SDE, Dependency, and Maximizing the Value of Law Firms

According to an article by Attorney at Work, partners viewed their law firms as opportunities for personal profit. However, attitudes have shifted towards seeing firms as businesses with inherent value. Consequently, determining the value of law firms has become a pertinent question.

Law firms are typically valued based on two key factors: Seller’s Discretionary Earnings (SDE) and dependency on the owner. SDE represents the total benefits derived by the owner from the firm, including net income, salary, benefits, and discretionary expenses. Normalizing earnings involves consolidating these components to present a clear financial picture.

Dependency refers to the extent to which the firm relies on its owner. Higher dependency translates to a lower value multiple, akin to a fixer-upper house requiring significant effort. Factors affecting dependency include marketing, sales, operations, employee turnover, production efficiency, and technology integration.

The article highlights that Improving these areas not only enhances SDE but also reduces dependency, thereby increasing the overall value of law firms. Three intriguing insights emerge from this process: 

• Fixing firm components leads to a rise in SDE
• Addressing these aspects decreases owner dependency and elevates the value
• Owning an attractive firm doesn’t necessitate selling it; instead, it becomes an asset worth retaining

By understanding and optimizing these factors, law firm owners can bolster their firm’s value, whether they intend to sell or maintain ownership.