Want Your Law Firm M&A to Succeed? Don’t Skip the Due Diligence
A merger and acquisition (M&A) can be tricky enough, but an M&A at a professional service firm (PSF) requires certain business and financial acumen. Globally, PSFs employ 5.6 million people and generate annual fees of $795 billion, according to the Managing Partners Forum.
Drilling down, the BTI Consulting Group Inc. estimates that the annual global M&A market for law firms is $277 billion. In fact, 2015 was a banner year as 91 law firm M&A transactions were completed in the U.S. – the highest annual total recorded since MergerLine began compiling the data in 2006. Last year also saw a historic merger when Dentons and the Chinese firm Dacheng joined forces to form the world’s largest law firm, with more than 7,000 lawyers.
Just what is driving law firm merger mania? Essentially, it boils down to demographics. Baby Boomers are retiring en masse, 10,000 a day by some estimates. There is also a financial component. Most law firms do not offer retirement benefits, which means partners are increasingly relying on golden parachutes to carry them through their golden years.
|Law Firm M&As by Year|
|Source: JLL Research, Law 360 and MergerLine|
It’s a long way from managing partners from two different firms talking on the golf course about a merger to a successful implementation. One of the first questions to ask yourself is: “Why do we want to merge with another firm?” Is it to gain market share? Is it to add niche specialties? Is it a defensive maneuver against the competition? Is it part of a succession plan? Will it add value for clients? The rationale for the merger requires clarity in order to successfully move forward.
Another critical step in the M&A process is proper due diligence, regardless if you are the acquiring firm or the target. This includes a thorough vetting of the firm’s staff, potential client conflicts of interest, financial position, legal exposure and reputation. This vetting can be performed by risk management personnel at your firm, an external consultant specializing in this area, or some combination of both.
One example of a lack of M&A due diligence occurred when a pair of large firms combined, despite the fact they were both overleveraged with debt. Not surprisingly, just a few years later, the firm filed for bankruptcy.
An often-overlooked criterion is firm culture. Proliferating institutional legacy from each company can be deadly. In fact, one-third to one-half of all mergers fail because the cultures of the two organizations simply do not mesh.
When two leading law firms (Pashman Stein and Walder Hayden) merged in 2016, the leadership paid particular attention to one aspect: “During the merger, we focused on the blending of our firms’ cultures,” said managing partner Michael Stein. “It’s easy to determine the synergies and the numbers going in, but culture is really the X factor that can make or break long-term success. Thankfully, we were able to manage that intangible and take our firm to the next level.”
There are numerous metrics that a law firm’s accounting and financial advisor can (and should) analyze. Here is a representative sampling:
- Taxes – Federal and state business returns, Forms 1099 and 1096, sales and use tax returns, payroll tax returns, and the results of prior taxing authority examinations.
- Financial Statements – Detailed general ledgers, accounts payable and receivable, works-in- process, notes payable, fixed assets and depreciation.
- Insurance – Health, disability, life, and other policies.
- Partners – Compensation, retirement obligations, loans, gross originations, billings, agreements.
- Liabilities – Off-balance-sheet, contingent, professional, litigation.
- Clients – Trust funds/escrow, revenues, advances, collections.
Be fully transparent during the negotiation phase. The goal here is to create a win-win for both parties, not try to “one up” the other. A big part of the negotiations will be partner compensation as well as buyouts for retiring partners.
Next, create an M&A plan that includes a schedule detailing areas such as management structure, space requirements, staff training, information technology integration, and other infrastructure needs.
Just as it is important to be transparent with a potential partner, the same holds true for other stakeholders. Providing regular updates to staff, clients, vendors and other parties will help make the transition a smooth one. This can help prevent legal talent from becoming disenfranchised and leaving the door open to talent poachers from other firms. Unlike certain other professions, clients belong to attorneys and not the law firm, which may foster staff movement. Periodic M&A updates will also help you market and brand the new practice to potential clients.
Part of the schedule should include developing metrics for a post-M&A review. After a designated period, 6 months to a year, leadership should determine if it met those metrics.
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