Bigger firms are now looking overseas for mergers, but more consolidation is expected in the mid-tier as ‘baby boomer’ partners retire. Rachel Rothwell reports
Law firm mergers are a delicate affair. For starters, firms tend to enjoy their independence and are not necessarily keen on finding themselves led around the dancefloor to the tune of a more dominant partner. Any suitor who comes knocking will be regarded with a suspicious eye, lest he be attempting to charm his way to the family fortune while his own coffers are all but spent – despite his apparent finery. And no matter how romantic the courtship, it is far from certain whether married life will be harmonious, or a house divided.
Small wonder, then, that the legal market has seen far less merger and consolidation activity recently than one might expect. The last sizeable merger between UK firms was the tie-up between Irwin Mitchell and Thomas Eggar announced last November, creating a £250m-turnover firm with more than 270 partners. In the same month, but lower down the scale by size, Knights revealed that it was to acquire Oxford firm Darbys, pushing the combined firm into the UK top-100.
More recently, the headlines have been more about merger talks collapsing – for instance, between the City’s Berwin Leighton Paisner and US firm Greenberg Traurig, or national practice Addleshaw Goddard and Scottish firm Maclay Murray & Spens.
Viv Williams, a director at consultancy Ampersand Legal who has helped merge more than 150 firms in his career, confirms: ‘Every firm in the UK has talked to others about merging, but actually most merger talks break up’.
When it comes to the large top-50 practices, Andrew Hedley, director of Hedley Consulting, predicts that we are unlikely to see any major UK activity. He says: ‘It’s hard to see a UK-based deal, as all the deals have been done. The larger firms are looking overseas… Most of the deals have been UK firms getting together with non-UK firms, for example in north America, Europe and Australasia.’
Beyond the larger practices, it is the mid-tier firms where the lack of consolidation has been particularly surprising. Tony Williams, former Clifford Chance managing partner and founder of Jomati Consultants, says: ‘The area that I expected to see more activity is in the £5m to £30m firm range; those firms in the top 200, or the lower part of the top 100.’
For these firms, the bigger scale that could be achieved through merger would yield valuable benefits in terms of dealing with the regulatory burden, updating IT systems to improve efficiency, and being able to show clients greater strength and depth. So why have more firms not pursued these advantages?
Jomati’s Williams speculates: ‘Law is still quite profitable; it is relatively rare to see a firm that’s got to do something because they can’t carry on. And firms do still relish their independence, and don’t like the idea of being taken over. Clearly, they don’t consider the opportunities that being a larger firm might bring as outweighing the uncertainty of a merger. And at the moment there is no great pressure to merge from the banks.’
He adds that the biggest issue likely to drive more mergers in the mid-tier and below is the age factor, as ‘baby boomer’ partners get older and want to retire: ‘Some of the core relationship partners will be retiring in the next five years or so.’
Case Study: Knights
Knights entered the top-100 through its merger with Oxford firm Darbys this year and has made clear its intention to grow through acquisitions of law firms and other professional services businesses. Its plan is to become the dominant professional services force in select UK cities. Knights became an ABS in January 2013 after receiving private equity from former Dragons’ Den investor James Caan through his company Hamilton Bradshaw. The law firm used the capital to buy out its former partners.
Knights’ CEO David Beech says the firm’s unusual management structure has made it far easier to pursue growth through merger.
He says: ‘Fundamentally, getting one partnership to merge with another firm is really challenging. It’s much better to have two or three people making the decisions… Lawyers are used to advising others, but they’re not used to making decisions for their own businesses. They are generally risk-averse.’
Beech adds that in terms of merger partners, the right ‘cultural fit’ for Knights will involve practices ‘where there are lots of employed partners who are used to being employees’. He adds: ‘Our culture is a team ethos, working together, rather than individual egos fighting for fees per fee-earner.’
After the tie-up with Darbys, the firm has more than 300 professionals across seven offices, generating turnover of around £40m.
One sector of the market where there has been more consolidation than elsewhere is personal injury. Zoe Holland, managing director of consultancy ZebraLC, explains: ‘Mergers and acquisitions in the PI sector started in earnest in 2012, largely based around WIP [work in progress] book deals in the run up to LASPO. Essentially, the market started with Neil Hudgell’s “webuyanyfiles.com”.’
She adds: ‘What we have seen since is a number of new entrants into the sector, some successful, and others high-profile failures, together with consolidation by larger practices acquiring smaller practices and/or departments.
‘As 2016 unfolds, the pace of M&A instructions in the PI sector has continued, but these have been largely focused around niche areas such as serious injury and clinical negligence – rather than volume-based road traffic accident work. There is certainly more caution around M&A deals, with future financial modelling more difficult, due to proposed fixed fees.’
In the past 18 months, Holland has seen a number of talks involving organisations that are considering entering the PI legal market that ‘have not come to fruition’. ‘With the number of high-profile failures from scenarios like Parabis, the new entrant market is undoubtedly more cautious. Combine this caution with the threat of fixed fees, and PI acquisition isn’t for the faint-hearted… The outcome of Slater and Gordon also has the potential to significantly impact on M&A in the PI sector. It’s a watching brief.’
Ampersand’s Williams notes that Slater and Gordon, which recently announced trading losses of nearly £500m, had engaged in a purchasing ‘jamboree’. Its ill-fated acquisition of Quindell for £637m stunned the market last year.
He adds: ‘As Slater and Gordon is listed on the Australian stock exchange, it has to declare what contingent WIP it has. So if the firm has a catastrophic injury case and it is carrying £5m for that case, if it doesn’t win it has to downgrade all its figures.’
Given the risks involved, a merger should always be approached with caution. According to the experts, the biggest trap is to regard the merger as an end in itself. Rather, it needs to be a way of achieving something specific: to dominate part of a market, to grow geographically, or to develop capability in certain sectors, for example.
‘The first thing is to have a plan,’ says Andrew Otterburn, founder of Otterburn Legal Consulting and vice-chair of the Law Society’s Law Management Section committee. ‘That might include a merger, but it might not. Many firms don’t really have a proper business plan.’
Otterburn adds that firms should be careful about assuming that a merger will automatically lead to efficiency savings. He says: ‘Sometimes efficiencies can be illusory. You might think that you can shed back-office staff, but in reality, because you are a larger organisation, you may not be able to, or you may find you need more senior people. For example, you may need a director of finance instead of a finance manager.’
For Jomati’s Williams the big question is, what will a merger enable a firm to offer its clients that it does not already? ‘If a merger is going to work, you should be able to articulate clear potential benefits at an early stage,’ he says. ‘One merger that has been effective and successful is the Hogan Lovells tie-up [in 2010]; it is one of the few transatlantic deals that has worked well. The two firms had known each other for a long time and they put together a good business case for merging. I wouldn’t say it has blown the lights out, but both firms would be quite happy with where it’s got the combined firm. It has certainly moved to a higher position in the market than either firm was at before the merger.’
Another success story, he says, is Herbert Smith’s merger with Freehills [in 2012], ‘with Herbert Smith now clearly a much stronger corporate firm’.
Sometimes the act of merging can have an added benefit for those seeking to bring about change in an organisation – the ‘Trojan horse’ effect. Hedley explains: ‘Mergers are all about getting an organisation to change. It can enable the management team to do things that they may have wanted to do for some time, but have never been able to. Post-merger, people are anticipating that things will be different, so they are “change-ready”.’
This might mean changing the partnership structure, the way partner performance is assessed, dropping certain practice areas – or simply renegotiating supplier contracts.
‘The merger can be a catalyst to do things, even if they are not strictly necessary for the merger,’ Hedley says.
Once a firm has spotted a real opportunity to be exploited through merger, how should it find the right partner? Hedley suggests a ‘merger scorecard’.
‘You identify the characteristics of the sort of firm you need to be speaking to,’ he explains. ‘But often no single firm will fill all the gaps – it’s not an exact science. You look at what is the best firm on the market. The challenge then is that often the firm you want to merge with does not want to merge with you.’
Hedley remarks that when you are approached by another firm, it will generally fit into one of two categories. It will have ‘visionary partners’ who see the advantages of a merger, or it will be ‘a firm that’s in trouble’. The problem is that the latter will often masquerade as the former.
Ampersand’s Williams adds: ‘Part of the challenge is, how do you merge a firm that’s “unmerge-able”? It might be due to succession problems, debt, or a professional indemnity record that’s less than good. There are 3,000 or more of these types of firm, which sit predominantly in the mid-tier.
‘It is not so much of a problem with the sole practitioners, who are getting more niche and specialist. It’s the five-to-ten partner firms where there are overheads and pressure. And the badly managed firms are the ones that are most vulnerable.’
He continues that even where a business is not performing well, partners will often overestimate how much it is worth – particularly the value of goodwill, and the amount of contingent WIP that will actually translate into fees paid. Williams believes contingent WIP is commonly overstated by 30%.
Still, the perfect partner is not just about the balance sheet. Otterburn explains: ‘You have to get the “people fit” right first; then the business fit; and then the money fit. But normally firms start off with the money. They will have an initial conversation and think it might work. Then they will instruct accountants, who do a huge amount of due diligence work, which is basically sorting out the money side [without addressing] whether you can work with these people – whether the culture is the same.’
Andrew Tucker is group chief executive of Irwin Mitchell, which has engaged in seven mergers since it became an alternative business structure in 2012. He observes: ‘In terms of the cultural fit, the starting point is what you think of your opposite numbers in the management team. You have got to get on and relate to them on a human level. You need a similar level of ambition and the other firm needs to have a plan too. I would be less interested in a firm if growing their business by merger had never crossed their minds.’
Case Study: Irwin Mitchell and Thomas Eggar
In December last year, national firm Irwin Mitchell completed a merger with south-west practice Thomas Eggar to create a £250m legal business in 15 locations with around 300 partners.
Irwin Mitchell’s group chief executive Andrew Tucker says the rationale behind the move was to help IM develop three key strands of its business plan.
First, Thomas Eggar’s significant private wealth practice enables IM to build on the private wealth offering created by its previous acquisition of Berkeley Law in 2014.
Second, the merger bolsters IM’s business law services to mid-tier corporate and entrepreneurial clients. This is a ‘significant business with a national footprint’, with added opportunities for cross-selling private wealth services to entrepreneur clients.
Third, the merger will assist a geographical expansion of IM’s complex personal injury practice, by taking advantage of Thomas Eggar’s network of offices across the south-east. ‘It gets complex PI teams access to the south of England, and we will start off with organic growth from some of these offices,’ Tucker explains.
He adds: ‘There is a lot of excitement about the opportunities internally. I feel sure that we have got a good fit with Thomas Eggar’.
Hedley notes that when it comes to culture, the physical environment can be very telling: ‘When you walk into the office, is it all leather-bound books and an oak-carved table? Or is it chrome and glass? You make an assessment of the firm instantly, and sometimes you can immediately see that there will be a cultural clash. But the people around the negotiating table don’t always see the cultural issues. After all, they themselves are likely to be the most progressive people within the firm.’
Sometimes what can seem like a small thing can be the thread that unravels the whole fabric of the deal. Take, for example, a lawyer’s writing style – or even a particular font.
Hedley says: ‘Does a solicitor always write in long convoluted sentences, or in plain English? If you get the guy to write shorter sentences, this actually strikes at the core of his belief system about what a lawyer does. And is the house style Arial 10 or Times New Roman 12? It is not just about fonts. It’s about an independent, self-directing professional thinking, “you don’t tell me what to do, and if I accept that I need to write in Arial 10, then that is the thin end of the wedge”.’
This kind of detail is more important than it seems and must be handled carefully. Whichever firm wins the ‘battle of the fonts’, it is suggested, will be the one that is truly in charge of the merged practice.
A storming job
In 1965 psychologist Dr Bruce Tuckman published a model that encapsulated four stages of group interaction: forming, storming, norming and performing. According to Hedley, these are phases that all firms will go through in a merger.
In law firm terms, ‘forming’ will be the polite stage where everyone takes turns to speak at partner meetings. In ‘storming’, the jostling for position begins; this is where the font issues will raise their head (if not already addressed), along with bigger control questions such as who is in charge of what department. A successful merger will whizz through this stage as soon as possible, but an unsuccessful one will become mired in it. ‘Norming’ sees people settling down and finding their roles within the new business. And once you reach ‘performing’, the merged firm can put its foot to the floor.
Hedley warns: ‘You have to be very careful, because during the storming phase people can retrench and you can have two firms within the merged firm. People talk about the enemy and they are talking about their [fellow] partners. You can have such intelligent people, and yet they allow themselves to get into that position.’
According to David Beech, chief executive officer at Knights, which recently concluded a successful tie-up with Darbys, the best way to ensure that newly merged firms integrate properly is to make good use of your key players. He says: ‘Put your most experienced senior decision-making people into play and put them into the acquired business. You need to get the senior people involved; you can’t outsource or delegate cultural integration.’
Beech accepts that this will slow the pace at which an acquisitive firm can move on to its next merger, ‘but if you go too quickly, your cultural integration will suffer’.
He adds: ‘Cultural integration will never be 100%. You are looking for 80% and I’d consider that a “gold star”.’
How do you know when a newly acquired firm has properly integrated? ‘You can feel when the noise levels start to go down. There’s a feeling of confidence and people are working in a similar way and working together,’ he says. ‘It starts to feel harmonious. You know instinctively that it’s starting to work.’
Jomati’s Williams also has a warning for firms contemplating a merger: they need to be realistic about the level of work involved and the time it will take.
‘It takes three to five years to get people to trust each other across the firm,’ he says. ‘The firm’s leadership needs to stay focused on these issues for a significant time. Firms that have had successful mergers would probably say that it was a hell of a lot of work for the first few years, but it was worth it.
‘But if you don’t make people go together to see clients, and if you don’t communicate the benefits around the firm and to clients, and start the momentum going, then the effects will be much more subdued.’
He concludes: ‘You need to harness the energy of the merger and show the market that this is now something different. What you can’t do is close the merger and simply revert to business as usual. The benefits will not happen by osmosis.’
Rachel Rothwell is a freelance journalist and editor of Gazette sister publication Litigation Funding