How to benefit from a merger

Credit crunch, legal services reforms, threats to legal aid... the competitive environment for small law firms operating in England and Wales exhibits more threats than opportunities. Traditional markets are at risk from new entrants and the availability of substitutes for the services that are traditionally supplied by solicitors.

Small firms are faced with a looming recession, higher levels of client sophistication and expectation, greater levels of regulatory control and increasing legal complexity. They face competitive pressure from one another and from larger firms. More importantly, they will shortly face competitive pressure from big retailers, membership organisations and (possibly) banks, building societies and insurers in many of their core business areas.

Moreover, recent studies have confirmed that, in general terms, smaller firms are less profitable than bigger firms and that the internal dynamics of the profession have polarised. It is almost as if two different professions have emerged. Never have lawyers at each end of this spectrum had so little in common with one another, in terms of their daily working lives and the financial rewards that they can reasonably contemplate for the rest of their careers.

Therefore, smaller high-street firms are urgently forced to consider their longer-term viability. The threat of substitutes and new entrants is exacerbated by recent changes to the legal aid system. The need to ‘push down’ the work to cheaper, less qualified staff, by investment in, and effective implementation of, appropriate technology is greater than ever.

Amid all this confusion there is a growing momentum among high-street practices to consider merger as a potential lifeline. Predictions have been made that there will be more deals in the coming year than there have been in the last 25 (see [2008] Gazette, 16 October, 4).

Merger is another form of growth. The difference is that a merger represents supercharged growth. By merging, firms combine their businesses, giving each other access to their respective know-how, capital, systems, image and reputation all in one go. As a route to growth, there is no denying that merger is the fastest highway. At some fundamental level it feels safer to be bigger. In a merger:

• The slowness of organic growth is overcome;
• The risk of feuding for work lateral hiring can involve is eliminated
• The vulnerability of a niche practice to changing competitive conditions can be overcome by the diversity of practice which mergers can bring;
• The ability of the merged firm to invest in necessary technology and human know-how may increase, since the larger firm may be able to access more substantial resources;
• Additional marketing opportunities are created by combining the client bases of both firms, allowing the new firm to sell additional services to the existing clients of both firms, which could power additional post-merger organic growth;
• If each firm is strong in the same areas of work, opportunities to develop these services increase. If each firm is strong in complementary areas of work, each firm can move into new practice areas post-merger and sell new services to their existing clients;
• Merger provides an opportunity for a firm which has expended effort developing systems and management expertise to infuse a larger organisation with these skills and procedures post-merger; and
• Perhaps most compellingly for many, merger creates one of the best environments for change - change that cannot always happen in small firms without external threat or crisis. Merger changes power structures.

The attractions of merging, in the absence of real prospects for wholesome organic growth, may seem overwhelming to a large number of smaller firms, especially in these troubled financial times. There is no such thing, however, as a neutral merger. One firm will have the ascendancy, either because of its financial strength, its existing mix of professional and managerial expertise, image and reputation, or, in the case of firms which are heavily reliant on legal aid work, its legal aid systems and expertise.

The risks of merger
Mergers are not about putting two different businesses together, but about putting two groups of people together. As a strategic issue, mergers raise the question of ‘to what extent it is possible to acquire human beings in this way?’ The main problem is the importance of culture.

If small firms approach the issue of merging out of a desire to solve their own economic problems, they may only be attractive to other small firms who are already in a similar position. Merging two weak businesses to create one strong one is an attractive idea. There is no evidence, however, that this is what happens. A merger of weaklings creates a larger weakling. Larger weaklings are more hungry (for cash and for work) and can die more quickly - and more expensively - than smaller ones.

Finance
A successful merger requires that at least one of the firms (preferably both) is already a strong financial performer. It should also have a strategic need to merge, to reduce perceived risks in the competitive environment, or to maximise the return from perceived opportunities. These strategic reasons for merger may be a response to both threats and opportunities. The desire to move into new practice areas, reduce reliance on threatened areas of work, and further dilute the individual risks of the partners in the ‘predator’ firm are typical strategic objectives in this context. Merger, in this sense, is seen as growing to produce economies of risk.

Friendship
Friendship means consistency in values and beliefs. Consistency of culture, or the belief that cultural diversity will not produce disharmony and can be managed. If the partners in the two firms have different philosophies and have created differing cultural environments, there may be problems ahead.

At partner level, a small firm that is effectively operating as a group of sole practitioners will have difficulty integrating with another small partnership that has a real culture of sharing and teamwork. The result can be disharmony and instability.

There are certain key areas in which consensus has to be developed internally in any new organisation. The starting point for partners is to develop a clear understanding among themselves of where they are in relation to these consensus issues.

Without a measure of consistency among partners in both firms with regard to core mission and tasks (or at least an openness to persuasion), the ‘bargaining’ which will have to be undertaken to allow the new firm to operate successfully, and identify goals, measurement criteria, management structures and performance indicators, will become more difficult, exposing the new firm to the possibility of deadlock and instability.

Fit
Fit means strategic fit. Each merger candidate will have core competencies. Without proper analysis of the way in which these will mesh, and more particularly, of the way in which the people will relate, the risks of proceeding are magnified. Each firm will have its own business ideas. If these are fundamentally inconsistent (for example, wanting to move into different practice areas, wanting to serve different client groups) no coherent business idea will emerge. It is important to look at the work actually handled by each firm, attitudes to clients, and areas of autonomy given to partners, fee-earners and support staff. Without this analysis, implementation issues will become a disputed area post-merger and the strategic gains being sought will not materialise.

Feuding
Feuding at all levels can result from resistance to change and is potentially disastrous to the success of a merged firm. Feuding is the opposite of friendship. It arises from cultural disharmony. Merger results in sudden and substantial growth. Inevitably, this creates conflicting pressures.

As the firm grows, function is diversified among individuals and the new firm will need to develop formal and informal procedures for satisfying the need to integrate these disparate roles into a common set of core values, beliefs and goals. This involves change. Without adequate leadership by the partners (walking the agreed talk), the danger is that resistance to this change will polarise non-partner fee-earners and support staff into their separate pre-merger ‘camps’.

The firm will continue to operate as two firms, both retaining their previous culture, routines, role definitions and structures. Alternatively, the new firm becomes a battleground where opposing camps of professionals wrangle about conflicting visions of where the business should go, and what constitutes the enlarged firm's core know-how.

Fear
The staff of any new firm are the internal clients of the new organisation, which they will be approaching for the first time.

They will feel insecure, threatened, impatient, ignorant, sceptical and suspicious.

The efficiency with which these feelings are addressed will define the extent to which staff will feel motivated to participate in change, and to integrate and promote the values and beliefs of the partners in the new firm. The central issue is communication. If staff are not engaged in the process from an early stage, and given answers to questions concerning their own place in the new firm, their own fears and insecurities may well scupper the strategic objectives which the partners have set for the new firm.

Failure
The final risk factor to consider is failure. Failure may result from inadequate attention to any of the other five risk factors. Inadequate preparation for merger, or profiling, by both firms from key perspectives, increases the risk of failure dramatically.

The risks of merging are myriad. Get it wrong and the financial consequences can be dire. The result can be misery for the partners and staff of both firms. Get it right and a merger can provide faster growth than organic growth and an opportunity to introduce positive change to both firms. Getting it right involves:

• Choosing the right candidate, which means carrying out the necessary profiling of both firms to ensure that the risk factors, always present in some combination, will not overwhelm the prospects of a successful merger;
• Negotiating the right deal, which means balancing the demands and aspirations of the partners and staff in both firms so that there is something in the merger for everyone;
• Getting it right post-merger, creating a new firm which has the systems, procedures and structures which will allow the partners in the predecessor firms to achieve their strategic objectives.

In summary, for smaller firms facing new competitive pressures in a post-Legal Services Act world, a merger could be an attractive option.

Merger: the risk factors

• Finance
  Two weaklings produce a bigger weakling, more hungry for cash and work
• Friendship
  There is a need for consistency of values and beliefs, especially among partners
• Fit
  Strategic fit. Core competencies in each firm must be complementary
• Feuding
  Arises from cultural disharmony and conflicting pressures
• Fear
  Staff are the internal clients of the new firm; they will feel sceptical and insecure
• Failure
  May arise from inadequate attention to any of the other ‘F’ factors. Getting it right will require effective profiling and negotiation