This blog post was originally posted, in late October, by Kevin McKeown at Above the Law and his blog Leadership Close Up.  Kevin has been a tremendous resource for us and has guided us greatly as we work at delivering meaningful content about the legal industry and the significant changes it faces.

These are challenging times for the nation’s 200k+ law firms. Just look at the pace of mergers. Combination announcements appear almost weekly. In fact, 2013 was a record year for law firm mergers. And, based on the first nine months of this year, 2014 will end with a similar number of transactions. Although the mega-mergers grab the headlines, a big number of transactions are between smaller firms or smaller firms being scooped up by larger concerns seeking to gain a foothold in new markets. Last month, The American Lawyer reported on this record merger pace citing deals closed in the hot southwest legal market. Two notables:

  • LeClairRyan’s merger with Houston’s Hays, McConn
  • Fox Rothschild’s combination with David Goodman in Dallas

In both mergers, Roger Hayse and Andy Jillson of Hayse LLC advised Hays McConn and David and Goodman in their respective transactions and helped shepherd those two firms through to successful deals. Why are Roger and Andy front and center in this robust merger market? For one, they have walked in your shoes. Here are two guys who led and helped build a strong regional firm that included the strategy of merger. So, how should small-to-medium size firms approach a merger strategy? What are the “rules of the road” for achieving a successful merger? What are the best ways to manage the inherent risks? 

Let’s hear from Roger and Andy:

…………………………………………………………………………………

Managing Law Firm Transitions blog by Hayse, LLC

Roger Hayse and Andy Jillson

Beginning in 2013, we observed an unprecedented string of law firm mergers – a remarkable fact in light of reports (here and here) of the risk and failure rates associated with law firm combinations. In his article A Myth that Motivates Mergers, noted legal industry thinker Steven Harper debunks the wisdom of the merger, splashing cold water on the notion that bigger is better.

For some firms finding themselves in distress, “any port in the storm” greatly influences leadership’s perspectives on merger. Ed Wesemann’s terrific White Knight is a must-read for any firm leader seeking counsel in an hour of trial.

The broiling merger market is added evidence of what we already know — the pressure on the leaders of small to mid-sized law firms is relentless. Even as the market recovers from recession, pressures from competition and from clients wanting more for less leaves leaders of mid-sized firms at the proverbial fork in the road. The future depends on the right choice, but many are unclear about the direction they and their firms should take.

FoxRothschild-150x32The last two years underscore the fact that for many of these firms the path chosen is to merge with a larger firm. To say this is a significant step is to understate the case. Post-closing, the smaller firm ceases to exist. In two of our recent merger engagements (LeClairRyan/Hays LeClair RyanMcConn; Fox Rothschild/David and Goodman), two smaller firms accepted this outcome, believing among other things that the future for their younger lawyers was served better by combining with a larger firm (kudos to leadership for this approach).

But in light of the uncertainty of success and the permanence of outcome, does it make sense for a small to medium sized firm to dance the merger dance, and waltz its way out of existence?

Despite the odds and the warnings of Mr. Harper, a merger can make sense — IF these four steps are carefully followed.

ONE–Clarify Who You Are and What You Want?

Start with the basics.

Establish Your Strategic Objectives. As in any high-consequence transaction, the process begins by establishing your strategic objectives. There are three solid strategic reasons a law firm might consider a merger:

  1. Valuable expertise and technical capabilities can be added to serve existing or targeted clientele better;
  2. Addresses succession planning, both in terms of firm leadership, and key clients; and,
  3. Yields financial stability.

You might add to this list; but one thing is almost certain — if the objectives are not clear from the beginning, pursuit of a merger will be haphazard and potentially ineffective, or worse yet, harmful.

Assess the risk. Pursuing merger can be unsettling to a firm’s personnel, including its key contributors. Uncertainty abounds and producers, non-producers, associates, and staff wonder whether a combined firm, from a personal standpoint, will be good or bad. Indeed, uncertainty can result in unanticipated departures that can tarnish a firm’s appearance and attractiveness.

Objectively Assess Your Attractiveness. Nothing can waste more time than being unrealistic about your firm’s attractiveness. Conversely, nothing will be more disappointing than to realize that your merger strategy undersold your value. To avoid missing the mark, hire an advisor experienced in law firm mergers that will provide an unbiased assessment of your place in the market.

TWO–How Do You Prepare for the Market?

If you have decided to move forward, it is time for spit and polish and a plan for marketing.

Make Your Firm Look Good. Many times, a home sells more quickly and at a higher price if it is “staged” to look more attractive. The same can be true if proposing to enter the merger market. Deferred maintenance needs to be remedied, lingering problems need to be addressed and contingent liabilities need to be resolved or at least contained.

Develop a “Sale” Strategy. Law firms are best marketed discretely and without being on the market for too long. It is essential that your advisor develop a strategy that presents your firm to qualified candidates without shoving a “for sale by owner” sign in the front yard. An indiscriminate approach to marketing your law firm can be counter-productive and leave you “market worn.”

THREE–Preliminary Due Diligence: Are the Firms Generally Compatible?

Once you have completed your preparations and suitors come calling, the “fit” of a prospective merger partner can be assessed preliminarily by considering five areas of compatibility.

Culture. Culture is more than being comfortable with your new partners. Culture involves many things that you may take for granted but define a law firm’s DNA, including employment arrangements and practices with legal and non-legal personnel. Promotion practices, performance evaluations and decision-making processes say a lot.

Finances. Firms with a wide gulf in metrics like profit margin, revenue per lawyer, productivity per lawyer, capital, pension obligations, debt, space utilization and realization are not likely to mesh. Metrics that are more closely aligned nonetheless need to be scrutinized to avoid false positives based on apples being compared to oranges.

Clients. Clients make a firm. Besides the all-important question of legal conflicts, a firm needs to know the philosophical and strategic approach of its betrothed to business conflicts, client profiles and the proposed billing rates. These philosophies and strategies need to be studied.

Conflicts. The easiest indicator of a bad fit is if diligence reveals that each firm represents a party to litigation or other matter than creates an ethical conflict that cannot be waived. And even if a waiver is ethically possible, the manner in which one is pursued can demonstrate a lack of fit between firms.

Compensation. The setting and paying of compensation is tough in any circumstance. But trying to blend two systems in which one firm’s lawyer behavior is different than the other firm’s due to compensation system induced motivations is even tougher. Moreover, if one firm’s lawyers are used to being paid a larger draw every month than the other firm’s lawyers, something will have to give.

FOUR–Deeper Due Diligence: Is There a Deal to be Made?

Once past the compatibility test, it is time to move to the second and deeper level of diligence.

Assess Past Merger and Acquisition Success. Your prospective partner may have a track record of mergers and acquisitions. If so, dig deep into its record of integration, post-merger success and failure. Bingham McCutcheonmerged with Riordan & McKenzie in 2004 and by 2007 only 50 percent of the new additions from that firm remained. Get an explanation.

Delve Into the Firm Policies. No one would contemplate a merger without digging into the other firm’s constituent documents. But a lot of what gets done in a firm is contained in the firm’s policies that can make day-to-day life starkly different from the happy talk heard during the courting stage. Read them and understand them.

Understand the Firm’s Strategic Plan and Vision. If the firm has a strategic plan, read it to make sure the firm’s strategy and tactics are clear, but also read between the lines. Gaining a holistic understanding of a firm’s strategy and vision for the future can help determine if your firm fits within the larger firm’s plan. If your prospective merger partner doesn’t have a strategic plan or it is old, its commitment to management has to be questioned.

Get a Handle on Recent Financial Performance and Productivity. While your suitor pours over your financial data, you should return the favor to determine whether financially a merger will be a net benefit or burden. You should also assess the value of your equity pre-merger and post-merger and seek compensation if appropriate. Are productivity levels close? Plans to lift up a slower firm are tough to pull off.

Capital. The capital invested by one firm’s partners may be very different than the capital committed by partners of another law firm. How capital is calculated and returned on departure is as important as knowing how much capital is invested. Two firms with widely different capital profiles and policies could find their combination ill fitting.

Debt Levels and Collection Practices. Debt can be the hobgoblin of law firms. Bringing two firms together with different debt levels and/or approaches to debt can be difficult. In some instances, however, a small debt laden firm can be acquired by a bigger firm with low to no debt if the debt in the combined firm ends up being small compared to the strategic gain delivered. Debt levels can be positively or negatively impacted by collection practices. Are both firms similarly disciplined about collecting bills?

Concluding Thoughts

Hayse Blog

This blog is co-authored by Roger and Andy.

Law firm merger, as an answer to crisis, competition, or succession, is a viable alternative for some, but not all, small to medium sized law firms.

Danger lurks for the law firm whose leadership pursues merger without methodically understanding whether merger fulfills a strategic imperative. Even if a compelling case for merger can be made, only careful execution can optimize the prospects for a successful merger. Following these four steps can be the difference between a merger that works and one that doesn’t.

For a small to medium sized law firm contemplating merger, can there be anything more important?