Preparing for the Merger
The law firm merger (also known in the profession as an integration) process generally has five stages: pre-transaction planning, transaction negotiations, execution, 30-90 day transition, and post-transaction integration. While each transaction has its own unique timeline, recognizing and properly executing on each phase is critical to success. To make this simple, we provide descriptions of each of the five phases.
About eight months before the anticipated signing date, the firms contemplate a merger and decide that a combination is in their best interest. Then, they designate transaction leaders within the two firms. The leaders form a joint deal team, typically with participants from their HR, finance, IT, marketing, and office administration groups. This team meets weekly (and then more frequently as needed) to formalize and complete a merger plan that will be shared with firm leaderships. A preliminary due diligence review is also completed during this stage to identify potential "deal-breakers" or unique issues that may require extra attention. At this point, firms also appoint a spokesperson who will be the public voice of the combined firm. Through practice group leaders, marketing and business development, surveys, and focus groups, firms begin evaluating their talent, clientele, and financials to determine the relative strength of the firms’ combined products and services that must be marketed after a merger.
During pre-transaction planning, firms should analyze six key factors: cultural compatibility, product and service fit, geographic and industry practice synergies, client and market share opportunities, financial compatibility, and risk. Too often, firms become highly focused on the deal terms and neglect a critical analysis of these six areas.
Once the deal team pre-plans things well enough and the firms decide to move forward, they begin supercharging their due diligence efforts. A deeper examination of their systems and infrastructure is completed. Clients are identified as to who will be retained and who will be dropped. Integration planning now takes center stage. The transaction teams start creating integration plans to be followed during the next phases. Those plans cover all areas, from the handling of all incoming communications, to the migration of files , to the consolidation of facilities. Also, once the deal team and their firms have agreed to proceed with the transaction, the firms schedule joint meetings with all employees to explain the proposed transaction. It is important during this phase to optimize the communication value to clients, prospective clients, and referral sources; this usually includes an announcement and a comprehensive press kit.
During this phase, firms begin creating integration plans that address operational and administrative matters. It also addresses service offerings and the ways that the firms will market the combined offerings in the years ahead. In addition, firms can create a social media strategy for the resulting firm from the merger. Finally, firms become DST’s (Designated Successor Trustee). This means that successor trustee partnerships (i.e., K-1s) that had been created by the target firm’s partners will be rolled up to the surviving firm’s D.S.T. partnership for all partnership tax years ending on or after the date of the merger for income and loss allocation purposes. This means that any losses or credits sustained by the target’s DST partnership will offset income prior to the date of the merger (generally up to three years prior to the date of the merger depending upon when the tax filings were due). Having an understanding of this transactional feature is critical to the merger process.
Perhaps the most important phase, it will eventually determine the success or failure of the transaction, is the ability of the merged firm to stay the course with its integration plan. Failure to do so will usually result in a level of discontent and eventually a deterioration of the expected firm culture. Some of the critical functions and issues addressed during post-integration planning include joint practice team integration, moving and consolidating operations, joint marketing, human resources integration, IT and financial systems integration, key leadership role and organizational structures, office facility consolidation, and budget guidance. Remember, what the firms commit to during the integration planning phase needs to be fulfilled during the post-integration phase. Otherwise, the merged firms will likely stumble into their instability rather than gracefully transition into the future.
Performing Due Diligence
As we note above, profitability is often an area of focus in a merger. A thorough examination of the financial condition of the firm is a major part of the due diligence process, but for various reasons, it does not always get the attention it deserves. An analysis of the firm’s financial health should go well beyond looking at the bottom line. A good business analyst can go back three years or more to identify trends and potential "red flags" in the information. Part of this analysis will look at staffing. Layoffs prior to or shortly after a merger are a big red flag, as they might indicate that the financial situation was known by insiders but hidden from potential partners. If layoffs are likely needed, the proposing firm should get a clear understanding of which positions would be eliminated before a deal is consummated. This information will be helpful for budgeting the post-merger firm. Also, any firm considering a merger should do its own financial analysis of the merging firm. Too often firms has relied on what they have been told by the merging firm. The results are not always what the firm expects. Certain recent acquisitions in the AmLaw 200 have not proven to be as productive as the acquiring firm had anticipated and have resulted in financial difficulties for the firm. The "three year rule" holds true in this case regardless of the "hockey stick" growth that might have occurred only several years earlier. The merger should be viewed as a three-year plus commitment by both firms.
The buyer of a firm needs to take the time to conduct a complete due diligence review of the firm being considered for acquisition. The financial period has been extended and this results in the delay in a firm getting all of the necessary documentation. If the supporting documentation is behind, use the best available information but hold an anticipatory reserve to provide for errors or avoided information.
Legal Terms and Regulatory Compliance
In the context of a law firm merger, the compliance landscape through the merger process will be anything but simple. Legal obligations and compliance issues that must be addressed will range from simple to complex. Addressing the basic requirements is not optional. Addressing complex issues may be required by regulators or otherwise satisfied through negotiation between participants.
For every merger, basic legal structural considerations will include providing for the approval by the boards of directors (or equivalent governing bodies) of each participant. One legal issue that often arises involves subordinate boards. For example, if one law firm is organized as a professional corporation, its subordinate board will need to approve the merger. To address this, aside from a basic approval, the participants in the merger may need to negotiate transition services or agreements with the subordinate board of the professional corporation. Another merger-related consideration involves matters related to state bar requirements. As part of the overall legal due diligence process, legal counsel for each participant will need to identify specific state bar requirements applicable to each participant. Once identified, state bar requirements will need to be carefully reviewed with the impacted parties in order to determine how they should be addressed.
A law firm merger will also normally raise legal issues in relation to both pending and anticipated litigation. Specifically, the merger may require a transfer of interests in pending or anticipated litigation. How the existing agreements are transferred and ongoing litigation obligations are dealt with is a variable that needs to be carefully considered during the due diligence process. For transfer approvals, often the approval process can be minimized by ensuring that approvals are provided for at the outset. In contrast, in other instances, the law firms may need to obtain approval from third parties even after the merger is completed.
As with most mergers and acquisitions across most industries, antitrust issues may be a significant concern. While antitrust risks are present in many mergers, antitrust issues may have a significant impact on law firm mergers. Specifically, where competition between merging law firms has the potential to be eliminated and where there are overlapping practice areas, antitrust issues may be triggered. Notwithstanding, antitrust can be a complex topic and is subject to various factors such as geography and competitive positions. Specific antitrust issues are fact-specific and the impact of such issues may differ even among law firms operating in the same city.
Culture Fit and Staff Transition
One of the most challenging aspects of a law firm merger is addressing the cultural differences that can arise between two law firms. When two law firms come together, they are often bringing together teams of attorneys and professional staff members that have lived and breathed the culture of their respective firms for many years. Any major changes to that culture could be jarring and disruptive to that team. Here are some thoughts about how to deal with cultural differences:
● Determine whether the cultural differences can be reconciled between the firms. For example, if both firms have been successful and have enjoyed substantial success in a particular practice or geographic area, you may find that the same culture can be sustained and fostered among that group going forward.
● Take a closer look at those cultural issues that cannot co-exist. Prepare a unified plan for how that cultural difference – which may be a deeper, more fundamental issue – will be resolved after the merger. If the legal marketing and client development culture are different, for example, you may want to have a series of meetings to discuss these issues and to develop a unified plan going forward for retaining and building the client base.
● Designate a cultural integration team, made up of well-respected lawyers and professional staff from both organizations, to address these issues. This team should be able to initiate a series of communications and meetings with the broader teams in order to explain and give context to the goals of the merger. This includes clarifying that, although the combined organization will be larger, it will only be successful if it retains the best talent and clients from both firms. In other words, the "glue" that is required to sustain the merger lies primarily in the ability of the combined team to create, grow and retain the same or, ideally, greater levels of business.
The cultural integration team should be given the time and the authority to speak freely and frankly about the issues associated with these cultural differences and work with both sides to develop a unified plan for addressing and resolving them. This is a key part of helping to keep teams together at the combination and understanding what the strategic combination means for that particular client group or practice area. The result is a significantly better chance of retaining the entire team that made each firm successful in the first place, as well as avoiding comments among clients like, "This was just another raiding of the firm that did us no good at all."
Sometimes, the solution to cultural differences will be to divide the team and create an organizational structure that will allow the professionals to develop their own businesses and practices under a common brand but a divergent culture. In other words, one firm may choose not to consolidate in the way that some have done in the past. An organizational structure that allows for teams to define themselves and operate in such a way can be every bit as effective as any other structural combination. There is no requirement that the law firms combine all of their resources into one structure. Rather, firms should keep in mind their strategic vision for the combination, and then chart the path of integration that will best accomplish that vision.
Finally, the merger team should be transparent about these cultural issues and the plans for resolving them. Success or failure will depend largely upon an understanding and acknowledgement of the challenges presented by those cultural differences and the need to address them proactively and ahead of time.
Financial Integrity and Asset Allocation
A disparity of wealth usually exists in any law firm merger. The larger firm will have the greater free equity, the smaller firm will have the higher contingent liabilities, the larger firm will be able to ride through the changes in the economy with less penalty than the smaller firm. To put it bluntly the bigger firm has the greater cash cushion and can better afford mistakes.
The first task is to determine what the value of each firm is in an absolute sense. This is done by performing a balance sheet valuation of each firm. This means that you must perform a fair market value for every asset and liability of each firm. Then you must set off the net fair value assets against the assets that may result in future contingent liabilities or costs. An example of such a liability is malpractice claims. A firm that has been in existence for 10 years without claims may well have no, or very low, value for such a continuing liability. However, a firm with the same size but which has been in existence only four years may have a very high value as to future claims liability. In short, an accurate balance sheet valuation must be performed for each law firm and the results "netted out" against future losses or liabilities.
One very important aspect of the financial planning for the merger will be the post-merger debt position of the new firm. As noted in the discussion of the new position of the firm after the merger , the firm’s economic health is tied very closely to its debt position. If the merger is highly leveraged, the new firm will be unable to absorb many changes in client business, including consolidation and mergers.
Some trouble may be brewing, in this respect, for some law firm mergers. Recently, there has been a large wave of law firm mergers resulting in firms with $500 million and $1 billion in revenues. As these firms move forward, there will no doubt be many clients who need to restructure their businesses. These changes will have a great effect on the new law firms. This is because there will be fewer major clients in each industry and each client will have a smaller market segment to deal with. This is especially true in industries such as the pharmaceutical, telecom, energy and financial services fields.
Wealthy law firms will be able to withstand these changes, although there could be fewer profitable industries and higher competition in the law firms than there are today. The danger will come to those firms who have leveraged themselves heavily. This is particularly true in an environment of consolidating industries. A heavy debt burden will stifle the firm’s ability to react with agile strategies.
Operations and Client Integration
It’s vital for the merging firms to have a solid client communication strategy if they’re to achieve success in their post-merger integration. The first step is to create a list of clients to whom you will need to communicate what, and when. Clients should receive notice of the merger, its time frame, and its implications for the client as soon as possible. They should also be invited to ask questions and to meet with representatives of the merging firm to discuss. A second communication is to be sent the firm’s "key contacts" — specifically, the contacts who will regulate their services. The announcement should give information about the advantage to them of the merger, which should ensure their loyalty. Whom else does your firm need to communicate with? Make a list that includes: The key is to have a clear, easy-to-follow communication roadmap that ensures your employees and your clients are aware of the changes taking place, the reasons for them, and reassures them about the new firm that is being created. With this in mind, you’ll also be able to assure clients about any issues that are troublesome to them, and to help them accept the change in their relationship with your firm. Providing dedicated individuals within the new firm who can assist clients with their questions will quickly assure clients that the merger will be an enhancement, not a liability.
Technology Roadmap
Often technology systems are often the final frontier to completing a merger or acquisition between two law firms. Sometimes the integration of the technology systems and databases is relatively simple. Other times, it is complicated by the sheer diversity of the systems and applications supporting the law firms.
Among the areas where unreconcilable differences may exist between the merging firms include:
• The respective database management systems;
• Specific practice management systems;
• Financial systems; and
• File retention and storage.
In eliminating redundancies, there are many potential problems, and the promise of operating efficiencies is seldom realized. The costs associated with integrating the IT systems of a merging law firm are expected to be borne in large part by the merging law firms themselves.
Technology integration can take many different paths, and in most cases the IT consultant tends to be the most valuable resource on standby. Often the merged law firm has a tumultuous IT infrastructure, with less than effective resources to maintain the system. In such cases, integrating the systems of the two firms may be more complex and require an entire overhaul of the IT department.
Integrating the technology systems of two merging law firms is a necessary component of an effective merger. In transforming the two merging law firm branches into a new tree, every branch will have to be expertly trimmed to achieve the desired outcome.
Integration Evaluation and Next Steps
Effective post-merger evaluation involves tracking key performance indicators (KPIs) and soliciting feedback from attorneys, staff, and clients. Metrics should include financial data, employee turnover rates, and client retention rates, among other areas. Such data can help determine whether the merger is on track to achieve its goals. Regular feedback from team members ensures they are adapting well to the changes, whilst also making clients feel supported in the transition.
While evaluating the merger’s progress, it is essential to continuously assess and refine processes for improved efficiency and quality. This should include identifying best practices and areas where technology and automation can enhance current workflows, thereby reducing errors that may arise from an increase in workload post-merger . Regularly revising internal documents such as engagement letters can also help to ensure that they still align with the firm’s vision and values.
After evaluating the initial merger success, acquiring firms should regularly meet with key personnel from the combined team, as well as stakeholders, to identify successes and challenges. This enables the law firm to recognize its strengths and address deficiencies before they can hinder the firm’s progress.
Adaptability is a key factor to success in law firm mergers. The firm should be flexible when assessing the strength of the combination. If after a year or two the result is not ideal, the firm should be receptive to the need for improvement, including devising an exit strategy if necessary.