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Law Firm Mergers: Why and How?

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In March this year, I wrote an article citing the large number of mergers in the Australian and New Zealand market. Some of these mergers were quite public but most flew under the radar – or out of the gaze of the legal media.

Reasons for mergers are many and varied and often go beyond the usual financial benefits of economies of scale. Common rationale for mergers are:

FINANCIAL PRESSURES OR OPPORTUNITY

Law firm performance and profitability is trending upward for the first time in a long while, regardless of firm size. What makes this somewhat newsworthy is not the financial buoyancy of the profession but how these profits have been made. The market for legal services is enduring price sensitivity (which likely won’t abate for a long time), and growth in fees is limited. What is driving the improvement in profit is that firms are right-sizing and operating with leaner structures. It is this low-growth environment, where organic growth is difficult, which makes the proposition of a merger an attractive option for many firms.

On the positive side, firms with an expansion mindset see acquiring a firm or practice group as the fastest and cheapest way to grow their business. They will usually have a support structure that can accommodate – both physically and managerially – an additional practice or two, which provides economies of scale.

At the other end, an acquisition or merger can provide a firm with a circuit breaker for some of their managerial challenges or deadlocks. This could be anything – ranging from succession, to disparity in contribution, or a hollowing out of market share.

SUCCESSION

It is often the case that a smaller firm that has been successful over a number of decades has a relatively small number of partners of about the same age. They have worked together for years, and they realise it is this collegiality and camaraderie that has been the ‘secret sauce’ for their success. With retirement on the horizon (and their personal financial positions well looked after) the idea of starting again with a new set of partners is not that appealing.

I have seen this happen with a number of firms where the development of internal successors has not been effective, and in some cases is not desirable in order to keep the equity tightly held. These practices are usually very profitable with a solid and transferable client base. In these instances rolling the firm into a larger organisation is a win-win for both parties. The larger acquiring firm picks up a solid parcel of fees and, as it has the managerial structure and support functions in place, is able to achieve economies of scale.

The smaller firm that is being tucked in achieves longevity with clients and a home for the staff. Depending on how it is managed, this may also be a one-off opportunity for the partners in the smaller firm to realise the value of their balance sheet (predominantly work-in-progress and debtors).

CLIENT DEMAND AND GEOGRAPHICAL REACH

Single-city firms with a national client base are often faced with pressure (real or imagined) to have a footprint that matches that of the client. Opening a Greenfield office in another city brings with it a lot of risk, such as convincing a partner or team to relocate. A merger may provide a ready-made solution as well as some benefits of economies of scale.

MAKING YOUR FIRM MORE ATTRACTIVE

With any merger, a range of cultural considerations and other issues need to be taken into account and would form part of any due diligence. Making your practice more attractive to potential purchasers relies heavily on the ease of transferability, or integration, of the practice.

A history of high performance is key. Firms where the merger is successful are ones that have been operating effectively for a long period of time and are not seeking the merger as the panacea for their operational shortcomings. To get your practice into shape consider the following checklist:

ACTIONS TO IMPROVE PROFITABILITY

Leverage / Staffing

  • Delegate anything that more junior people can do
  • Implement a robust internal training program
  • All junior lawyers to be ‘allocated’ to a partner who meets with them daily or weekly to discuss their file load and performance
  • Support-staff-to-fee-earner ratio of less than 0.7

Price

  • Ensure rates in the upper 25% of what would be considered ‘market rates’
  • Discuss fees regularly with clients and train all fee earners about how to do this

Time utilisation

  • Minimum performance levels – recorded 5.5 per day (most firms would thrive if all solicitors billed 5.0 hours per day)
  • Hold people accountable to minimum acceptable performance
  • Daily review for juniors; weekly review for seniors
  • Look at hours leverage (number of chargeable hours per fee-earner for each hour generated by an equity principal) – it should be greater than headcount leverage. This step: 1) measures the effectiveness of delegation, and 2) requires management to be more focused on the fees generated by employees than the personal billings of equity principals

ACTIONS TO IMPROVE CASH FLOW

Managing Work in Progress

  • Record all time
  • Set maximum file limits for each fee earner
  • Regularly monitor activity (and non-activity) on each file
  • Bill fortnightly
  • Hold quarterly client-free billing days

Managing Debtors

  • Discuss price in the initial interview. Be the first to raise the issue of fees. Draw matter trees
  • Bill clients the way they want to be billed – hourly rate, fixed fee, capped, etc.
  • Implement a ‘no surprises’ policy to ensure all clients are expecting an invoice and anticipate the amount of that invoice
  • Have the responsible fee earner phone delinquent clients after 30 days
  • Be open to payment plans

CLIENT MANAGEMENT AND TRANSITION

  • Have a documented approach to seeking and receiving client feedback
  • Conduct end-of-matter reviews
  • Detailed client data base – ideally with a ranking
  • As many touch points between clients and firm as possible
  • With trusted repeat clients and referral sources, discuss your succession with them. They may be more willing to help than you imagined.

Discrepancies in gross fees and profitability between merger parties can be worked through to ensure the merger doesn’t fall apart. If you tick the boxes in the above checklist then you are putting your firm in a strong negotiating position for how things will operate post merger.

As I mentioned in March, the appetite for exploring opportunities is high. Almost everyone I call to discuss a merger or acquisition wants to find out more, so the fear of rejection (in the first instance) should be put to one side.

Sam Coupland

Director, FMRC

P +61 2 9262 3377

E enquiries@fmrc.com.au