creating value through law firm mergers

Consolidation in the legal seCtorCreating value through M&A.

contents

Law firm M&A is at an all time high and is likely to intensify further

M&A as a growth strategy has a mixed history

In most cases, law firm M&A fails to create sustained value

People and cultural issues are a critical success factor in M&A

How can a firm create value through M&A?

Managing the hard factors is necessary but not sufficient to deliver value through M&A

Acquisition strategy and candidate identification

Due diligence and deal execution

Post merger integration

PA’s experience in the legal sector

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3Consolidation in the legal seCtor

M&A activity within the legal sector continues to accelerate, with 20 to 30% pa of the top 100 firms subject to an acquisitive move of some sort in each of the last few years. There are several drivers for these mergers: some troubled firms have merged to ensure survival; some strong firms have merged simply to grow or gain critical mass; and some have merged to gain critical capabilities.

The legal sector is undergoing a period of unprecedented consolidation, across all segments of the market. In each of the last three years 20 to 30 of the top 100 Global and top 100 UK firms have been subject to M&A activity of some sort whilst 2012 saw a record high number of nine cross border mergers involving a US firm. Furthermore there are an additional 23 mergers and acquisitions that have been confirmed but are yet to become effective.

Global law firms are reaping the rewards of decade old expansion strategies; those in the upper mid-market are now playing catch up.

The general consensus is that there are too many law firms at all levels of the market, legal panels are being heavily pruned by clients and scale is now more important than ever in achieving profitable growth. So most firms will have to confront the question of whether they should merge with or acquire another firm in the near future, if they are not doing so already.

This is not the first time that the legal sector has experienced waves of accelerated merger activity. Most notably, the 1987 merger of Clifford Turner and Cowan Chance to form Clifford Chance reshaped the European legal services market of the 1990s.

The wave we are seeing today is already reshaping markets with new global players – such as Hogan Lovells, Herbert Smith Freehills and Norton Rose Fulbright – emerging. Meanwhile, in domestic legal markets, firms such as Bond Dickinson and Clyde & Co. have firmly established their nationwide credentials through transformational mergers.

Law firm M&A is at an all time high and is likely to intensify further

4 Consolidation in the legal seCtor

Consolidation is an imminent certainty...on a scale not previously witnessed. SIR NIGEL KNowLES.

our research shows that, while drivers, and results, are varied. M&A in the legal sector typically falls into one of the following four categories:

Figure 1: Total law firm mergers

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Despite this record level of M&A activity, the sector remains very fragmented compared with other professional services sectors.

Acquiring a distressed firm

Broadening service capability

widening domestic coverage

Expanding international coverage


It is well known that most mergers fail to create value. Our research has shown that one of the most important critical success factors in ensuring M&As do create value is getting the people and cultural context right. This is particularly the case for law firms given the often complex nature of partnership structures, the highly specialised nature of many legal services and the variations in legal practice across different jurisdictions.

M&A as a growth strategy has a mixed history

In the legal sector we have conducted some research examining value creation for over 40 law firm mergers over the last six years. In summary, two key findings came from that work. First whilst in most cases incremental revenues were generated in the first year, by the end of the second year in many cases that incremental growth was lost and growth rates start trending down. Second in relation to profits, whilst in most cases PEP increased over the first two years, by the third year PEP was back to the pre-merger levels. It is almost as if the mergers are producing a sprint in the early years, but beyond that firms are struggling to keep the pace going. And some firms might say, why did we bother – we are bigger, but now more complicated and we aren’t making any more money. our findings are detailed opposite.

Generating greater revenue

Across three of the four categories of driver for merger, the combined entities generated greater revenues than the sum of their parts had achieved in the year prior to the merger.

Mergers driven by the need to increase domestic geographic coverage fell in the year immediately after the merger, and generated the lowest revenue increase over the three year period.

Mergers driven by international expansion and the acquisition of a distressed law firm both saw an immediate boost in revenue however the gains had begun to reverse by the second and third years respectively.

Striking impact on profitability

The results of our study of the impact on profitability were striking. with the exception of domestic expansion, in all categories of merger the early gains in profitability that were enjoyed immediately following a merger were reversing and had all but disappeared by year three.

Domestic expansion mergers meanwhile demonstrated significant and sustained improvements in profits per equity partner (PEP).


Figure 2: Percentage change in revenue following M&A Go live

Figure 3: Percentage change in profit following M&A Go live

Rev – Distressed acquisition

Rev – Market entry – Capability

Rev – Market entry – Geographic (international)Rev – Market entry – Geographic (domestic)

PEP – Distressed acquisition

PEP – Market entry – Capability

PEP – Market entry – Geographic (international)PEP – Market entry – Geographic (domestic)

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During the period under consideration, the ‘Big law’ sector achieved an average compound annual growth rate of 5.75% (revenue) and 5% (profit) respectively. When taking into account the growth that firms party to a merger would have been expected to achieve, had they merely kept pace with the market, the financial impact of M&A activity appears to be negative.

In most cases, law firm M&A fails to create sustained value

Disappointing revenue that raises questioning

M&A involving international expansion and those involving the takeover of a distressed firm both exceed the markets performance in the years immediately following M&A deals being executed. However these mergers, and all others, subsequently underperformed the market by the third year.

A distressed firm that is acquired by another firm would not be expected to keep pace with average market growth so the underperformance in this regard is understandable. However all other categories involve firms that are prima facia merging from a position of strength, or stability at least.

The underperformance of the majority of firms relative to the market raises questions about how targets are being identified, and how the integration of merger partners is being managed.

Poor profitability in all but one category

A similar trend is observed with regards to profitability, all types of M&A activity saw the parties keep pace with the markets performance in terms of PEP before trailing off by the third year.

The one exception is the performance of firms who have merged to bolster their capabilities in domestic markets. In this case, these firms significantly outperformed the market from the outset and maintained their profitability advantage over time.

Profitability is suffering to a greater extent than revenue in three of the four categories, even by Y2 and Y3 (we would expect merger integration costs to be reflected in Y1 figures).

within the international expansion merger category, a distinction must be drawn between large scale mergers of equals and the acquisition of medium sized firms by a larger rival – the former saw no increase in profitability in the early years, a reflection of the large scale investment required for integration activities in a merger of this nature.


Figure 4: Percentage change in revenue following M&A Go live

Figure 5: Percentage change in profit following M&A Go live




Market CAGR




Market CAGR

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People and cultural issues are a critical success factor in M&A

The charts on the previous page demonstrate the mixed fortunes resulting from the four categories of law firm M&A. A key difference in the approach taken post merger that separates these domestic mergers from other categories is with regards to Equity Partner numbers.

Domestic expansion mergers tended to see firms cut EP numbers immediately, and deeply (by 15% net on average) before boosting the ranks of EPs in subsequent years. In contrast, distressed acquisitions saw EP numbers cut in each of the three years following a merger, whilst the remaining two categories saw a net increase in EP numbers every year following M&A activity.

The inverse relationship between the number of EPs and level of PEP amongst firms merging for domestic expansion suggests these firms are tightly managing EP numbers for a one time PEP benefit rather than achieving sustained value add from the merger. As EP numbers begin to rise from Y2 onwards, PEP begins to fall.

The threats and opportunity of change

The challenge in achieving a cultural fit amongst the parties to a merger is one of the most commonly cited reasons for merger talks failing, and for the anticipated benefits of a merger not being realised. Changes in the culture of a firm, changing strategic priorities and the disruption to informal power bases frequently result in Partner departures – often with whole teams of associates – following law firm mergers.

At the same time, a merger offers law firms a significant one time opportunity to shake up their EP ranks, address performance issues and better align incentive and remuneration structures – all changes that are difficult to give effect to during normal times.

If law firm are really getting to grips with these cultural and people issues then we would expect to see this feed through into increased revenues and profits per EP. However the data suggests that neither the threat nor opportunity are being effectively managed in the majority of cases.

Distressed acquisition

Market entry – Capability

Market entry – Geographic (international)Market entry – Geographic (domestic)

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Figure 6: Percentage change in EPs following M&A Go live


So how can a firm create value through M&A?

Mergers and acquisitions are a notoriously challenging undertaking to design, plan and execute in a way that creates value to the organisations involved.

Countless sector agnostic studies of the results of M&A have been carried out in the past decade by leading business, consulting and academic organisations. whilst they differ in the precise numbers, they all conclude that anywhere between 55 and 85% of mergers and acquisitions destroy value.

The reasons for these failures are numerous, varied and in many instances unique. However a small number of specific reasons are cited in a significant proportion of merger failures across industries and sectors.

Most commonly cited reasons for failure (%)

Limited integration planning 80

Took longer than anticipated 76

Inadequate training 62

Information systems inadequate 56

Poor management practices 45

A value creating merger is all the more challenging for law firms, and indeed other professional services companies, due to the key assets of the business being its people who are highly mobile, and for the most talented, highly sought after by rival firms.

There is broad consensus amongst sector analysts that the legal market will consolidate further and a group of 10 to 20 major global players will emerge and pull away from the rest of the market. As the legal market continues to globalise and consolidate, the prize on offer for the firms that can successfully grow their reach and capability in a sustainable way is significant, the potential cost of getting it wrong is no less so.

What should a Managing Partner be focused on in planning a value-creating M&A strategy or campaign?

Managing both the ‘hard’ and ‘soft’ factors through the entire process from acquisition strategy and candidate identification, through due diligence and deal negotiation to post-merger integration is vital to assuring value is created for the Partnership.

Commonly reported issues in law firm mergers

•Poor strategic fit of M&A candidates.

•Social and cultural challenges of integration.

•No process to identify and exploit synergies.

•Failure to anticipate competitor, client and employee reaction.

As the legal market continues to globalise, the prize on offer for the firms that can grow is significant.


Managing the hard factors is necessary but not sufficient to deliver value through M&A The soft factors; people and culture are critical.

when looking at the M&A journey, we typically break it down into three distinct phases:

Formulating the strategy and identifying candidates

Conducting due diligence and executing the deal, and finally

The post-merger integration


law firm

consolidationlaw firm

consolidationCreating value through M&A

BUILD THE VISIONFOR THE FUTURE

BE CLEAR ABOUT THE RATIONALE

ENSURE THE PEOPLE DEAL WILL WORK

OVERINVEST IN PEOPLE ISSUES

THROUGHOUT pmi

DUE DILIGENCE and

DEAL EXECUTION

ACQUISITIONSTRATEGY AND

CANDIDATEIDENTIFICATION

POST-MERGERINTEGRATION

Managing both the ‘hard’ and ‘soft’ factors through the entire process is vital to assuring value is created for the Partnership.

within each phase there are a number of both hard and soft factors that need to be managed to ensure value is created for the partnership. The hard factors are of course necessary to deliver value through M&A, however they are not in themselves sufficient. The more interesting area, and the one that is frequently neglected, is around the soft factors, namely people and culture.


For law firms, a successful merger can at a stroke add capabilities in new fields or markets, and can boost prestige and open the doors to an entirely new class of clients.

Acquisition strategy and candidate identification

Be clear on the rationale for merging and consider the specific challenges that your merger strategy will bring.

Mergers can have a transformative effect on the parties involved, and indeed upon the sectors in which they operate. For law firms, a successful merger can at a stroke add capabilities in new fields or markets, and can boost prestige and open the doors to an entirely new class of clients.

The rationale for a merger will inform a firms acquisition strategy and how they go about identify potential merger targets. The merger rationale will be determined by the following key considerations:

•what is our vision of the future combined entity?

•what benefits are we targeting and when, what are the key risks involved?

•How can we ensure our key assets, our people, are protected through this?

•How will we evidence success?

Law firms are adopting a range of structures to accommodate merged entities, amongst them; Full integration, Swiss Verein and ‘Franchises’. Each brings with it a unique benefits and risks profile. Decisions regarding structure are fundamental to your merger strategy.

we have defined four categories of merger rationale which defined by their target outcome. This is by no means the only way to classify mergers and it may be that a firm has other reasons for consolidation. However the merger is categorised, it is critical to be clear on what a firm is seeking to achieve as this will inform everything from the candidate identification process to negotiations strategy to merger integration planning.

In the first phase, managing the soft factors means building a powerful internal coalition that has informed, bought into and can really get behind and support the merger strategy. If pockets of strongly held opposition or even apathy to the merger ambitions remain at this point, then there are likely to be significant challenges later down the line when some of the more contentious decisions arise.

Each category of merger will have its own risk and benefits profile. The benefits profile associated with mergers can range considerably and may include; enhanced international profile and capability, increased revenue/profitability or simply survival.

The respective risk profiles are similarly broad and may include excessive overlap in capabilities or property portfolios, significant numbers of partner and associate exits, or unforeseen client conflicts arising post merger.


During this phase it is also essential to conduct an honest appraisal of your culture. The term culture is often treated as little more than a buzzword and is a notoriously difficult concept to define but we think its encompasses such things as:

•how lawyers are targeted, rewarded and their careers developed,

•the way in which profits are shared amongst partners,

•how power is exercised,

•the degree to which work life balance is a reality within a firm, and

•the relationship between lawyers and business services staff.

Taking into account these factors , determine what are the things that are really important to the partnership, the things that make a lawyer choose your firm over all others. This can only be achieved through widespread and meaningful consultation with your people.

Many of the challenges faced later in the integration journey stem from the fact that the two (or more) firms involved are simply too different in terms of culture. It is difficult to overemphasise how damaging it can be, if parties to a merger do not honestly appraise their own culture and put that front and centre in merger candidate identification. In respect to those cultural considerations, a clear view is required as to what are the red lines that you can’t or won’t compromise on? The answer to this will be a key influencer of who you choose to merge with.

The acquisition strategy and candidate identification process should be built around these requirements and red lines. These requirements, combined with the answers to the key questions outlined opposite will lead to a set of selection criteria for evaluating proposed merger candidates. Firms should diligently and robustly consider how each of the potential targets line up against this criteria.


In deal-making, the plan is as important as the price.

Due diligence and deal execution

This phase provides the firms with the first opportunity to really interrogate the respective assumptions, and claims, made by the firms regarding the hard (finances and operations) and soft (people & culture) factors.

Each party should at the outset independently draw up their acceptance criteria or list of issues that need to be satisfactorily addressed in order to proceed. Identify early on what are likely to be the key elements of the deal which are likely to cause problems later.

As part of this, a firms ‘red lines’ should be shared openly in order to set reasonable expectations as to the likelihood of success.


The critical role of financials and operations

Financials are of course a crucial aspect of DD. Best practice indicates particular diligence should be applied to the pipeline of work, trends and any assumptions that underline a firms revenue projections. Are the firms respective assumptions regarding market trends and the impact on projections similar, or contradictory?

Look behind the numbers at the robustness of the firms recent revenue stream – a firm that has undertaken a significant number of lateral hires in recent years may have enjoyed a bump in revenue owing to a partner bringing with him a book of clients which may in the short term revert to the partners former firm.

In terms of operations, decision will need to be taken over the property portfolio, location of headquarters and migration to common technology systems, to name just a few. The earlier these decisions can be taken, the sooner the accompanying transition risks can be grasped and mitigation developed.

Additional elements which should be considered as part of any merger negotiation are those regarding rate structures, alignment of practice capabilities and client relationship management and client conflicts. These are likely to be of primary concern to your clients, who will likely have learned of merger discussion by this point. Your partners will want clear and consistent answers to the questions their clients will inevitably raise with them on these points.

Don't ignore the significance of people and culture

The merging of professional services firms is essentially the combination of two groups of people, so the key success criteria is going to be the degree to which the respective firms culture are compatible, and what trade-offs in culture may be necessary to make the deal work. The ‘people deal’ should therefore be at the heart of DD and deal execution. Law firms should be realistic in ensuring that the ‘people deal’ will work and be prepared to walk away if necessary.

Culture is more than just a buzz word or platitude. Culture encompasses the vision, values and ways of working of a firm and will likely have been built up over many years. The billable targets, work life balance, approach to promotion (lock step or otherwise), structure of equity banding and even secretarial ratios all have a powerful effect on behaviours and the type of people who are attracted to and retained within a law firm.

Law firms in merger discussions will commonly form working groups involving staff of all levels in the organisations to meet and work through specific issues relating to their roles and job functions in the combined firm– the success, or otherwise, of these collaborative teams will provide a clear insight into the degree to which the firms are culturally compatible.

For firms who have invested years in cultivating a particular culture, and are highly successful, there is likely to be a very low tolerance or appetite for cultural trade-offs. This is arguably the biggest stumbling block to the type of magic circle-US elite law firm merger that would truly transform the legal sector. Some of the most successful elite firms have elected to pursue organic growth rather than mergers due to reluctance to compromise on their prized culture.

Law firms equally should not expect the combination to be without challenges. Questions of profit sharing, the name of the firm, leadership roles and other organisational considerations will inevitably be contentious. The temptation to kick these questions into the long grass should be avoided and instead these challenges should be addressed head on.


over invest in people issues during integration and for the first three years.Employees typically find the merger and integration experience an unsettling and indeed a threatening one. During this period firms are vulnerable to competitors poaching their top talent.

The challenge for law firms is to keep hold of their key talent, manage the creation of a combined unified culture, whilst also ensuring the business case benefits profile is being realised – that’s quite a balancing act

The integration of two firms post merger is a hugely complex undertaking that requires a very disciplined project management approach. Most law firms will not possess in house capabilities experienced in a project of this nature and should look to the external market to source a dedicated merger integration PMo and highly skilled project managers to manage the process.

For many law firms, the focus of the leadership team in the immediate aftermath of a merger is on organisational structures, equity splits and cost reductions. It is right and proper that they should do so, but firms should be mindful not to exclude consideration of front line staff and lawyers. Employees typically find the merger and integration experience an unsettling and threatening one. During this period firms are vulnerable to competitors poaching talent during this time.

Honest and transparent communications with staff about the combined firms vision and what the implication of that are for them are important to ensure the firm retains their key assets during this period. The communication plans should include all key stakeholder, particularly the clients of both firms

An integration plan that focuses on achieving quick wins that deliver tangible and personal benefit to individuals is the most effective way to maximise the chance of achieving this balance. Get this right and firmwide benefits - the hard benefits - will naturally follow.

Make cross selling a reality early on. Employ a structured programme (and seek external support to do so if necessary) to work with the two sets of partners to identify and take advantage of the cross selling opportunities.

This will drive the benefits delivery profile of the merger and also help to demonstrate to the partners that the merger is mutually beneficial, thus helping to build trust and relationships within the newly formed teams.

The process of merger integration is a long term one and will in most cases stretch to a number of years. Throughout this period the progress against goals and objectives should be measured robustly and routinely with corrective action employed where necessary.

Post merger integration18 Consolidation in the legal seCtor

Over invest in people issues during integration and for the first three years.

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1. Target the optimal mix of benefits

5. Ensure a governance structure which facilitates rapid decision making and clear accountability

2. Structure the programme for fast, efficient delivery of benefits

3. Recognise the speed required – with rapid start up and realistic time horizons

4. Clear management around the benefits case

Figure 7: Five steps for effective post merger integration


PA understands the dynamics of professional services firms and law firms in particular.

we are familiar with the challenges in the current market and the requirement for substantial change in the way legal services are delivered and law firms are configured. These include:

•Significant merger activity as firms seek to gain and consolidate market share.

•In-house legal departments growing in size and power, absorbing work that would otherwise be given to law firms.

•Increasing use of legal panels and procurement leading to the disaggregation of the client relationship.

•Rate reductions forcing a re-examination of service delivery models.

•Legal Process outsourcers and alternative business structures (ABSs) entering the market, currently focusing on commodity work but aspiring to move up the service value chain to challenge established firms.

•Support services playing an increasing role in organisation success and differentiation. Billing, financial and matter reporting, programme management, access to know-how and sales support and technology that will all be critical in developing stronger links with clients.

•Flexibility and adaptability that will be critical in a two-speed global market, where growth remains buoyant in developing countries but stagnant elsewhere.

•The critical role that technology and legal project management can play in delivering consistent client service and managing profitability.

PA’s experience in the legal sector20 Consolidation in the legal seCtor

In 2013, the professional services sector represented approximately £12 million revenue for PA. we have worked in the sector for over ten years and have provided assistance to a number of law firms including:

•global elite firm – identified £150 million savings in back office functions;

•global business law firm – built and embedded world-class sales/business development process and capabilities;

• leading international firm – developed a strategy for taking cost out of the routine elements of legal services;

•major UK firm – developed a business led IT strategy to support the firms growth ambitions;

•major UK law firm – conducted a firm wide review and optimisation programme for key business processes.

we bring this knowledge and experience to bear through our team, all of whom have significant relevant sector experience, including lawyers and consultants who specialise in the legal sector.


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