Law firm mergers can make sense in a tightening legal market, but without clarity of purpose and a good deal of hard work they will achieve little, says Stephen Pritchard


There are a lot of law firms in England and Wales - some 10,114, a figure that has been slowly increasing in recent years. The vast majority - 86% - have four partners or fewer.



For some years the commercial firms have been gradually polarising: the big getting bigger, the small getting more specialist. The generalists in the middle have been squeezed - too large to do the small work and not large enough to do the major work. One prediction is that 3,000 high street practices could close as a result of competition introduced by the Legal Services Act 2007. When you add to this pressure from the legal aid reforms, emphasis on economies of scale, and increasingly demanding clients, merger and/or acquisition should be on the agenda of every law firm - at least as an option.



Size, of course, is not everything and a merger for merger's sake will achieve little. It has to be a means to an end. But scale can improve operating effectiveness and even simply allow you to take on more work. With margins being continually squeezed, doing more work on a more economic basis is an eminently sensible approach.





Why do it?

Before you start checking out other firms you need to take a long, hard look at your own. There can be both offensive and defensive reasons to merge. Do a SWOT (strengths, weaknesses, opportunities, threats) analysis; look at benchmarking information, such as that supplied by the Law Society's law management section, to work out what you do well or badly; identify your key objectives - both those of the partners as individuals and of the firm as a whole; reflect on your business needs - what are your working capital requirements; consider your clients' needs and how they might change, especially with 'Tesco Law' on the horizon; and review your existing staff and resources to see if they match what is needed.



You must have clear objectives. Perhaps you want to bulk up an existing specialism to have a greater presence in that market, or maybe you want to fill in the gaps in your existing provision. If you know your objectives and are confident they can be achieved by organic growth, then all well and good. But if they cannot be met by other means, then the merger/acquisition route should be explored.





Making the approach

Hopefully you will know your local legal market well (if not, why not?) and can begin to draw up a shortlist of targets which should be agreed by all the partners. Be prepared when you make that first, informal approach - you get one shot at setting out a clear vision of what both parties can achieve from a deal. If the other side is interested, you then need to put confidentiality agreements in place and ensure also that information does not leak and destabilise staff at both firms.



You must identify the heads of terms and solve possible deal-breakers as early as you can. You also need a vision of how the business will progress post-merger. But perhaps most important of all, you simply need to get to know each other. Culture is a nebulous and often overlooked, but vital, element of the merger process. Essentially, can you work with these people? Do you want them as your partners?





The merger process

You need to carry out due diligence across the other firm, reviewing all areas of operation:

- Client base, average fees per client and per partner/fee-earner;

- Work type and quality control/procedures;

- Staffing, departments, structure, salary rates and training;

- The finances: historic results, profitability, accounting policies and work-in-progress methods;

- IT systems and their compatibility;

- Marketing and PR; and

- Governance and partnership arrangements.



There will be a number of tax issues requiring specialist advice. These could include considering the effect of overlap relief, the transfer of VAT and PAYE, and capital gains tax that may be chargeable if any partner times their retirement with the merger. This could also be a good moment to become a limited liability partnership.



Other issues to consider are governance arrangements, retaining the 'old' agreements for future partnership retirements, future partner terms, financial arrangements for partners and property issues - are you all going to be in one office?





Acquiring a practice

In some ways, it is simpler to acquire another firm - the integration issues are fewer. But it throws up its own questions: if it is not a case of the principal(s) of the smaller firm retiring, what should their role be in your firm? If it is, how can you ensure their clients successfully transfer to you?



Valuing a practice can be tricky, especially because putting a figure on goodwill is notoriously difficult, and there are various methods, such as paying a multiple of the partnership profit or on a fees ratio. When looking at the accounts, do watch out for work in progress and UITF40 adjustments made in recent years. You also need to build in future costs of the acquired practice, such as possible declines in fee income, taking on former partners as consultants, potential redundancies and property that has a charge to exit early.





Summary

This is just an overview of the many issues that need to be considered. In essence, you need to identify your strategic goals, consider whether merger/acquisition is the way to reach them, find an attractive match, evaluate the deal and plan the process carefully. It is hard work but well worth the effort. Done properly, you can be ready for whatever the market has to throw at you.



Stephen Pritchard is a partner in the solicitors group at Menzies Chartered Accountants and a Lexcel consultant