Lessons from Failed Mergers Attempts

Even under the best circumstances, the odds of merger discussions between two law firms actually resulting in a combined firm are relatively low. There are numerous cultural, logistical, and business case issues that naturally prevent two firms from unifying. In addition, for the large majority of small and mid-size firms in this country, pursuing and evaluating a merger represents new and uncharted territory. Consequently, these firms tend to approach the merger process without the tools and information required to succeed. What are some of the issues and challenges that inhibit many firms from achieving a successful merger? Below we offer several real-life scenarios that often prevent stable and profitable law firms from successfully finding a merger partner.

Unfunded Retirement Plans

Sample Scenario: T&Y is a well-respected 300-lawyer firm that operated a large, unfunded retirement plan (estimated liability totaled $20 million (NPV)).

Unfunded retirement plans are obligations the firm has agreed to pay retired partners out of current-year profits, as opposed to a separate account that was funded over time to pay the plan participants. Often, these unfunded retirement payments are set for the life of the retired partner.

When T&Y underwent its merger search process, management soon realized that it would have to do something about the unfunded plan. The partners at the target firms wanted nothing to do with having a portion of their future profits go toward paying retired partners that they never even knew. And, while T&Y was open to the idea of structuring a merger in such a way that its legacy lawyers were responsible for paying the retirement obligations, the target firms did not feel that approach was appropriate for a combined firm and even doubted the practical feasibility of such an arrangement.

T&Y walked away from the merger search process with a belief that its unfunded retirement plan needed to be closed out. It then took the necessary steps to freeze the plan and develop arrangements to pay out its current participants. T&Y's realization is not uncommon. We have seen many firms come away from dissolved merger talks with a belief that they could no longer afford to run their current retirement plan.

Excessive Number of Unproductive Partners

Sample Scenario: M&N is a Midwest regional firm that has solid Business and Litigation practices, but it harbors a large number of underperforming partners (25% of the partnership consistently has low hours and originations). The firm's management is self-described as “too nice” and the firm is looking to grow its business through a sizeable merger.

It is not uncommon for a firm to have a considerable number of partners who are performing significantly below partnership standards. There are countless reasons as to why and how this happens; for M&N, it was because management struggled to make difficult decisions, such as to let underperformers go or address their work shortfalls. So when it decided to pursue merger opportunities, each firm it approached balked at the number of underperforming partners M&N carried. Although the overall strengths of M&N may have outweighed the performance challenges, the target firms simply did not want to add such a large number of underperforming partners to their firm.

Some firm leaders justify underperformers by stating the underperformers' compensation matches their low productivity, and therefore the firm doesn't lose money on them. These leaders are not considering the opportunity cost of keeping underperformers. M&N learned this the hard way, and eventually did come to terms that its partnership had to part ways with a number of individuals before it could move forward in its merger search.

Lack of Focus

Sample Scenario: P&Q is a national full-service firm and several of the firm's primary competitors have recently completed acquisition transactions. Now P&Q feels it needs to acquire a firm in order to keep pace with its competition. The firm has no formal strategic plan.

Ideally, the decision to pursue merger opportunities comes as a result of a detailed strategic planning process where the strengths and needs of the firm have been carefully analyzed and determined. Unfortunately, for many firms, the decision to pursue merger opportunities comes in response to an unforeseen internal or external event (e.g., a group of lawyers departing, competitors merging). Merger searches that spring from a knee-jerk reaction frequently have a scattered and unfocused approach. These firms are typically more interested in “doing something (anything)” than following a strategic plan.

P&Q is such a firm. When management was asked about its merger and acquisition priorities, it listed its need to expand the Litigation Group, Business Group, Energy Group, Health Care Group, and Real Estate Group. When asked about its geographic target, its response included every major city on the East Coast for its Business Group and any major city nationwide for its other groups.

P&Q used a shotgun approach for its merger search and blanketed firms in a wide variety of markets with merger overtures. Those representing the firm had a difficult time convincing target firms that P&Q was serious about moving in any particular direction or geographic location. For example, the targeted Energy boutiques wanted to hear specifics as to how they would benefit from joining P&Q; they also wanted to see a trend of demonstrated commitment to the Energy industry (i.e., recent Energy-related lateral hires, a Web site highlighting the Energy practice, increased marketing expense to promote the practice). P&Q was only able to provide superficial generalizations for the future, and therefore left its targets underwhelmed. P&Q ultimately had to put its merger search on hold until it could develop a thorough strategic plan that would focus and prioritize the firm's needs and objectives.

Unrealistic Expectations

Sample Scenario: G&F is a full-service southeastern regional firm with profits that are competitive with its regional peers. The firm believes it should expand its reach through a merger with a national/international firm.

Unrealistic expectations are another trait that can sink a firm's prospects early on in the merger search process. G&F's executive committee worked with this author's firm to develop a merger target list, and was nearly outraged by the firms that appeared on the preliminary target list. The firms on the list were all second- or third-tier national firms with very pedestrian profits. G&F's leadership wondered why top-tier or “white shoe” firms were not identified, and why they would be shown such an unexciting list of potential merger partners. We had to explain the reality of the situation; only the firms listed on the target list would be interested in a firm like G&F. The firms G&F had in mind would have zero interest in G&F as a whole entity.

G&F's executive committee was able to get past the initial letdown of the realistic list. However, it had originally coaxed the partnership into approving the merger search by suggesting they would likely be acquired by an A-list firm. Once word got back to the general partnership about the firms on the target list, the search process lost momentum and, eventually, the necessary support of the partnership. While a merger with a firm on the target list would have still strongly benefited the firm, G&F was unable to move forward in the process due to unrealistic expectations established at the outset of the process.

Only Swinging for Home Runs

Sample Scenario: D&C is a 200-lawyer, full-service firm with an up-and-coming Corporate and IP practice, and an Insurance practice that represents the majority of the firm's revenue. In an attempt to dilute its reliance on Insurance, D&C wanted to merge with a similarly sized firm that had a strong Corporate practice and little or no Insurance. D&C approached the eight firms at the top of the target list and was rebuffed by each one.

A “home run” merger represents a merger in which the partnering firm satisfies all the criteria of the searching firm's checklist. Or, in other words, it is when a firm merges with its ideal partnering firm. Unfortunately, some firms are not in a position to land a home run merger, even if their ambitions appear modest. The issue D&C ran into was that its eight ideal target firms were all turned off by D&C's large Insurance practice. D&C tried to portray its Insurance practice as the portion of the firm's business that provided economic stability. However, the target firms felt it represented too much of D&C's overall revenue.

After striking out with its top eight firms, D&C ceased its merger search and decided to continue as a standalone firm. What D&C should have done was to move on to its B-List merger candidates (non-home run candidates). The firms on the B-List were smaller firms that had the practice mix D&C coveted, just not the overall size. A merger with the right B-List firm could have helped strengthen the practices D&C was interested in strengthening, while helping to dilute its reliance on the Insurance practice. One or two of these B-List mergers could have significantly repositioned the firm and allowed D&C to take another (and possibly successful) subsequent run at one of its A-List firms in the future.

Conclusion

Firms with the best chance of finding merger success are those that have taken the time and effort to position themselves for success, prior to the merger attempts. These firms have taken the initiative to reduce their number of underperformers, ensure clean financial operations, and develop a realistic and prioritized plan of attack toward the merger process. Firms that are properly prepared not only improve their odds of merging, but are also able to save time, money, and credibility by minimizing the number of target firms that are approached and minimizing the number of show-stopper issues that arise late in merger discussions.

As law firm merger activity increases in 2011, there will undoubtedly be firms that successfully complete mergers and those that do not. It is hoped that the lessons learned from the scenarios presented above will assist a few merger-seeking firms in avoiding some common pitfalls and help them achieve their merger-related goals.

Jonathan S. Kuo is a consultant with Hildebrandt Baker Robbins, a global management consulting firm that specializes in the legal profession. He is based in Washington, DC, and can be reached at [email protected].

Even under the best circumstances, the odds of merger discussions between two law firms actually resulting in a combined firm are relatively low. There are numerous cultural, logistical, and business case issues that naturally prevent two firms from unifying. In addition, for the large majority of small and mid-size firms in this country, pursuing and evaluating a merger represents new and uncharted territory. Consequently, these firms tend to approach the merger process without the tools and information required to succeed. What are some of the issues and challenges that inhibit many firms from achieving a successful merger? Below we offer several real-life scenarios that often prevent stable and profitable law firms from successfully finding a merger partner.

Unfunded Retirement Plans

Sample Scenario: T&Y is a well-respected 300-lawyer firm that operated a large, unfunded retirement plan (estimated liability totaled $20 million (NPV)).

Unfunded retirement plans are obligations the firm has agreed to pay retired partners out of current-year profits, as opposed to a separate account that was funded over time to pay the plan participants. Often, these unfunded retirement payments are set for the life of the retired partner.

When T&Y underwent its merger search process, management soon realized that it would have to do something about the unfunded plan. The partners at the target firms wanted nothing to do with having a portion of their future profits go toward paying retired partners that they never even knew. And, while T&Y was open to the idea of structuring a merger in such a way that its legacy lawyers were responsible for paying the retirement obligations, the target firms did not feel that approach was appropriate for a combined firm and even doubted the practical feasibility of such an arrangement.

T&Y walked away from the merger search process with a belief that its unfunded retirement plan needed to be closed out. It then took the necessary steps to freeze the plan and develop arrangements to pay out its current participants. T&Y's realization is not uncommon. We have seen many firms come away from dissolved merger talks with a belief that they could no longer afford to run their current retirement plan.

Excessive Number of Unproductive Partners

Sample Scenario: M&N is a Midwest regional firm that has solid Business and Litigation practices, but it harbors a large number of underperforming partners (25% of the partnership consistently has low hours and originations). The firm's management is self-described as “too nice” and the firm is looking to grow its business through a sizeable merger.

It is not uncommon for a firm to have a considerable number of partners who are performing significantly below partnership standards. There are countless reasons as to why and how this happens; for M&N, it was because management struggled to make difficult decisions, such as to let underperformers go or address their work shortfalls. So when it decided to pursue merger opportunities, each firm it approached balked at the number of underperforming partners M&N carried. Although the overall strengths of M&N may have outweighed the performance challenges, the target firms simply did not want to add such a large number of underperforming partners to their firm.

Some firm leaders justify underperformers by stating the underperformers' compensation matches their low productivity, and therefore the firm doesn't lose money on them. These leaders are not considering the opportunity cost of keeping underperformers. M&N learned this the hard way, and eventually did come to terms that its partnership had to part ways with a number of individuals before it could move forward in its merger search.

Lack of Focus

Sample Scenario: P&Q is a national full-service firm and several of the firm's primary competitors have recently completed acquisition transactions. Now P&Q feels it needs to acquire a firm in order to keep pace with its competition. The firm has no formal strategic plan.

Ideally, the decision to pursue merger opportunities comes as a result of a detailed strategic planning process where the strengths and needs of the firm have been carefully analyzed and determined. Unfortunately, for many firms, the decision to pursue merger opportunities comes in response to an unforeseen internal or external event (e.g., a group of lawyers departing, competitors merging). Merger searches that spring from a knee-jerk reaction frequently have a scattered and unfocused approach. These firms are typically more interested in “doing something (anything)” than following a strategic plan.

P&Q is such a firm. When management was asked about its merger and acquisition priorities, it listed its need to expand the Litigation Group, Business Group, Energy Group, Health Care Group, and Real Estate Group. When asked about its geographic target, its response included every major city on the East Coast for its Business Group and any major city nationwide for its other groups.

P&Q used a shotgun approach for its merger search and blanketed firms in a wide variety of markets with merger overtures. Those representing the firm had a difficult time convincing target firms that P&Q was serious about moving in any particular direction or geographic location. For example, the targeted Energy boutiques wanted to hear specifics as to how they would benefit from joining P&Q; they also wanted to see a trend of demonstrated commitment to the Energy industry (i.e., recent Energy-related lateral hires, a Web site highlighting the Energy practice, increased marketing expense to promote the practice). P&Q was only able to provide superficial generalizations for the future, and therefore left its targets underwhelmed. P&Q ultimately had to put its merger search on hold until it could develop a thorough strategic plan that would focus and prioritize the firm's needs and objectives.

Unrealistic Expectations

Sample Scenario: G&F is a full-service southeastern regional firm with profits that are competitive with its regional peers. The firm believes it should expand its reach through a merger with a national/international firm.

Unrealistic expectations are another trait that can sink a firm's prospects early on in the merger search process. G&F's executive committee worked with this author's firm to develop a merger target list, and was nearly outraged by the firms that appeared on the preliminary target list. The firms on the list were all second- or third-tier national firms with very pedestrian profits. G&F's leadership wondered why top-tier or “white shoe” firms were not identified, and why they would be shown such an unexciting list of potential merger partners. We had to explain the reality of the situation; only the firms listed on the target list would be interested in a firm like G&F. The firms G&F had in mind would have zero interest in G&F as a whole entity.

G&F's executive committee was able to get past the initial letdown of the realistic list. However, it had originally coaxed the partnership into approving the merger search by suggesting they would likely be acquired by an A-list firm. Once word got back to the general partnership about the firms on the target list, the search process lost momentum and, eventually, the necessary support of the partnership. While a merger with a firm on the target list would have still strongly benefited the firm, G&F was unable to move forward in the process due to unrealistic expectations established at the outset of the process.

Only Swinging for Home Runs

Sample Scenario: D&C is a 200-lawyer, full-service firm with an up-and-coming Corporate and IP practice, and an Insurance practice that represents the majority of the firm's revenue. In an attempt to dilute its reliance on Insurance, D&C wanted to merge with a similarly sized firm that had a strong Corporate practice and little or no Insurance. D&C approached the eight firms at the top of the target list and was rebuffed by each one.

A “home run” merger represents a merger in which the partnering firm satisfies all the criteria of the searching firm's checklist. Or, in other words, it is when a firm merges with its ideal partnering firm. Unfortunately, some firms are not in a position to land a home run merger, even if their ambitions appear modest. The issue D&C ran into was that its eight ideal target firms were all turned off by D&C's large Insurance practice. D&C tried to portray its Insurance practice as the portion of the firm's business that provided economic stability. However, the target firms felt it represented too much of D&C's overall revenue.

After striking out with its top eight firms, D&C ceased its merger search and decided to continue as a standalone firm. What D&C should have done was to move on to its B-List merger candidates (non-home run candidates). The firms on the B-List were smaller firms that had the practice mix D&C coveted, just not the overall size. A merger with the right B-List firm could have helped strengthen the practices D&C was interested in strengthening, while helping to dilute its reliance on the Insurance practice. One or two of these B-List mergers could have significantly repositioned the firm and allowed D&C to take another (and possibly successful) subsequent run at one of its A-List firms in the future.

Conclusion

Firms with the best chance of finding merger success are those that have taken the time and effort to position themselves for success, prior to the merger attempts. These firms have taken the initiative to reduce their number of underperformers, ensure clean financial operations, and develop a realistic and prioritized plan of attack toward the merger process. Firms that are properly prepared not only improve their odds of merging, but are also able to save time, money, and credibility by minimizing the number of target firms that are approached and minimizing the number of show-stopper issues that arise late in merger discussions.

As law firm merger activity increases in 2011, there will undoubtedly be firms that successfully complete mergers and those that do not. It is hoped that the lessons learned from the scenarios presented above will assist a few merger-seeking firms in avoiding some common pitfalls and help them achieve their merger-related goals.

Jonathan S. Kuo is a consultant with Hildebrandt Baker Robbins, a global management consulting firm that specializes in the legal profession. He is based in Washington, DC, and can be reached at [email protected].