Following a pandemic driven drop in the number of law firm mergers in 2020, based on what our practice is seeing, 2021 will see a substantial increase in combinations. It seems like scarcely a week passes without an announcement of another law firm merger.

We have been particularly interested in the pending Thompson Knight – Holland & Knight transaction.

This reported combination appears to be experiencing some unwanted attritionthat is fairly common in large mergers. This article reminded me of how important it is to ensure that key firm assets understand the strategic value and support the deal.

There are a number of solid strategic reasons for law firms to consider merging. In my opinion, three at the top of the list are:

  • The addition of specific expertise and technical capabilities necessary to better serve existing or targeted clientele;
  • Succession planning; and,
  • Financial stabilization.

I have been encouraged by the fact that two of the recent mergers our firm was privileged to consult on were specifically driven by succession concerns. In each case, senior partners made the strategic and selfless decision to seek a culturally compatible merger partner in order to provide a platform of future opportunity for its younger lawyers.

Unfortunately, a significant percentage of mergers are driven solely by the misguided idea that  getting bigger is better.

Why do I say “unfortunately” and “misguided” Isn’t growth a good thing?

Simply put — I believe the numbers-driven strategy is the root cause of a majority of failed merger initiatives. Getting bigger often only magnifies and compounds existing deficiencies.

If your law firm is considering a merger, what is driving the pursuit.

Law firm mergers can accomplish a great deal, so it is no wonder they are popular. The number of mergers consummated each year is steady if not growing. Strategically designed and executed law firm mergers can boost combined firms to places otherwise difficult to achieve in the time frames desired.

Even though many mergers make sense and receive the accolades deserved, there are other combinations that fail. Indeed, by some assessments, fifty percent of all mergers fail. Failure can be traced to many reasons, but when post-mortems of failed mergers are performed five ill-conceived notions behind merger are frequently observed. Based on that history, merger contemplated by leadership should be rethought if its impetus is premised on any of the following rationales or motivations:

Obsession with Growth. Without question, growth is a prominent feature with all mergers. But more than the result should be the impetus for pursuing merger. Many mergers that fail can trace their failure to an obsession with growth and allowing that obsession to dominate thinking. The move to merge must be borne of sound strategy, analysis, and due diligence, not a belief that bigger always is better. Growth will be a subsidizing inevitable by-product.

Desire to Dominate in the Wrong Areas. A law firm may be known for a particular specialty and the strategic desire to dominate that specialty may drive decision making. When thinking of domination, it is advisable to look at the coveted area and ask, is it sufficiently profitable, does it have an inspiring future, will it help or hurt other areas of the firm? Applying basic business analytics should be employed so that any merger boosts the brand long-term and is, in the long run, accretive. More “meh” from a merger helps little.

The Clamor for Excitement. It is not uncommon for a faction within a firm to appeal for action to jolt a seemingly staid and stodgy firm to life. Excitement is good, but the big splash that goes with a merger will recede from the consciousness sooner than often imagined. While the excitement may have been fun, a merger fundamentally must strengthen the firm. Being saddled with nothing more than the burden of a bigger firm is the antithesis of exciting.

“Keeping Up.” Closely tied to a clamor for excitement is the interest in “keeping up” with competitors that have grown or merged. While competing is all about keeping up or overtaking your market rivals, channeling that desire into a non-strategic merger is not the answer. All firms are different, and just because another firm merged successfully, doesn’t mean a merger is for you. Strategy, analytics and due diligence, not fads, should drive mergers.

To Fix the Unfixed. Firms with challenges frequently compound those challenges by adding more variables to day-to-day life. A firm with problems should address those problems before jumping into the merger world. Worse still is a merger birthed with the belief that the merger partner will cure ills nagging the present. Bypassing a pre-merger fix will only make things worse in the long run.

When examining the scene of failed law firm mergers, one or more of these five fingerprints often can be lifted. If your firm is thinking about a combination, are its thoughts based on questionable impulses or well-thought-out strategies and analytics?

 

It has been a good while since I have written on this topic but two recent events prompted me to address it again.

The first: last week, Bruce Matson, former General Counsel of LeClair Ryan, reportedly (subscription required)  admitted embezzling $2.5 million dollars from a client trust account.

The second situation relates to a client — a relatively small firm located on the West coast. In this instance my client discovered that an employee has misappropriated more than $300,000 over a period of several years. The now former-employee was also unfortunately a gambling addict.  Consequently, virtually none of the funds are recoverable and a criminal prosecution is providing little relief.

SURPRISINGLY COMMON

I am shocked at the number of times I’ve seen this happen inside a law firm. No firm is immune, and there is no set pattern. The size of the firm doesn’t matter.  The villain might be a partner or a staff member. And it may be theft from a client trust fund or an operating account.

But in virtually any situation the abuse of trust could have been prevented.

 Most lawyers (therefore, most law firm management teams) have not been trained to design basic internal control processes that safeguard firm resources. As a result, many law firms provide numerous opportunities for financial abuse.

MISSING GUARDRAILS

None of us enjoy considering the possibility that colleagues might actually steal from the firm. But while leadership strives to inspire trust, an awareness of some of the typical methods used to embezzle funds can result in firms establishing processes that serve to prevent a brand of theft that might occur.

A short and incomplete list of ways in which funds are misappropriated include:

  • “Shadow” vendors are established, complete with a company name and address, in order to receive payments that wind up in the hands of the individual committing the fraud. This is a common approach; the payments (checks or electronic transfers) typically start small and increase in frequency and amount over time.
  • False expense reports are submitted for reimbursement. Again, these tend to grow as the thief is successful. In some cases, the firm is the direct victim in others the fraudulent charges are passed through to clients who unwittingly absorb the loss.
  • In larger firms, fictitious employees are sometimes set up in the firm’s payroll system.
  • Some law firm allow an individual to have sole control over authorizing and issuing and accounting for payments. In some instances the perpetrator has made direct payment to themselves, family members or personal creditors.
  • In other cases, firms allow the same person to receive and deposit client payments while, at the same time, having the authority to “write-off” client receivable balances. This can lead to an employee endorsing a client payment to their own benefit and then eliminating the client receivable with no one the wiser.

These are just a few of the countless ways in which law firm and law firm client funds are misappropriated.

PROTECTIVE MEASURES

The question is what should one do to decrease the probability of such a loss. The short answer is to engage a local accounting firm to review your firm’s procedures and design an internal control process. As your firm grows the process should be re-evaluated by an external accounting firm. Ideally, as the firm grows have the firm’s books and records audited.

In addition, there are a host of things that can be done to decrease the probability of loss. Here are seven ideas that represent easy protective measures:

  • Have background checks conducted on all new employees
  • Make sure a person independent of handling cash deposits has authority to “write-off” client receivables
  • Separate the responsibilities of making disbursements and reconciling bank accounts
  • Require two signatures for larger payments
  • Separate payroll review from payroll preparation
  • Have all requests for reimbursement signed by another person
  • Maintain an annual budget for all types of expenditures and receipts and diligently review variances to that budget

In addition to the above, a firm of any size should consider fraud insurance. This won’t provide protection from the event, but can limit economic exposure.

In thinking about this blog post I did a simple google search on law firm embezzlement during the last year and was discouraged by the tremendous number of reported incidents.

How long has it been since your firm’s internal controls have been evaluated?

Law firm succession can be easy, and it can be hard. It tends to be easy for the law firms blessed with talented people, a deep and repeatable client base, and a stellar reputation. Transition from one generation to the next can be natural and seamless. Unfortunately, not all law firms enjoy such a profile.

Most law firms find law firm succession a greater challenge. These firms, grinding daily to succeed in the here and now, are susceptible to succession failure. Because everyone at the firm is busy pursuing the short-term rewards that drive their behavior, interest in succession barely makes it into the firm’s consciousness. So, while the firm may be enjoying a strong and steady performance today, starting an initiative to create a comprehensive succession plan can be difficult.

Developing a workable plan in firms not naturally gifted towards succession requires four steps:

Identify the Extent of Shared Aspirations in Favor of Succession and Act. Nothing is more important than shared aspirations. To see if they exist, the owners must meet and honestly discuss whether preserving the firm’s legacy is valued. If few owners care about succession, then playing out the string and preparing for the eventual firm wind-down is the logical approach. But if succession is a goal shared by all (or at least most), the shared aspiration must be converted into action. When resolve for succession exists, a plan can be created, debated and adopted. A firm’s high-minded determination for succession must result in action, or opportunity is lost.

Drill Down into the Details. Any resolve to create a succession plan requires, as a first step, identification of the kind of succession needed. Are your succession requirements related to leadership, client transfer, or both? A firm’s approach to preserving its legacy can depend greatly on accurately identifying the succession plan’s focus. Only when the challenge is clear can the plan hope to create the solution.

Create Milestones. Measuring success towards any objective is important and in succession it is no different. Yet because succession is a long-term project with rewards realized later, it is essential to create markers of success that can be celebrated and rewarded as the initiative proceeds. Unlike year-end bonuses or compensation setting that occur in the ordinary course of a law firm’s business, succession plan implementation doesn’t typically lend itself to immediate gratification. To stay on target, it is vital to fete and reward milestones met yearly-long before succession has been completed. Without milestones, succession will struggle.

Put Someone in Charge. A ship without a captain drifts with the current. To avoid a similar fate for your succession plan, appoint a succession plan leader or project manager with credibility and respect. Put the full weight of leadership behind him or her. But more must be done. To enhance credibility for the initiative, make that person accountable for meeting expectations and reward that person in tangible ways as progress is made. And since accountability also means addressing performances that fall short of expectations, deal with inadequate progress in a responsible, direct, and prompt way. Accountability with tangible responses from leadership will show the rest of the firm that succession is a high priority.

Succession commonly is outside the ordinary course of most firm’s operations and can become an afterthought. Focusing on these four steps now can prevent later regret that more was not done. Will your firm take those steps?

One of the most underappreciated factors associated with law firm success or failure is the effectiveness of leadership.

The fact is, no single factor has a greater impact on the success or failure of a business than the quality of its leadership. During a period of increasing change in the legal services industry a well-defined means of developing effective leadership is a must.

First, let’s debunk a myth – effective leaders are born, they are not made.  Much has been suggested about “natural born leaders” and there is no substance to the suggestion. This should be good news to members of law firms. With enough focus, desire, dedication and effort, effective leaders are developed.

There are three primary steps to creating effective law firm leaders.

  1. Identify interested lawyers.  Firms should routinely engage its members, (including junior associates) in activities that will provide insights as to who has interest in leadership.
  2. Develop the capability. Once identified, find opportunities to develop their leadership experience and knowledge. Opportunities include:
    1. Assign leadership positions,
    2. Provide leadership assignments,
    3. Connect the leader to be with a mentor (inside or out of the firm) and
    4. Direct them to educational programs intended to develop knowledge and build a network of other emerging leaders.
  3. Obtain feedback. All effective leaders are consciously or unconsciously committed to learning. They strive to become better. Nothing provides a stronger learning experience than lessons learned on the job. A formal system of routine feedback, from all applicable personnel, provides the opportunity for that learning.

Maintaining an appropriately sized group of emerging leaders is critical to law firm success. Prudent firms proactively develop that leadership capability.

What is your firm doing to prepare tomorrow’s leaders?

Some law firms seem to be full-time participants in law firm merger activity. As new markets are entered and competitors gobbled up, the voracious law firms bring to their transactions a wealth of experience their counterparts often lack. If your law firm is thinking about merger for the first time, will a lack of experience lead to rookie mistakes that are a source of regret forever?

Avoiding ever-lasting errors requires a number of things. For starters, good professional help, be it legal, financial, or strategic, is essential. A do-it-yourself merger, even if your M&A practice group is stellar, is fraught with risk. But beyond the professional assistance, a driven curiosity in five merger elements can guide first-time merger participants towards fewer mistakes and happier outcomes. Being inquisitive about the following five things may not assure eternal bliss, but they likely will prevent abject misery.  

Understand the Terminology.  In most mergers, the more experienced firm opens discussions with a language unique to it that describes basic concepts. The terminology may seem unintelligible, it may seem a little familiar, or it may match perfectly with concepts at the novice firm.  But don’t assume that familiar sounding terms have a familiar meaning. Unless all the nomenclature is understood, key components of any proposed transaction will be missed, and post-closing life may be disappointing.

Check References. A lot of firms seeking to merge or acquire other firms have been doing similar transactions for a while.  If so, dig deep into the firm’s track record of integration, post-merger success and failure.  Calls to former partners for references on the other firm is simply good diligence. You’d be surprised at how much you learn.

Understand the Firm Policies.  No one would contemplate a merger without digging into the other firm’s constituent documents.  Don’t stop there.  A lot of what gets done in a firm is contained in its policies.  Many law firms use policies extensively as management tools-those tools can make day-to-day life very different from the glorious stories told while courting.  Understand the policies-they will provide a glimpse into future.

Understand the Firm Strategic Plan.  Read the other firm’s strategic plan to be sure its strategy and tactics are clear-but also read between the lines.   Understanding a firm’s overall strategy helps you determine whether your firm fits within the other firm’s plan.  For example, if the experienced firm’s strategy seeks to eliminate low margin practices, some targeted firm practices may not fit well.  Worse yet, if your prospective merger partner doesn’t have a strategic plan or it is old, the quality of management has to be questioned.

Compare the Values of Ownership.  No doubt your suitor is pouring over your data in an attempt to determine whether a merger will be a financial net benefit or burden.  You should do the same and not assume that just because it is a familiar name it is financially stronger.  You should assess the value of your equity pre-merger and post-merger.  Do the values at the other firm compare favorably? How a delta in comparative net equity, and other financial disparities, is resolved may be the difference in doing the deal or not.

When agreeing to merger for the first time, getting it right is very important because a second chance is seldom given.  With so much at stake, shouldn’t you methodically cover all the bases before saying “yes?”

First generation law firm leaders find themselves confronted by a classic “good news-bad-news reality.” The good news is that they are nearing the end of what for many has been a rewarding career. The bad? Most have no clear path of succession— for client relationships or leadership responsibilities.

There are a host of reasons; but the reality for most is an unplanned career dilemma — remain active long enough to develop and execute a succession plan, or go ahead and step away and put equity (not to mention legacy) at risk  post departure.

Faced with the dilemma, many law firm leaders find themselves entertaining a merger as a succession solution.

For those considering merger as a succession strategy, there are five compatibility issues to consider.

Culture

There is a lot of confusion about what culture really is. Simply put culture is what work life is like inside a firm day to day. What characterizes behaviors…what do conversations sound like…what topics and issues capture attention and imagination.

There is a strong correlation between a firm’s culture and what the firm most values. Not what it says about these things on the website or in recruiting materials; but where investments are made and stakes put in the ground. Eloquent copy describing a shared commitment to client service, community, collegiality, and collaboration are common. Too often there is a world of difference between what the website says and what the law firm is.

When entertaining a merger, combining with a firm with a compatible culture is essential to continued happiness and long-term retention of personnel at all levels.

Client profile compatibility

In addition to the obvious issue of legal conflicts of interest, compatibility of client/work profile is critical to executing a merger that will meet a firm’s succession goals.  The more dissimilar the profile of clients in terms of sophistication of work, size of client companies and the related rate structure, the more difficult it is to achieve an effective integration of the two firms. A merger between a firm that represents large multinational companies on “bet the company” matters and a firm that does more routine work that yields a lower rate structure is problematic from the word “go,” no matter how much both parties want to believe otherwise.

Compensation system

Differences in the cornerstones of each firm’s compensation system — the degree of subjectivity in the system, the level of draws, the balance between draws and catch-up distributions, open vs. confidential, broad based participation in compensation setting vs. a small controlling body — all of these factors provide an opportunity for conflict. Finding a merger partner with similar compensation system values and function will help in achieving succession objectives.

Financial ambitions

Every firm is different in terms of financial performance and objectives. A lack of similarity in what is valued will yield dissatisfaction, a sense of us versus them and, over the long haul, a combination that will drive attrition from one side or the other.

Leadership style

Finally, the issue of compatible leadership is a critical consideration when a merger is considered as a solution to succession issues. A group of partners that have existed in an environment with a leader that routinely engaged partners, allowing them to actively participate in the decision making and policy-setting process will be unhappy in a new environment that doesn’t include such involvement.

A merger can be a solid, even dynamic solution to issues of succession; but a critical success factor is the honest evaluation of leadership styles on both sides of the equation.

Conclusion

The market for mergers has become very hot again. Law firm leaders looking to merger as a succession solution will likely find a number of options. It is easy to be seduced by the perceived upside. Leaders who devote appropriate attention to these five factors will be much more likely to engage in combinations that survive the test of time…and deliver succession solutions for clients and firm personnel alike.

Two. That’s the number of essential conditions that any law firm merger participant should never eschew. No doubt there are other vital elements to achieving merger success, but two are so vital that their absence can doom the law firm merger of your dreams. These decisive factors, the ones merger parties must insist upon for the future, are quality leadership and culture.

When embarking on a merger strategy, identifying merger objectives is an important step. Staying true to those objectives through the merger process positions your firm for success. Merger candidates should also employ a compatibility matrix examining in detail the fit on matters of finances, compensation, culture, clients and operations. And developing a focused integration plan with identifiable follow-up activities and accountability contribute greatly to merger success.

But all those steps will mean little if the post-merger firm does not have strong leadership to lead it forward and the commitment to blend disparate cultures into one.

Leadership. Without strong leadership at the combined firm, fraying at the edges can expand to broken seams. A compelling vision will not be developed, critically correct decisions will not be made when needed most, and your peoples’ confidence in the future will be lost. The leadership vacuum will suck away the prospects for success. If the presence of a strong leader for the future is not obvious, it is wise to pause until confidence about this critical element exists.

Culture. Equally non-negotiable is the understanding of the elements and means to achieve a unified culture. In law firm merger, it is inevitable that differing cultures get brought together. While many firms have similar cultures, no two law firms have the same cultures. Being complacent that similarities alone will suffice undermines a firm’s future. Rather, a sound plan and resolve to blend two cultures into one is essential. If the merged firm cannot fuse into an institution that pursues common goals using uniformly accepted strategies, methods and conduct, its future becomes suspect.

Merger season is upon us. The details matter. But any law firm considering merger should never lose sight of the big picture. Quality leadership and culture are the big picture. If merger is in your law firm’s future, will these two must-haves be non-negotiable?

“Adaptability is the simple secret of survival.” – Jessica Hagedorn

 

 

 

The above quote from the writer and poet Jessica Hagedorn speaks to the incredible circumstances that most law firms have faced in the last year or so. In our practice we see clients responding to the environment in many ways, some are breathing deep and hoping for a return to “the good old days” and others are analyzing the environment in an effort to understand the change that is occurring as part of preparing to adapt. We have the following comments on adapting to change.

Adapting to change – At first blush the need to adapt is so obvious there would seem to be no need to discuss it. Then we see firm after firm, small to large, fail because of a reluctance, unwillingness or sheer inability to adapt.

In our experience there are 4 steps to adapting:

  1. Acceptance
  2. Evaluation
  3. Planning
  4. Execution

Step 1 -Acceptance

It has been long understood that all species operate in an environment of constant change.  The same is true for business. There are two choices, adapt or die.

In slowly changing environments, like the legal market during most of its history; responding to change doesn’t need to be hurried. In an environment like the legal market of the last several years, where change is rapid and accelerating, the appropriate response must be developed with a sense of urgency.

So, if the constant nature of change is an absolute, why do so many firms fail to adapt. I suggest that it can only be one of two things, lack of understanding of the effect on their firm, or a lack of the knowledge/capability necessary to do anything about it.

Step 2 – Evaluating Impact

There are numerous ways in which change may impact a law firm;

  • New competitors – this might include new law firms as well as a growing list of non-traditional service providers
  • Changing methods of service delivery fueled in large part by innovations in technology and/or process
  • Shrinking demand for certain types of services
  • Increasing experience and expertise among clients, in particular General Counsel, who are utilizing their power of choice —  resulting in pricing pressure, and in some cases the loss of an important client

Law firms must regularly engage in an evaluation process that attempts to understand the specific nature and ultimate impact of the changes their firms are facing.

Step 3 – Planning for Adaptation

This step includes discussing options for how a firm will respond to the primary changes it is facing.  Often this is a difficult step because the plan will almost always include the reallocation of resources in a way that improves the odds of success. A third party participant in the process can be very helpful in maintaining a level of objectivity.

Step 4 – Execution of the Plan

As is so often the case, execution can be the point of failure. A firm can expend all the resources — time and money – and end up with a killer-strategy that addresses change and scopes new opportunities. But we’ve all seen great plans fall victim to the pressures of daily realities. The plan winds up collecting dust in a desk drawer.

Meanwhile, change continues its march.

Firms that beat the “desk-drawer” fate typically do three things well:

  • Set up “short fuse” milestones for the implementation of the change plan,
  • Include a process designed to build consensus, and
  • Put the right people in charge of driving the plan.

It all begins with a full acceptance that our choices are to adapt or die.

Are you adapting?

 

As every new year begins, the idea of law firm merger grabs the attention of more than a few law firm leaders. Although the pandemic impacted the number of law firm mergers closed in 2020, all indications for 2021 suggests a strong merger season. It is no wonder as a well-constructed merger is an effective tactic to achieve strategic goals.

Law firm leaders doing their first merger often ask, “how does a merger come together?” While all transactions have their unique aspects, virtually all mergers involve four distinct phases that are interrelated and build on each other. Poor analytics and execution in any one of the phases can undermine the prospects for success. However, with the exercise of care and good judgment consistently applied through each phase, a merger can deliver the original strategic goals that drove the idea of merger in the first place.

When contemplating merger, understanding these four phases and how they relate to each other is critical.

Phase One-Understanding the Reason for Merger. The reasons behind a firm’s decision to pursue a merger can be many. Some firms need a rescue, others see a need for additional capabilities or have a desire to enter a new and critical market. A frequent reason to merge is that the combination will add market share not easily gained through organic growth. Merger can also address leadership or succession issues. Whatever the impetus, the decision to consider merger should premised on meeting a strategic initiative identified through thoughtful and critical analysis. If a clear strategic goal is not apparent, stop.

Phase Two-Understanding the Important Criteria. In Phase Two, it is essential that the criteria for merger be identified before seeking a mate. Only once the criteria are clear should a firm pursue candidates-all the while remaining faithful to the identified criteria. Whether acting opportunistically or methodically, staying true to the criteria prevents the thrill of the chase from distorting tactics. It also provides the discipline needed to walk away from a bad deal that momentum would have you close otherwise. If the criteria are unclear, or a candidate fails to meet strategically identified “must haves,” then slow down or don’t go forward.

Phase Three-Zeroing in on the Right Merger Partner. When getting to the stage of evaluating prospects, a well-designed process turns to firm compatibility. In this phase, a firm should consider whether it and its prospect are compatible on matters of culture, finances, compensation systems, clients and operations. The fit of leadership styles and the potential for future leaders that can guide a unified firm also needs attention. Do the two firms have a similar vision for the future? While compatibility need not be perfect, a pass is best for any combination with too many misfits.

Phase Four-Making the Combination Work. While it is essential that the integration and blending of the two firms be planned before closing, execution post-merger with an attention to detail are vital to bringing two disparate firms together as one. Forging a singular culture and creating systems, processes and procedures universally applied will establish the new firm’s valued behaviors. Hard work post-closing is not only important to avoiding crisis during the next honeymoon period, but also important to building the next generation of leaders and performers.

Success in law firm merger takes work. Working through the four phases carefully and methodically, with purpose and commitment, helps dramatically. If you are thinking merger, will you keep these four stages in mind?