The Urge to Merge

In the midst of the current recession-induced pummeling of law firms and in-house legal departments, some positive changes are occurring that are setting the stage for a stronger industry. One is the quantity and quality of law firm mergers that are being consummated.

Though the second quarter had an anemic showing ' just seven mergers, according to Altman Weil ' it followed a bullish first quarter of 25 mergers. As of mid-September (just before press time), 13 mergers had been recorded for the third quarter. Last year, a record 70 mergers occurred ' 18 in the first quarter, 26 in the second, 13 in the third, and another 13 in the fourth ' a 17% increase over 2007.

Many firms are justifiably concerned about not being able to provide clients with what they need in an increasingly global and complex world. Some see mergers as the best way to add a practice group, move into a new geographic location, pick up/absorb a competitor, or combine with another small firm to increase their prominence in a given market. Others want to ensure they are not cherry picked. Mergers can accomplish a lot, but they are serious undertakings and should not be entered into without careful analysis and planning.

The Importance of Due Diligence

The first and most important issue for firms to consider is the other firm's culture. It is often more important than financial considerations and if not attended to upfront can undermine a deal even when other aspects seem to work. In fact, in the Lateral Partner Satisfaction Survey (LPSS) conducted by Major, Lindsey & Africa (MLA), partners ranked culture as the second-most important factor when considering which firm to move to. It should be equally important when evaluating a potential merger partner. To help determine compatibility, find out what the other firm emphasizes and the relative importance of each, e.g., hours, originations, diversity, cross-selling, prestige, and pro bono work. Asking a lawyer about his/her firm's culture, however, may not generate the information sought. The better question to ask may be, “How does the firm determine equity partner compensation?” That will undoubtedly reveal which behaviors the firm rewards and which it discourages, which is essentially what a firm's culture is all about.

A critical financial review is also essential. No merger should occur that does not make sound economic sense. A 10% to 20% difference between the two firms' profits per partner (PPP) is generally the maximum one should allow. Equally important is any significant disparity in the firms' revenue per lawyer (RPL).

Firms considering a merger also need to review all potential client conflicts, just like a partner considering a lateral move. The larger the firm, the more client hurdles there are likely to be. Conflict searches should be performed very early in the discussions.

Management and Structure

Equally important is each firm's management and structure. You need to determine how the firm is managed. It is usually by a strong chair or co-chairs in consultation with an executive committee elected by the equity partnership, but that is not always the case. Inquiry should be made into term limits, staggered terms and how the executive committee is constituted ' geographically, by practice area or in some other way. It is also worth finding out if there is a separate compensation committee that acts independently from the executive committee and how that committee is elected and constituted. Another important consideration is whether the partnership is multi-tiered. Given today's economic realities, one must inquire whether thought has or should be given to changing the existing structure.

Compensation

Compensation of all attorneys is an increasingly important and changing element and must be discussed. Thought should be given to the firm's system ' e.g., lockstep, target compensation plus bonus or straight points ' and how often compensation is determined. Is the compensation system open or closed? What are the targeted billable and non-billable hours for associates, counsel, and equity/non-equity partners and what were the actual numbers for the past three years? What are the targeted billing rates and realization rates (after write-offs/write-downs) for associates, counsel and equity/non-equity partners? What are the partner/associate and attorney/staff ratios? Are the people and mechanisms in place to provide proper support? Are their personnel and tax records available?

Capital Structure

Inquire about the firm's capital structure. What capital does the firm have on hand currently? What are the capital requirements for incoming partners and are they adjusted annually? Also inquire about possible unfunded firm obligations, such as pension payments to partners and, if there are, whether (and what) the cap is as a percentage of firm profits that can be distributed in any given fiscal year? The same applies to long-term liabilities, whether or not those liabilities are limited to the partnership, the partners' individual interests in the partnership or personal to the firm's partners, including leases or the financing of leasehold improvements, lawsuits, and bank loans. Unfunded liabilities can be real deal killers. Their size and scope need to be disclosed early in the process.

While still in the minority, a good number of firms now own ancillary businesses, e.g., title and malpractice insurance companies, labor consulting companies and government relations entities. These entities can not only be additional sources of revenue, but also client work. Find out if the firm owns any such entities, how profitable they are and how profits are distributed to the partnership.

It is helpful to have each firm develop a pro forma list projecting its future performance as a stand-alone entity and another projecting the performance of the merged entity, thereby enabling determination of the kinds of activities the two firms can expect to accomplish together. While conducting this exercise, remember that it is easier to increase conservative assumptions than retreat from outlandish ones. Make sure your negotiation papers include adequate confidentiality and non-poaching provisions.

Many firms think that mergers will accomplish great economies of scale. This is not always the case ' not like in the business world, where merged companies can often reduce expenses by consolidating departments like IT, HR and payroll. Law firms incur expenses no matter where they are. In fact, experience shows that the larger a firm becomes, the more it costs on a per-lawyer basis.

Market-Specific Questions

If the merger is primarily about moving into a new market, the questions set forth below should be asked, some of which may require an in-depth market/demographic analysis:

• Which of the firm's existing clients will be better served by this merger?
• Which firms are already serving the proposed market?
• What is the potential demand for legal services at your firm's price point?
• How satisfied are the potential clients with their current law firms?
• Would it be possible to serve those clients from the firm's existing offices?
• Are there local lawyers you can or should recruit and/or do you have existing partners and associates in key practice areas that would relocate, either temporarily or permanently?
• Which of your practices are most likely to succeed there?
• Exactly which companies are waiting for you to call?
• Is that market healthy and growing?
• What factors are driving that market, and will they last?
• Are there any particular costs specific to the new market that should raise red flags (taxes, rent, etc.)?

Wrap It Up

While the importance of due diligence cannot be overemphasized, it is also important not to get bogged down by minutiae. It shouldn't take that long to negotiate a deal. Our experience shows that four to nine months is the average time frame for a successful merger to be consummated.

So don't get caught in a quagmire of minor, small-ticket items. Those can always be addressed later. One of the issues that slows down many mergers is what the new firm's name will be and whether there should be a transitional name (most commonly found when a much larger firm merges with a smaller firm with a limited geographic footprint). If there are arguments about this, put it aside and revisit it after the more important items have been covered.

Once it is clear the merger is moving forward, senior management needs to decide what it wants to divulge, and when, to the general partnership. Nothing is gained by not getting everyone on board as soon as possible. There is a point, however, when you must have the general equity partnership involved to ensure buy-in, but don't share partial information too early. The best way to inform the partners of the details they need to know, including relevant financial information, is within the merger prospectus. The financials can then be seen within the larger scope and context.

Another thing that should be decided well before the papers are signed is the post-merger management and governance structure. These details should be hashed out during the negotiations so they are clear to everyone involved. Long-term growth objectives and a marketing plan for the new entity should also be discussed and agreed upon.

Here's to Your Future

Now that you're linked how can you ensure long-term success and happiness? Perhaps the single most important item to focus on post-merger is integration. In MLA's LPSS, partners ranked integration, or “the ability to support/expand a partner's practice,” as the most important factor when considering which firm to move to. Integration and marketing plans should be ready to roll out as soon as the deal is publicly announced to ensure maximum continuity and as seamless a transition as possible for the firm's attorneys, staff and clients. Make sure everyone feels included and is introduced to each other. Help them realize the additional opportunities they will be enjoying.

While the instability of today's economy makes it more difficult to get an accurate read on a firm's finances and prospects, well-capitalized firms will continue to look for merger partners that can provide whatever they think they are missing ' whether it be clients, geographic location or practice mix ' to help them become more efficient and competitive.

Lawrence N. Mullman is a Partner and Global Practice Leader of the Partner Practice Group of Major, Lindsey & Africa, He can be reached at 212-201-3964 or [email protected]. Based in Hong Kong, Carl Hopkins is Head of MLA's Partner Practice Group in Asia. He can be reached at 852-3628-4618 or [email protected].

In the midst of the current recession-induced pummeling of law firms and in-house legal departments, some positive changes are occurring that are setting the stage for a stronger industry. One is the quantity and quality of law firm mergers that are being consummated.

Though the second quarter had an anemic showing ' just seven mergers, according to Altman Weil ' it followed a bullish first quarter of 25 mergers. As of mid-September (just before press time), 13 mergers had been recorded for the third quarter. Last year, a record 70 mergers occurred ' 18 in the first quarter, 26 in the second, 13 in the third, and another 13 in the fourth ' a 17% increase over 2007.

Many firms are justifiably concerned about not being able to provide clients with what they need in an increasingly global and complex world. Some see mergers as the best way to add a practice group, move into a new geographic location, pick up/absorb a competitor, or combine with another small firm to increase their prominence in a given market. Others want to ensure they are not cherry picked. Mergers can accomplish a lot, but they are serious undertakings and should not be entered into without careful analysis and planning.

The Importance of Due Diligence

The first and most important issue for firms to consider is the other firm's culture. It is often more important than financial considerations and if not attended to upfront can undermine a deal even when other aspects seem to work. In fact, in the Lateral Partner Satisfaction Survey (LPSS) conducted by Major, Lindsey & Africa (MLA), partners ranked culture as the second-most important factor when considering which firm to move to. It should be equally important when evaluating a potential merger partner. To help determine compatibility, find out what the other firm emphasizes and the relative importance of each, e.g., hours, originations, diversity, cross-selling, prestige, and pro bono work. Asking a lawyer about his/her firm's culture, however, may not generate the information sought. The better question to ask may be, “How does the firm determine equity partner compensation?” That will undoubtedly reveal which behaviors the firm rewards and which it discourages, which is essentially what a firm's culture is all about.

A critical financial review is also essential. No merger should occur that does not make sound economic sense. A 10% to 20% difference between the two firms' profits per partner (PPP) is generally the maximum one should allow. Equally important is any significant disparity in the firms' revenue per lawyer (RPL).

Firms considering a merger also need to review all potential client conflicts, just like a partner considering a lateral move. The larger the firm, the more client hurdles there are likely to be. Conflict searches should be performed very early in the discussions.

Management and Structure

Equally important is each firm's management and structure. You need to determine how the firm is managed. It is usually by a strong chair or co-chairs in consultation with an executive committee elected by the equity partnership, but that is not always the case. Inquiry should be made into term limits, staggered terms and how the executive committee is constituted ' geographically, by practice area or in some other way. It is also worth finding out if there is a separate compensation committee that acts independently from the executive committee and how that committee is elected and constituted. Another important consideration is whether the partnership is multi-tiered. Given today's economic realities, one must inquire whether thought has or should be given to changing the existing structure.

Compensation

Compensation of all attorneys is an increasingly important and changing element and must be discussed. Thought should be given to the firm's system ' e.g., lockstep, target compensation plus bonus or straight points ' and how often compensation is determined. Is the compensation system open or closed? What are the targeted billable and non-billable hours for associates, counsel, and equity/non-equity partners and what were the actual numbers for the past three years? What are the targeted billing rates and realization rates (after write-offs/write-downs) for associates, counsel and equity/non-equity partners? What are the partner/associate and attorney/staff ratios? Are the people and mechanisms in place to provide proper support? Are their personnel and tax records available?

Capital Structure

Inquire about the firm's capital structure. What capital does the firm have on hand currently? What are the capital requirements for incoming partners and are they adjusted annually? Also inquire about possible unfunded firm obligations, such as pension payments to partners and, if there are, whether (and what) the cap is as a percentage of firm profits that can be distributed in any given fiscal year? The same applies to long-term liabilities, whether or not those liabilities are limited to the partnership, the partners' individual interests in the partnership or personal to the firm's partners, including leases or the financing of leasehold improvements, lawsuits, and bank loans. Unfunded liabilities can be real deal killers. Their size and scope need to be disclosed early in the process.

While still in the minority, a good number of firms now own ancillary businesses, e.g., title and malpractice insurance companies, labor consulting companies and government relations entities. These entities can not only be additional sources of revenue, but also client work. Find out if the firm owns any such entities, how profitable they are and how profits are distributed to the partnership.

It is helpful to have each firm develop a pro forma list projecting its future performance as a stand-alone entity and another projecting the performance of the merged entity, thereby enabling determination of the kinds of activities the two firms can expect to accomplish together. While conducting this exercise, remember that it is easier to increase conservative assumptions than retreat from outlandish ones. Make sure your negotiation papers include adequate confidentiality and non-poaching provisions.

Many firms think that mergers will accomplish great economies of scale. This is not always the case ' not like in the business world, where merged companies can often reduce expenses by consolidating departments like IT, HR and payroll. Law firms incur expenses no matter where they are. In fact, experience shows that the larger a firm becomes, the more it costs on a per-lawyer basis.

Market-Specific Questions

If the merger is primarily about moving into a new market, the questions set forth below should be asked, some of which may require an in-depth market/demographic analysis:

• Which of the firm's existing clients will be better served by this merger?
• Which firms are already serving the proposed market?
• What is the potential demand for legal services at your firm's price point?
• How satisfied are the potential clients with their current law firms?
• Would it be possible to serve those clients from the firm's existing offices?
• Are there local lawyers you can or should recruit and/or do you have existing partners and associates in key practice areas that would relocate, either temporarily or permanently?
• Which of your practices are most likely to succeed there?
• Exactly which companies are waiting for you to call?
• Is that market healthy and growing?
• What factors are driving that market, and will they last?
• Are there any particular costs specific to the new market that should raise red flags (taxes, rent, etc.)?

Wrap It Up

While the importance of due diligence cannot be overemphasized, it is also important not to get bogged down by minutiae. It shouldn't take that long to negotiate a deal. Our experience shows that four to nine months is the average time frame for a successful merger to be consummated.

So don't get caught in a quagmire of minor, small-ticket items. Those can always be addressed later. One of the issues that slows down many mergers is what the new firm's name will be and whether there should be a transitional name (most commonly found when a much larger firm merges with a smaller firm with a limited geographic footprint). If there are arguments about this, put it aside and revisit it after the more important items have been covered.

Once it is clear the merger is moving forward, senior management needs to decide what it wants to divulge, and when, to the general partnership. Nothing is gained by not getting everyone on board as soon as possible. There is a point, however, when you must have the general equity partnership involved to ensure buy-in, but don't share partial information too early. The best way to inform the partners of the details they need to know, including relevant financial information, is within the merger prospectus. The financials can then be seen within the larger scope and context.

Another thing that should be decided well before the papers are signed is the post-merger management and governance structure. These details should be hashed out during the negotiations so they are clear to everyone involved. Long-term growth objectives and a marketing plan for the new entity should also be discussed and agreed upon.

Here's to Your Future

Now that you're linked how can you ensure long-term success and happiness? Perhaps the single most important item to focus on post-merger is integration. In MLA's LPSS, partners ranked integration, or “the ability to support/expand a partner's practice,” as the most important factor when considering which firm to move to. Integration and marketing plans should be ready to roll out as soon as the deal is publicly announced to ensure maximum continuity and as seamless a transition as possible for the firm's attorneys, staff and clients. Make sure everyone feels included and is introduced to each other. Help them realize the additional opportunities they will be enjoying.

While the instability of today's economy makes it more difficult to get an accurate read on a firm's finances and prospects, well-capitalized firms will continue to look for merger partners that can provide whatever they think they are missing ' whether it be clients, geographic location or practice mix ' to help them become more efficient and competitive.

Lawrence N. Mullman is a Partner and Global Practice Leader of the Partner Practice Group of Major, Lindsey & Africa, He can be reached at 212-201-3964 or [email protected]. Based in Hong Kong, Carl Hopkins is Head of MLA's Partner Practice Group in Asia. He can be reached at 852-3628-4618 or [email protected].