Mergers and acquisitions (M&A) activity was once a much more discreet and less competitive area of the legal sector. Aside from the really high-profile deals, firms that wanted to join together, acquire another firm or be acquired for whatever reason, would typically get on with it in relative privacy, with a carefully managed (usually fairly local) PR approach.
In recent years however, M&A has become something that hits the headlines regularly and is reported widely across the legal press. Even during the toughest periods of COVID-19 related lockdown, it was the topic du jour, and it still forms a key part of lots of firms’ long-term strategies.
Indeed, for many law firms, there is going to be some degree of direct and indirect involvement with the M&A world – as advisers in some cases and participators in others.
From our perspective as advisers to law firms, the last year has seen a big increase in M&A related discussions. This has been driven by a combination of firms finding balance and looking further ahead following the pandemic, the growing necessity for imminent and decisive succession planning for some and the availability of external investment.
Despite the increase in discussions and apparent appetite, the level of completed deals achieved is surprisingly low. Recent SRA data showed that completed deals reached a 10-year low in 2021, with only 99 deals completed in 2021, and that followed a general, albeit gradual, decline from previous years.
However, the enthusiasm clearly remains, and a recent study suggested that two thirds of law firms are expecting to see an increase in legal M&A activity.
The drivers behind this enthusiasm have shifted over the years, as the ever-increasing cost base for firms has created increasing stress on profitability, and M&A is seen by some as a way to counter this stress.
At the same time, succession planning has landed back at the top of agendas, following a couple of years where the subject was largely put on hold as partners focused their minds on the short-term operational challenges. Now we are over that hill, we may well see an acceleration of retirements over the next few years.
The other significant change has been a growing base of external investment. 2022 saw some sizeable private equity (PE) funds being spent in the sector as some PE houses looked to expand their portfolios into new sectors. Based on the direction of travel in the last 12 months, we anticipate this will continue to grow in 2023.
So, in light of all that is happening, firms would be well advised to keep growth and succession strategies as key agenda items for the foreseeable future, and that means making sure they keep the component parts of these strategies under review at all times as well. If the time comes where M&A becomes an action point, it is important that firms have considered both the opportunities and the pitfalls that can arise through the process.
Although employee ‘value’ is not necessarily quantified as part of a firm’s goodwill valuation, people make up the bulk of the operational and cultural goodwill in a law firm.
Recruitment and retention of good quality members of staff have been the common objectives and main challenges for all professional practice firms for many years, and of course key employees can leave if they feel the firm of the future does not match their view of what they originally signed up for.
There will be some level of staff attrition with most deals, but the more it can be contained, the more successful the deal will be.
Staff happiness does not always correlate to tangible benefits, and a large amount of energy should be dedicated to ensuring that the culture of the newly merged firms is aligned as far as possible from the outset.
A famous management consultant once said, “Culture eats strategy for breakfast” and that is probably truer with professional service firms than any other type of business.
From a logistical point of view, there are plenty of points that can become ‘culture clashes’ if they are not fronted up and agreed at an early stage, but they are frequently overlooked.
For example: who pays for what? There will be more than the initial deal costs to think about, and longer term issues such as property dilapidations, future client claims, rent reviews, bad debts, long-term contingent work in progress; the list is long, but not endless.
There are basic operational issues too. Who calls themselves managing partner? Who is the finance director? Perhaps even the decision of who gets to park where. These can be sensitive conversations, but are not always approached with the care that they require.
Getting key members of staff and management from both sides to meet before the deal is done can be a really positive experience and build links at a stage
when both sides might be feeling anxious about what the future looks like.
There is always a risk that clients will not show the same loyalty under a new firm, so being able to demonstrate continuity and a ‘business as usual’ (or
perhaps a ‘business+’) approach will be key to calm client jitters.
Focusing on delivering a personal service to clients requires buy-in from all staff, and those members of staff need to feel they have the support and time to
build relationships. A partner-led approach for key clients, while not always the most cost efficient, can add resilience to those relationships.
Do not forget that there will also be a pressing legal need for conflict checking between clients of the newly merged firms to avoid a potentially damaging
situation in the future.
Firms do not always seek professional advisers on M&A transactions. Although there is no requirement for them within a deal, it limits risk immensely and alleviates the stress and time constraints of a deal process.
Professional advisers are used to issues that arise and therefore can advise your firm on all aspects of a transaction. Likewise, a seller who carries out ‘reverse
due diligence’, can prove to be useful to both sides, as this helps ensure that where, for example, deals contain deferred consideration elements or earn out
arrangements, they are reasonable and bearable.
The importance of robust due diligence in all areas is critical, but financial due diligence is often overlooked or too broadly summarised as being a general ‘kick
of the tyres’ to make sure the numbers stack up. The reality is anything but, and firms should have a detailed checklist of the really important factors.