership.
The firm’s balance sheet gives you a snapshot of your firm’s assets and liabilities at a fixed point in time. To assess solvency, you need to check the following:
- that the firm’s current assets are larger than its current liabilities.
- that the level of its working capital is positive. (Take the current assets (not the fixed assets) and minus the current liabilities. If this is low or negative, then your firm may have
cash flow problems)
If you are concerned about anything financially related, then do talk with the Finance Director in your firm. In addition, get an independent accountant to review the accounts for you.
3. Is it robust?
Of course, you don’t have a crystal ball to identify what could go wrong whilst you are a partner. What you can do is understand how robust your firm actually is. For example:
- Look at the firm’s PI insurance and claims track record. Above-average or escalating PI costs could indicate that there is something very wrong with the firm and how it is managed.
Be aware, in 2020 PI insurance cover costs shot up as a result of the COVID-19 global pandemic. Additionally, look to see if there are any outstanding or potential PI claims that the firm is aware of.
- What are the 3-year trends in the firm’s performance? If the trends carry on for the next few years, will the firm still be profitable and solvent?
- Find out how reliant the firm is on its top 5–10% clients. How many of these clients could leave before the firm would be unprofitable?
- How dependent is the firm on its top work-winners? Would the firm struggle to bring in revenue if a few of them left, or a practice team upped and left?
- How prepared is your firm to make quick, tough decisions when the market or economy turns against them? Many firms have gone under because its partners refused to take action, believing the problem would go away.
- How actively does the firm manage risk? What are the key risks that the firm is facing at the moment? Does it have a plan to mitigate these risks?
Download now our free due diligence for partnership checklist to make sure that you ask the right questions before buying into your firm.
4. Is it well-managed?
Doing your due diligence isn’t just about the financial performance or sustainability of the firm. It’s also about how well-led and managed your firm is. It is not uncommon for partnerships to be well-managed but badly led, or vice versa. Bad leadership decisions such as stalling on a highly beneficial merger or delaying making crucial decisions could drastically impact the profitability and sustainability of a firm.
Therefore, it is worth finding out:
- What is the strategic plan for the firm and why is the firm’s
leadership following that particular strategy? Can you support this strategy?
- What are the firm’s core values and culture? Is this something that you can role model both internally and externally?
- Does the firm have a clear idea of how current and future changes in its marketplace will impact it? Does it have a strong vision as to how to deal with this?
- Is there a culture of robust leadership in the firm with a well-defined strategy as to how the firm will develop in the future? Does the management have the authority to implement the actions necessary to achieve this?
- If the current Management Board is up for reelection in the next 12-24 months, who are the likely candidates to be in the firm’s leadership team? Are these partners you like and respect?
- To what extent will you, as a partner, be able to participate in/affect decisions concerning the future of the firm?
- Does the firm have a clear strategy and business plan for client and business development?
- How will you be involved in delivering this business development strategy?
- What support does your firm’s marketing and business development team offer to new partners?
Think about what this move to partner really means before signing!
As stated earlier, these are just some of the basics you need to ask your firm. For a full list of questions, download our free due diligence for partnership checklist.
Before you sign the partnership agreement, take the time to fully explore the implications of making partner in your firm.
Firstly, is this definitely what you really want and does it fit into your family life?
And second, is this firm financially sound, what will my money be used for, and is this the right agreement for me?
Once you have these answers, you will have complete peace of mind that what you’re signing is the right career move for you
Don’t forget to download the full chapter of the 3rd edition of Poised for Partnership. This chapter will help you work out what motivates you, what makes you tick, and whether partnership is right for you and if it’s what you want. Download the full chapter for free here.
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