Altman Weil MergerLine tracks law firm mergers of virtually any size, and they report that 2017 is a banner year. Those of us who are embedded in the legal industry knew this, but it’s important to have the data supporting all the water-cooler conversations – and happy hours over Pinot Noir or a Sazerac. MergerLine reports, “There have been 52 combinations announced through mid-year, including 24 in the second quarter, topping the prior mid-year peak of 48 in 2015 and 2016. Cross-border combinations are also on track to reach an all-time high in 2017.”
So now we know the numbers for 2017. We hope 100% of them are successful, but statistically, that’s not likely. Like marriages, about 50% of them fail.
If you want your firm to grow and you believe the best way to become more competitive is to merge, pay heed to Bob Denney’s post below. This originally appeared in his July 2017 Legal Communique.
Law firm mergers may set another record this year because, in order to grow in this flat legal market, more firms are merging in other firms, in many cases smaller ones, or at least entire practice groups.
Yet history reveals that about 50% of all mergers subsequently fail. In many cases, the reason(s) for the eventual failures were issues that were evident beforehand and should have raised red flags about proceeding with the merger. On the other hand, when firms end merger discussions, whether the potential merger had been announced or not, it is often only after they have spent an undue amount of time trying to resolve red flag issues.
I call these “red flag issues” because they are difficult and, in many cases, are issues that can never be resolved. These are the red flags that arise most often.
- Although they have agreed to seriously consider merging, one or both of the firms does not make it a high priority item, dragging their due diligence or the discussions on for an extended period of time.
- A major client that represents a significant amount of the revenues – and also probably the profits – of one of the firms announces it is taking its business to another firm.
- There are wide differences in the partner incomes between the firms.
- The firms have different work ethics as indicated by wide differences in average billable hours.
- The acquiring firm requires partners to buy-in and contribute capital while the firm being acquired does not.
- One of the firms has considerable debt while the other firm is debt free.
- One firm has an unfunded pension liability. The other firm does not.
- The practices do not fit. An example from two litigation firms: One firm’s practice consisted mainly of major, “bet the company” cases for large corporations. The other firm’s practice was largely commodity litigation with a high percentage of insurance work at low hourly rates.
- Legal conflicts can usually be identified and possibly resolved. However, there can also be business conflicts such as when a major client of one firm says it will withdraw all its work because a major competitor is a client of the other firm.
- A major producer in one firm opposes the merger and threatens to leave, taking his/her clients and even an entire practice group.
- Different compensation systems. Partner compensation in one firm is based on billable hours or collections while, in the other firm, partners are compensated mainly on origination. Another example: One firm has a formulaic system while the other firm subjectively evaluates partner performance based on published criteria.
- The average billable hours in one firm are far below those in the other firm.
- Management in one or both of the firms has not informed the other partners that it is in the process of negotiating a merger. Then, with little notice or time for discussion, presents the merger to the partnership for approval.
- The name of the new firm. This has been the “deal breaker” in a surprising number of potential mergers that were called off. When a smaller firm is merging into a much larger one, this is rarely an issue. However, when it would be a so-called “merger of equals”, this often becomes sensitive because both firms want their firm’s name to survive in whole or in part.
- But the first red flag that can appear is when the firms are drafting the confidentiality agreement. This document should include a stipulation that, if the merger does not occur, neither firm will attempt to recruit lawyers from the other for a specified period, usually one year. This is often referred to as a “cherry-picking clause”. If either or both firms are unwilling to agree to this, that should raise a huge red flag.
Negotiating a merger is a complex and delicate process. However, there would be fewer failed mergers, or considerably less time and resources spent on potential mergers that do not occur, if firms recognized and addressed the red flags when they arise.
To paraphrase the old adage: “Look long and hard before you leap.”
Bob is a recognized authority on management, leadership, and strategy for law firms and companies. He is on several company boards and has also served as an Interim CEO in crisis and turnaround situations. He can be reached at 610-804-7850 or at robertdenney.com.