A merger, sale or IPO should be a streamlined process approved by senior management.
Many commentators billed 2011 as the equivalent of the 1980s ‘Big Bang’ for the legal sector. The introduction of alternative business structures under the Legal Services Act 2007 (which allowed non-lawyers to own or invest in law firms for the first time), would lead to a surge in legal sector mergers and acquisitions and initial public offerings and would liberalise what was previously a closed profession.
While the promised flurry of transactions has taken time to gain traction, 2018 appears to be the year that law firm stock market listings have become in vogue, with regional firm, Knights, listing on AIM and Rosenblatt and DWF also announcing their intention to float. The pace of consolidation in the legal market has also continued in 2018 with ‘mega’ transatlantic mergers, such as Berwin Leighton Paisner and Bryan Cave, to smaller ‘bolt-ons’, such as Charles Russell Speechly’s acquisition of sports law boutique Couchmans.
Despite the increase in deal activity, law firm LLP agreements are often not equipped to cover the inevitable questions such momentous capital events bring. Even if an IPO, external investment or sale/merger is not currently on the horizon (or even desirable) for your firm, as a matter of prudent management, it is always worth ensuring that your LLP agreement is ‘deal ready’, so that it facilitates rather than hinders the firm if and when a viable capital event opportunity presents itself.
When reviewing your LLP agreement, you should ask yourself the following questions in relation to potential capital events:
1. Who has authority to negotiate a deal?
Any potential merger, IPO or external investment will be highly sensitive and will require extensive negotiation and due diligence ahead of a concrete deal (if any) being presented for partner approval. Ideally, the process should be streamlined and led by senior management, so that deal-making does not become a distraction for all the partners in the business. It is therefore important to ensure that adequate delegated authority is given to management under the LLP agreement, so that they are able to lead negotiations on behalf of partners to a relatively advanced stage.
2. Can you stop the leaks?
Your ability to control the flow of information can often make or break a deal. Disgruntled partners can often succumb to the temptation to vent their frustration about a potential deal to the press. This can undermine the management team leading the deal negotiations and cause significant reputational harm to the firm. Robust confidentiality obligations in your LLP agreement protecting the firm’s confidential information (including information regarding potential deals) are therefore an absolute necessity.
3. Who approves a capital event?
You should think carefully about the approvals required to get a deal over the line. A merger, sale or IPO is a significant event for any firm and will therefore typically require approval or recommendation by the management board as well as a relatively high partner approval threshold (for example, a ‘special’ or ‘extraordinary’ resolution). At the same time, you should ensure that the partner approval bar is not so high that it becomes unattainable.
4. How do you deal with dissenting partners?
Inevitably, there will be some partners who (for various reasons) do not agree to the capital event. If the deal is approved by the requisite majority, going forward, it may not be ideal for the dissenters to continue in the business as there will be a question mark over their commitment to the newly merged or listed firm. If a partner dissents, they are also unlikely to sign up to any transaction documents which, for example, may require partners to provide warranties and indemnities to an investor or merger partner. Yet, in some circumstances, dissenting partners may still be entitled to a share of any consideration, even if they vote against the deal and do not sign the transaction documents.
To avoid the pitfalls that can arise in respect of dissenters, it is useful to include a mechanism in your LLP agreement to exit dissenting partners immediately before a capital event is completed. You could also specify that dissenting partners will lose their entitlement to any capital event proceeds.
5. How do you divide the pie?
Nearly all law firm LLP agreements will specify in detail how revenue profits are to be divided between partners. However, it is not always the case that law firm LLP agreements will contain detailed provisions regarding the allocation of capital profits which arise from a sale, merger or IPO. It is quite common for LLP agreements to simply state that capital profits are allocated on the same basis as revenue profits, which may in fact not be desirable.
It is possible to allocate capital profits on a different basis to revenue profits. For example, founding and/or senior partners who own a greater share of the ‘equity’ in a firm than is reflected in their share of the revenue profits, could receive a greater share of capital event proceeds.
6. Should retired partners enjoy a slice?
Including ‘anti-embarrassment’ type provisions in your LLP agreement may smooth the partner succession process. Senior partners (who will have played a significant role in building the goodwill of the firm) will enjoy the right to a share of any proceeds that arise from a capital event which occurs within a certain period (for example, two to five years) after their retirement. Anti-embarrassment provisions need to be carefully drafted and tax advice should be sought on the effect of any payments to retired partners.
So, even if a capital event is not immediately at the forefront of discussions for your firm, it is important to consider whether or not your current LLP agreement is fit for purpose. It is always better to be prepared, then to risk losing out on an opportunity when it does present itself.
Zulon Begum is a partner at CM Murray