It’s no myth that firms must grow to survive. In the industry, either the firm grows by successfully serving clients to create more business and referrals, or it stagnates, shedding talent and clients to other firms that are growing. While the need for growth is widely accepted as truth, the best strategy on how to achieve growth depends on the business.
For law firms that choose to grow, the options are limited to: growing organically using existing resources, making lateral additions of key partners or mergers with other firms.
Although most studies suggest 70% to 90% of mergers and acquisitions fail to reach their goals, recently there has been a wave of mergers and acquisitions among law firms in an effort to achieve various strategic objectives.
According to legal consulting firm Altman Weil Inc. there were 88 mergers of law firms in the U.S. during 2013, the most since Altman Weil began tracking such information.
In our experience, the most common reasons for a merger are some variation of the following:
To gain or expand expertise in certain industry groups
To alleviate financial burdens or improve the firm’s financial outlook
To gain access to new markets
To better serve growing clients that have an increased demand for services
To achieve top tier status in the marketplace by increasing lawyer headcount and revenues
There are a host of reasons why firms choose to merge but one fact remains true and that is the importance of due diligence throughout the initial phases of the merger. A strategic plan should be approved before the merger process is started, then the firm should address the following questions:
How do we want our clients to perceive us and how do they perceive us now?
How does the profession view us and how do we want them to view us?
How do our non-partners and our staff perceive us and how do we want them to perceive us?
What are the things we value about our current firm and how can we protect them?
What clients do we wish to attract and how will we go about attracting them?
How do we view our management structure?
With law firm mergers becoming more prevalent, many firms are reaching out to consultants and advisors to assist with the creation of strategic plans, perform due diligence procedures and help create merger agreements. The entire acquisition process can be intricate, extensive, and time-consuming. Consultants that work with law firms are likely to have experienced staff that can assist with identifying issues and other risks that arise throughout the acquisition process.
With each acquisition being different, there is no template or checklist available to ensure that the merger will go as smoothly as possible. However, throughout our experience as consultants and advisors to law firms, we’ve identified several best practices that should be considered as a part of a merger due diligence process:
Identify a Merger Committee
The firm should assemble a small group that has the respect and confidence of the partner group to serve as a merger committee. The committee must have the ability to make decisions that bind their partners without further consultation but they must also be willing to communicate with everyone and get them involved in the process. The need for other committees should also be considered.
Pro Forma Budget
Short-term and long-term budgets are necessities in establishing the financial goals for the merged firm.
The agreement should be simple but detailed enough to address matters such as: the effective date of the merger, the firm name, the form of the merger, who will be the partners, what their percentage ownership will be, how the capital accounts will be structured, who the Merger Committee shall be, the form of firm management, who will be the non-partners with the new firm, how conflicts will be dealt with, the use of committees, liabilities from before and after the merger, and a statement of the principals affecting a partner's percentage share in the firm.
Upon merging, a modification should be made to the Partnership Agreement to address matters such as: withdrawal, retirement, expulsion, resolutions, an amending formula, fiscal year end, duty to practice, admission to the partnership, partner's disability, death of a partner, disclosure, benefits payable to partners, voting rights, arbitration, and its relationship to the Merger Agreement.
Client concentration risk among partners and the tenure of those partners should also be considered. Will a substantial book of business be lost if a partner retires after the merger? Also, how long have certain clients been with the firm? The odds of retaining clients usually improve with relationship longevity.
If a valuation for assets, accounts receivable (including bad debts and the possible future recovery of them) and work in progress is necessary, consultation with your accountant is recommended so that your decision includes all applicable tax considerations.
A review of information systems involved in a merger is often either not given enough attention or overlooked completely. Due diligence of information systems includes a review of the hardware and software, information security, and the firm’s website, as well as an assessment of the potential need for system upgrades and increased security.
Analyze and determine where the home office will be and where the business office will be located. The day-to-day systems of the firm will have to be examined, adjusted to fit the new firm and conveyed to all professionals and staff. This includes: billing procedures; the various forms to use; the type of filing system (centralized or decentralized); disbursement recovery procedures and payroll. In the beginning stages of any merged firm, it’s common to have duplicated roles and positions. However, mass dismissals tend to hurt the success of a merger, so firms should consider reallocating job duties, if possible.
As the market has shown us recently, it appears that the odds are stacked against merging firms. However, if proper and thorough due diligence is completed, the chances of success of the deal in terms of its impact on the firm’s growth can be enhanced.
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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