Merger, Acquisition or Organic Growth?
Last year I wrote an article for “Managing for Success” magazine looking at the topic of merger, acquisition or organic growth. Given the effects of Covid19 on the market, I thought it worthwhile revisiting the article and seeing what, if anything, had changed.
Changes in the legal market still continue at a pace, although there may be more fire-sales than previously. Recessions and traumatic events tend to hit poor players more than most and some law firms that were hanging on pre-pandemic may now be forced into situations where they have no option but to seek a buyer. This of course create opportunities for those firms who have access to cash or just the ability to become a successor practice,
In September 2018, there were 10,456 law firms in England and Wales. In the year to June 2018, 345 firms closed and 154 merged or amalgamated. Of these 10,000 firms 2,392 were sole practitioners and that the distribution by turnover has a long tail – to get into the top 200 firms you need a turnover of under £10m.
In September 2020 there were 10,135 firms with 2,073 sole practitioners. In the year to July 2020, 510 firms closed and 408 opened. Approximately 40% of the closures were due to amalgamations with 60% ceasing trading. These will be interesting figures to view next year.
The implication of this is that there are still an awful lot of small to medium size firms, and many are ripe for merger or acquisition.
We can add to this evidence that law firm partners in the small to mid-size firms are getting older. Our experience is that before the 2008 crash many law firms were making good profits and some partners, aged in their 40s, they 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 60s and often with no succession plans, making their firms good acquisition targets for growing firms.
Add a global pandemic into the mix, coupled with hardening PII prices and there are even more firms looking for saviours.
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.
As the title to this article implies there are three main ways of growing – merger, acquisition or organic growth. One of my favourite truisms in the M&A sector remains “There is no such thing as a merger” and, 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.
In this article I 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 on the firm.
Having said that there’s no such thing as a merger, they do exist. Where two firms of complementary size and with complementary sectors and, crucially, 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. Beware of course 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.
If the parties decide that it is a merger but the new firm will still be Smith & Co (possibly using the phrase “incorporating Jones & Co” for a minimum period) then it begins to look less like a merger. Similarly if the majority of senior positions are occupied by partners from one of the old firms, it looks like an acquisition.
Often the parties think a merger is easier to sell internally to partners and staff, but it becomes obvious who is taking the decisions and not being truthful does not help. Of course, flattering the egos of those being acquired may make sense.
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).
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.
As with all acquisitions, post-merger integration is key. This will be discussed in more detail under acquisitions below.
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 solicitors to act for you on a merger or acquisition as they are being paid to make the time and to offer an external perspective. Trying to do it internally comes up against the pressures of paying client work and a desire to make it happen irrespective of any evidence that comes to light.
Decide on a rationale for the acquisition. What are you looking for and why? What sort of firm? Think about: Number of people, turnover, profitability, areas of work, geography etc.
Conduct a market search: This is often best done by outside consultants. Narrow the search down a small number of firms that meet your criteria and make an approach to them for initial conversations. This can be done anonymously by a consultant working for you. If there is interest on both sides you will then need to sign a Non-Disclosure Agreement (NDA) and start talking.
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. What partners do you want to come on board and for how long? Are you becoming a successor practice?
Once you have agreed structure you need to get your solicitors to draft heads of terms which set out the key terms of the deal, 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.
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 both parties know about the other. If some of the acquired partners are joining the buying firm, it is reasonable for them to ask some questions about the firm which they are joining.
This leads to the transfer agreement – be it an asset transfer, a share transfer or even a merger agreement (which is just an asset transfer). This will contain the warranties against which the sellers can disclose any known issues.
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 the 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! With no PII cover in place, the deal will not happen.
It is often said in the M&A market generally that 70% 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 advisor 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 (apart from a few process driven firms) is nothing.
From the above, we can see that merger and acquisition 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.
Firms looking to grow organically must also look to their systems and processes. Do they have systems and processes in place that are capable of servicing more work? If the firm has not been growing, the partners must ask themselves why.
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. Moving into different areas of law in order to diversify is a sensible move for some firms, but do the 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!
The management team of the firm must be integrated and competent. Organic growth needs a good HR team to recruit, develop and – crucially – retain new people, a good marketing and business development team to market the organisation and attract new clients, a good IT team to ensure the systems are in place and some headroom in all the support functions to support a growing business. In simple terms, ask yourself if you have enough empty desks – or these days good enough systems to manage more people remotely.
One way of achieving quicker organic growth, other than by a full scale merger or acquisition, 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 specific skills that you need. We are seeing a lot of this in the personal injury sector where small firms are selling their Pl book to specialty Pl 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 good, although team moves have created plenty of litigation and are often prohibited in LLP agreements. Please take specialist advice before contemplating acquiring a whole team, unless with the other firm’s approval.
The conclusion has not altered in the past year or so, there are pros and cons to growing by merger, acquisition or organic growth. There is no “one size fits all” and firms may well grow by a mixture of all three as appropriate.
The current market certainly creates more opportunities to acquire good people, struggling firms or to use the time to revisit your strategy for organic growth.
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.
The three key messages are: Culture, Culture and Culture.