Growing pains

Change in the legal market continues at a pace. This creates an exciting opportunity for law firms that are looking to grow. There are three main ways of growing: merger, acquisition or organic growth. In this article, we look at each option and how to make the best choice for your business.

Throughout, we use the term ‘partners’ to refer to those who own and manage law firms, whether they are partners, members, directors, shareholders or even senior employees responsible for the strategic direction of the business.

The size of the opportunity

In the year to June 2018, 345 firms closed and 154 merged or amalgamated. In September 2018, there were 10,456 law firms in England and Wales. Of these 10,000 firms, we know that 2,392 are sole practitioners and that the distribution by turnover has a long tail – to get into the top 200 firms, you need a turnover of over £10m. The implication of all this is that there are an awful lot of small to medium-sized firms, and many are ripe for merger or acquisition.

Mergers are often acquisitions in disguise

We can add to this evidence the fact that law firm partners in most small to medium-sized firms are getting older. Our experience is that before the 2008 crash, many law firms were making good profits and some partners, aged then in their 40s, did not bring senior staff into partnership.

The crash happened and life got difficult for many firms, and the overlooked aspiring partners left. This has now improved for most law firms, but those partners are now in their 50s and often have no succession plans, making their firms good acquisition targets for growing firms.

Additionally, we are seeing mergers and acquisitions at the top end of the market, with larger firms looking to get closer to the top tier.

Merger

One of our favourite truisms in the M&A sector is there is no such thing as a merger; with very few exceptions, all mergers are in effect acquisitions, and the more the partners of the merged firm stress that it is a true merger, the less likely it is to be one.

Having said that, ‘true’ mergers do exist. Where two firms of complementary size within complementary sectors and, crucially, with the same culture, ethos and beliefs come together, then a merged firm can come into being. If the businesses of Smith & Co and Jones & Co are both transferred into a new entity, Smith Jones & Co, it may well be a merger.

A merger makes sense where a firm operates in some niche practice areas but is struggling to achieve growth. A firm can merge with another firm practising in the same niche areas to achieve critical size, or with a complementary firm to achieve greater cross-referrals and economies of scale (although this is often easier said than done).

The key message is to be clear on your strategy: growth for growth’s sake is pointless

However, as we said, mergers are often acquisitions in disguise. Perhaps the new firm will still be Smith & Co (possibly using the phrase ‘incorporating Jones & Co’ for a minimum period). Or are the majority of senior positions occupied by partners from one of the old firms and not the other? In both cases, this begins to look a lot more like an acquisition.

It could be that the parties involved decide to describe an acquisition as a merger because it’s easier to sell internally to partners and staff – but it will become obvious who is taking the decisions, and the deception will make your people distrust you. Conversely, flattering the egos of those being acquired may make sense.

A true merger requires firms of a similar size with a similar culture and complementary practice areas. It requires a new merged identity, and probably name, and a management team made up equally (as far as possible) from people in each of the merged firms.

Even in a ‘true’ merger, there will still be problems: beware the disenchanted partners in Jones & Co who still believe that Jones was a better firm than Smith and that the new name should have been Jones Smith & Co. And as with acquisitions, post-merger integration is key. For more on this, see below.

Acquisition

A simple way to grow your law firm is to bolt on another law firm by acquisition.

The stages of an acquisition (or even a merger) are set out below. It is often a good idea to appoint external advisers (accountants and solicitors in lead adviser roles) to act for you on a merger or acquisition, to offer an external perspective. Trying to do it internally comes up against the pressures of delivering client work and a desire to make it happen, irrespective of any evidence that comes to light that could cause pause for thought.

1. Decide on a rationale and strategic objective for the acquisition. What are you looking for and why? What sort of firm? Think about: the number of people, turnover, profitability, areas of work, geography etc.
2. Conduct a market search. This is often best done by the lead adviser. Narrow the search down to a small number of firms that meet your criteria and make an approach to them for initial conversations.
   This can be done anonymously by the lead adviser. If there is interest on both sides, you will then need to sign a non-disclosure agreement (NDA) and start talking.
3. Once you are talking to a potential target, you need to agree a deal structure. Price is obviously key: not just whether a premium is payable, but the payment terms, earn-outs etc. Which partners do you want to come on board, and for how long? Are you becoming a successor practice?
4. Once you have an agreed structure, you need to get your advisers to draft heads of terms which set out the key terms of the deal, as well as confidentiality and exclusivity. As a word of warning based on bitter experience: once you get to the seventh draft of the heads of terms, consider walking away. If you cannot agree outline terms easily, the rest of the deal will be difficult, and any ongoing relationship post-acquisition is likely to be fraught – and a merger really will not work.
5. Then comes the due diligence. This is the opportunity to ‘look under the bonnet’ of the target in detail. Your solicitors and accountants will review the accounts, contracts, staff, claims record, litigation etc to make sure there are no nasty surprises post-completion. For a true merger, due diligence will have to be both ways, so each party knows about the other. If some of the acquired partners are joining the buying firm, it is reasonable for them to ask some questions about their new workplace. And of course, if some of the consideration is deferred, ensure that the acquiring practice is solvent!
6. This leads to the transfer agreement – be it an asset transfer, a share transfer or even a merger agreement (which is really just an asset transfer). This will contain the warranties against which the sellers can disclose any known issues.
7. The hard work begins on completion. There are a lot of practicalities such as systems integration, changes of solicitor notifications, client contact, and most importantly, staff integration. Much of the pre-work for this, especially around regulation and compliance, must be in hand long before completion. The first person to speak to if you are contemplating a merger or acquisition is your insurance broker. Without professional indemnity cover in place, the deal will not happen.

It is often said in the M&A market generally that 70 per cent of deals fail to generate the expected synergies post-completion. Much of this boils down not to the underlying strategy of the deal, but to the people in the enlarged organisation and the effectiveness of the integration. You will need a team working on this and, again, especially for larger deals, an external professional adviser is really useful. The great management guru, Peter Drucker, said ‘Culture eats strategy for breakfast’. If the staff do not feel supported and valued, especially those who are joining a bigger firm, they will leave – and a law firm without its people is nothing.

Organic growth

Clearly, we can see that mergers and acquisitions are hard work! Organic growth is the process whereby a firm looks to grow purely by investing in itself – acquiring more clients, or carrying out more work for existing clients, and then recruiting more people to deliver that work.

There are a number of questions firms looking to grow organically should ask themselves.

• Do you have systems and processes in place that are capable of servicing more work? We have seen attempts at growth go wrong through a lack of integrated planning. Just recruiting a new sales team, without investing in staff or systems to process additional work, may result in poor service and dissatisfied clients.
• If you’re thinking about moving into different areas of law to diversify, do your partners have the skills to manage a team in the new area of law? There have been some expensive insurance claims where firms have got this wrong!
• Are your support functions set up to deal with growth? Your HR team will need to be able to recruit, develop and – crucially – retain new people; your marketing and business development team will need to market the firm and attract new clients; your IT team will need to ensure the systems are in place; and all support functions will need headroom to support a growing business.

One way of achieving quicker organic growth is to acquire a team of people or a book of work from another firm. There is none of the liability associated with a full merger or acquisition, and you can acquire any specific skills that you need. We are seeing a lot of this in the personal injury (PI) sector, where small firms are selling their PI book to speciality PI firms. In larger firms, we see a lot of team moves, where, for example, a partner or two, plus a couple of associates and solicitors all move from one firm to another. This can be effective, although team moves have created plenty of litigation and are often prohibited in LLP agreements. Take specialist advice before contemplating acquiring a whole team, unless with the other firm’s approval.

In conclusion, there are pros and cons to each way of growing: by merger, acquisition or organic growth. There is no ‘one-size-fits all’ option; firms may well grow by a mixture of all three as appropriate.

The key message is to be clear on your strategy: growth for growth’s sake is pointless. Spend time looking at the options and, where merger or acquisition is a possibility, spend time investigating the other firm. And never forget the importance of implementation: remember, culture eats strategy for breakfast.