3Kites’ Brief Guide to Law Firm Mergers… and How to Make a Success of Them

Introduction

A quick search for the term ‘Merger’ on the website of The Lawyer shows 342 results for 2010, rising through subsequent years to 1,188 for 2014. This may be a pretty broad brush, but the number of articles relating to this subject reflects the increased activity in this area. The aim of this article is not to provide chapter and verse on law firm mergers, but to help identify the key areas that need to be considered by a law firm in order to make the right decisions.

These areas are:

• Drivers for merger – why they are on the increase

• Would a merger be right for your firm?

• Choosing your merger partner

• Making a success of your merger – things to think about.

About the authors

Duncan Ogilvy joined 3Kites from Mills & Reeve, where his management career included the role of managing partner and more recently knowledge management partner. Over the many years he was involved in law firm management, Duncan has reviewed merger opportunities, both those that went ahead and those that didn’t, and played a part in planning and execution.

Paul Longhurst founded 3Kites in 2006 after almost 20 years of working in the legal sector including senior IT roles at Allen & Overy and Herbert Smith. He has been involved in the practical elements of law firm acquisitions and the start-up of new offices.

Drivers for merger

Scale in itself can be an advantage. Simply put, (with conspicuous exceptions admittedly) the recent published Profit per Equity Partner figures of law firms in England and Wales show a distinct trend in the direction of growth. To get a better understanding of this one needs to look for the underlying reasons. Here are a few:

• Major deals and major litigation need scale. Small firms may miss out on major (profitable) work through their inability (actual or perceived) to handle the scale.

• Large firms can spread support costs amongst a greater number of fee earners, making it possible to have higher levels of support at a lower cost per fee earner. This will include support personnel as well as the infrastructure such as IT.

• Small firms, even successful ones, may find themselves reliant on a single client or group of clients, or one work type, with consequent exposure. Merging into a larger unit may facilitate diversification with the security that comes from that.

• A diversified firm may be able to cross sell following a merger resulting in more work for all.

• Even a successful firm can only achieve a certain market share in its chosen geographical patch or client sector. A merger may give the firm’s experts access to new markets.

• All firms depend on their clients to survive, and it may pay a firm to follow clients into new geographical areas or markets – a merger may achieve that.

• Finally, the legal landscape is changing. Non-law firm entrants are shaking up the market and competition within the existing legal market place has also increased since the downturn in 2008. This, of itself, is not a driver for merging but it should require firms to consider what their place will be in any new order and this may include an option for merging.

For many, if not all firms, the status quo is not an option. Every firm should take time to review its strategy, and merger may be one way to achieve that strategy. We would argue that merger should never be a strategy in itself, i.e. a means to an end in some circumstances but not the end in itself. Two small firms in difficulty could come together to create one large firm in difficulty!

Would a merger be right for your firm?

By far the most important criterion in any proposed alliance is strategic fit, as described above. But even when a merger looks attractive in theory considerable due diligence is needed before deciding to go ahead, even in principle. Some deal breakers that should be flushed out quickly include:

• Financial performance and debt. No two firms are identical, and indeed one firm’s financial challenges may be one of the reasons for the merger. It will be necessary to review each firm’s financial performance. If there is significant variation in financial performance, that will need to be addressed. It may be capable of integration with, for instance, a change in partner profit sharing ratios or some key retirements, but if there is an underlying difference in profit margin, the causes need to be properly understood before the two firms integrate. Some firms have always avoided debt whilst others are up against their borrowing limits. Whilst such differences could be allowed for in the detail of a merger, does it point to a fundamentally different approach to financial risk? If so, that might be a cause for concern.

• Conflicts. It is no good if the target firm’s best client is regularly transacting with your best client, so that a merger would rule one of them out! Even before decision day, a review of the top clients is needed to check that conflicts are not a major issue.

• Complaints and claims. Your firm may have an enviable claims record and therefore find professional indemnity insurance affordable, but that might come to an end if the target firm has had a major claim in its recent past.

Ideally, firms would always favour a merger that reflects a long term strategy which it has already thought about and articulated, rather than a response to falling numbers or simply an opportunity. It makes sense to do this strategic thinking when the firm is in full control of its destiny. If this is not possible (for instance if profit is declining or key clients leaving), then it is advisable to take stock now and make an informed decision rather than simply walking into a merger as an unavoidable eventuality of the firm’s current course, i.e. try to bring as much control to the decision as possible. There must be times when an unexpected opportunity presents itself, and some of those must be absolutely right to pursue, but a merger takes a lot of unravelling and should not be entered into lightly. A documented (and regularly reviewed) strategy makes it much easier to assess a passing opportunity with minimum disruption to the business.

Merger is not just about the firm or its equity partners, but also about employees (lawyers and support staff) and clients – what is in everyone’s best interests? Decisions are, of course, for the equity partners as owners, but most will at least want to consider the impact on that wider group.

Choosing your merger partner

Finding the right business partner depends upon the reasons for merging. If your firm is failing, your choices are more limited but your responsibilities to staff and clients are probably more acute.

If this is a strategic acquisition of a smaller firm or a practice group, the decisions will be more about fit with the acquiring firm’s plans and objectives, client base, etc. and will probably require more negotiation if the firm or group being acquired is already successful.

The third (and potentially most difficult) option is a merger of equals. Motivation may be growing a firm in a region not yet covered, adding more lawyers and therefore a greater income stream, or any number of other reasons. If not planned carefully, the outcome might be a firm with too many support staff, too many offices in the same location/s, operating in sectors where the long term outlook is for reducing work, or overburdening the new firm with too much debt on the back of the merger costs. However, a well thought through and executed merger can result in a firm which is greater than the sum of its parts over time, with a sustainable business model and a strong brand.

Making a success of your merger – things to think about

So, consider. There has been a decision in principle to merge. Relevant partners have met and satisfied themselves that it is a good proposition. The real work starts here! The merger needs to be treated by both firms as a project and resourced and managed accordingly.

It was no surprise to us that the individual award for law firm management in the Lawyer Management Awards 2014 recognised work in connection with a merger – awarded to Rachel Reid, Strategy Director of King & Wood Mallesons for her key role as project director in relation to its recent merger with SJ Berwin. Only by staying on top of all the many issues will two or more firms move successfully from the decision in principle through due diligence to the creation of the new firm, on time and on budget.

We have set out below a range of topics which need to be considered. It is by no means exhaustive.

• Status - is this to be a full merger or a confederation? The latter is easier to agree and to deliver. Indeed it may be the only option with some cross border mergers. On the other hand it may only be a true merger that delivers all the identified benefits. A hybrid is quite common whereby a confederation is implemented quickly with a view to full integration a year or so later.

• Governance - both for the merger itself and for the new firm once it is up and running. This may be a delicate topic. A merger project team will need representatives from both “sides”, but the new firm may benefit from more streamlined management. Failure to streamline the firm’s governance can result in an impasse, frustration and an inability to take decisions.

• Finances - what is expected (getting on top of actual figures as soon as possible) and cost savings (e.g. through economies of scale)? A cost for the merger should be budgeted and a budget for the first year of the operation should be established. You should seek the help of the firm’s accountants if you don’t have the resources available internally to do justice to this fundamental task.

• Partner shares - how to allocate equity shares across the newly merged firm.

• Infrastructure - these issues will take up a lot of attention between the decision in principle and go live. Within this category we include office space and other facilities. Above all one needs to consider both the opportunities and costs of IT. In a perfect world the new firm would, on day one, have single, firm-wide systems, as below. Pragmatism may have to come into play of course, and some systems (for instance case management operating out of one office only) might be left alone at least in the early days. The merger may provide a catalyst for new systems perhaps because existing infrastructure is nearing the end of its life or is not suitable for the larger firm. Aside from choosing to go with one or other application where two or more are in use, considerations may include all or any of the following:

• Document Management- harmonising document repositories (metadata fields, policies, etc) and knowledge banks (especially the categorisation of items);

• Practice Management - harmonising client and matter naming/numbering, accounting approach, time recording, invoicing and the like;

• Human Resources- harmonising people data, benefits selection, self-service and along with broader policies (see below);

• Client Relationship Management - harmonising the types of data held about clients;

• Case/matter management - these can be highly entrenched systems built up over many years and closely tied to the specific needs of each firm, and can therefore be the most difficult to reconcile;

• Intranet - the intranet has the capacity to carry internal messaging crucial to the communications noted below and can also surface the merged firm’s knowledge, experts, clients and matters, all of which can demonstrate commitment to the new structure.

• Seamless operation - there is a lot at stake both in terms of cost and risk. It is hardly a luxury to have smooth running IT these days and it will be expected seamlessly on day one.

• The public message - Why are you doing this? What’s in it for clients? What’s the rationale for the new firm? It is helpful to create a clear message (almost an elevator pitch that sums up the new firm) that can be consistently presented from the word go.

• Branding - Linked to the public message, there will be any number of issues ranging from house style and press releases through to signage that need to be resolved – and this assumes you have agreed the name of the new firm!

• Communications across the new firm – This is probably the single most time consuming topic and the one that in our experience is often under-rated. Failure to handle internal communication can be very serious. At the very least it limits the effectiveness of the merger and interrupts the smooth running of the combined firm, but it could jeopardise the success of the merger itself if everyone is not “on message”, or at least clear what that message is.

• HR issues – reconciling salary levels, TUPE, redundancies, etc. Everyone, of course, wants to know exactly where they stand, so if possible one wants to keep negotiations confidential until answers to as many of these questions as possible are available.

• Client/prospect management - Major conflicts will have been identified before the decision, but they still need to be handled and may present a number of new opportunities. Indeed cross selling the skills of the “other” firm may form part of the rationale for the merger. This won’t just happen and will need careful planning.

• Knowledge management (KM) - we firmly believe that effective KM is a key enabler for an effective merger, and failure to plan that resource can make it hard to get the best from the new firm. KM aspects of a merger will feature in a future article.

• Policies and processes – these should be common across the new business from early on, and it will require work to both agree and harmonise them which will be no small task.

Treat this as a project and create a proper project plan. Keep a risk register to keep on top of risk issues and document everything in an information memorandum to make sure that at go live date, the firm’s operation runs smoothly and that there are no nasty surprises later.

With so much to think about it is hardly surprising that firms often struggle to make a success of merger, yet the strategic arguments in favour may be compelling and there are some highly successful merged firms around. It needs proper resource and careful planning but the prize of creating a new firm greater than the sum of its parts should make the effort worthwhile.

Our consultants have experience ranging from IT through KM and law firm management. We are well placed to help firms to assess the merger challenge objectively and once merged to help actually to deliver the benefits identified, whether that be in integration of systems or people.

Duncan Ogilvy and Paul Longhurst, 3Kites Consulting, January 2015

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