How to Finance a Law Firm Partner Buyout
Every law firm with more than one owner eventually faces the same question: when a partner retires, leaves, becomes disabled or dies, how will the firm pay for that partner’s ownership interest? A law firm partner buyout is the purchase of a departing partner’s interest by the firm or by the remaining partners. It is one of the most consequential transactions a firm will complete, because it affects cash flow, ownership, client relationships and the firm’s ability to keep operating smoothly.
This article is written for the remaining partners and the firm: the people who have to fund the buyout. It is different from a partner buy-in, where an incoming partner funds their own equity stake, and from long-range succession planning. Those topics are covered in our guides to law firm partner buy-in financing and law firm succession planning.
Start With the Partnership Agreement
Most buyouts are shaped by an existing partnership, operating or shareholder agreement. Before discussing financing, the partners should review what the agreement says about:
- Events that trigger a buyout, such as retirement, withdrawal, disability, death or expulsion
- How the departing partner’s interest is valued: formula, capital account, appraisal or negotiation
- What the payment covers: capital account, share of receivables and work in progress, goodwill or some combination
- Payment terms, including whether payments are made over time
- Any limits on total annual payments to retired partners
- Restrictions on the departing partner’s future practice, to the extent permitted in the jurisdiction
Agreements drafted years ago may use formulas that no longer reflect the firm’s economics or may be silent on important issues. Interpreting or amending the agreement is a matter for qualified counsel. Professional conduct rules on payments to departing or retired lawyers and restrictions on practice vary by jurisdiction and should be reviewed as part of the process.
What Is the Departing Partner Being Paid For?
Law firm buyouts often separate the payment into components:
- Capital account: the partner’s contributed and retained capital, often returned relatively directly
- Share of receivables and work in progress: fees earned while the partner was an owner but not yet collected
- Goodwill or enterprise value: a share of the firm’s ongoing value, if the agreement provides for it
Each component may be paid on a different schedule and may have different tax treatment. Our guide to law firm valuation explains how goodwill and receivables are commonly evaluated.
Plan for the Departing Partner’s Clients
A buyout is only affordable if the revenue that supports it continues. If the departing partner originated or managed significant client relationships, the firm should plan how those relationships will transition: joint client meetings, introductions to the partners who will take over and a reasonable period of cooperation from the departing partner. Clients are generally free to choose their lawyer, so the firm should assume that some relationships are at risk and plan accordingly.
Common Ways to Fund a Partner Buyout
Firm cash flow over time
Many agreements provide for payments over several years from firm cash flow. This avoids outside debt but places a long-term obligation on the remaining partners and can constrain distributions and investment.
Entity redemption financed with a loan
The firm borrows to redeem the departing partner’s interest, and the remaining partners’ percentages increase. A loan can provide the departing partner with a defined payout while giving the firm a predictable repayment schedule.
Cross-purchase
The remaining partners personally buy the departing partner’s interest. The choice between redemption and cross-purchase can have legal and tax consequences, so it should be reviewed with advisors.
Seller financing
The departing partner accepts part of the payment over time. This is common in law firm buyouts and can be combined with outside financing. Lenders will review how any deferred payments relate to their loan.
SBA and conventional financing
Lenders may finance buyouts through SBA-backed or conventional loans, depending on the firm’s cash flow, the amount and the structure. Our guide to SBA loans for law firms explains how SBA financing is commonly considered for ownership changes, subject to program rules and lender review.
What Lenders Review in a Buyout
- Historical financial statements and tax returns
- Revenue by client and the share originated or managed by the departing partner
- Accounts receivable and work-in-progress aging
- The partnership agreement and proposed buyout terms
- Existing obligations to previously retired partners
- Projections showing cash flow after the departure, including any replacement hire
- Personal financial information and guarantees from the remaining owners
One often-overlooked point is the departing partner’s compensation. If that partner drew a large share of profits, part of that cost may disappear after the buyout. If the firm must hire a lateral attorney or promote an associate to cover the work, that cost belongs in the projections.
Modeling the Payments
Before finalizing terms, the remaining partners should model the obligation under different structures. A conventional loan calculator can provide rough payment estimates for planning. Actual terms depend on the lender, the borrowers and the transaction.
Retired-Partner Obligations
Some firms carry obligations to several retired partners at once. When those payments stack up, they can significantly reduce current partners’ income and make the firm less attractive to future partners. Partners should review whether existing and future buyout obligations are sustainable together, and whether refinancing or restructuring them into a single, predictable payment would help.
Common Mistakes
- Relying on a buyout formula without testing whether the firm can afford it
- Ignoring the transition of the departing partner’s clients
- Overlooking stacked obligations to previously retired partners
- Failing to consider professional rules on payments and restrictions after departure
- Negotiating terms before confirming that financing is realistic
Plan the Buyout Before You Need It
The best time to plan a law firm partner buyout is before anyone announces they are leaving. A clear agreement, a realistic valuation method, a client-transition plan and a sense of how the buyout will be financed give both the departing partner and the firm confidence.
US Professional Funding works with established law firms and their partners on financing for buyouts and ownership transitions. Learn more about our law firm partner buyout financing.
