Business of Law
A Primer on Due Diligence for Acquiring / Merging
With Lateral Hires

By Joel A. Rose

Individual and groups of attorneys oftentimes seek to join with a larger law firm because they expect size and a better balance of skills and client base to provide them with improved professional service and long-term economic advantage.

However, the potential problems that may occur after joining with an established firm are infinitely complex. Such a merger, if consummated, will call for a change in the manner in which the attorneys in the newly merged firm currently practice law and manage their business. It will potentially require different approaches to management and compensation, but will open numerous new opportunities, especially with the enhanced professional, substantive and economic objectives of the newly merged organization. In spite of these possible opportunities, the integration of individual or smaller groups of attorneys into a larger firm does not always succeed. The miscarrying of a merger provides more problems in the disentanglement for the individual or group of attorneys than the original bringing together of these attorneys.

A Composite Case History

The reasons a well-established, small boutique law firm joined with a larger law firm, in one recent case in which the author's management consulting firm was involved with, was the desire on the part of the partners in the boutique for improved earnings on a continuing basis, more effective lawyer management and augmented expertise in certain potentially profitable fields of law.

The principal reason for the larger firm was the desire to improve measurably its economic position on a continuing basis by establishing greater depth and expertise in the boutique's specialty practice area. The larger firm also hoped to be able to transition the boutique's clients and to continue to attract larger and more profitable clients within this specialty.

Significant Differences

Initial analysis indicated that there was a complementing of the fields of law, and the high probability of transitioning to the larger firm clients of the boutique in order for the merged group to continue to service the profitable clientele and further develop the specialty area of practice.

Preliminary conferences among partners in each of the firms revealed substantial differences. The partners in the small firm exercised complete control over the financial issues relating to their practice. As such, they increased the amount and frequency of their compensation, on an "as needed" basis, cash flow permitting. The larger firm had an agreed upon compensation system, administered by a compensation committee, with set draws for each partner, but calculated units of participation on the basis of work performed, business obtained, profitability and other consequential contributions of the partners. The attorneys in the small firm worked hard when they had to, and enjoyed a high quality of life. Essentially, they were accountable to their clients, but unaccountable to anyone else for producing a targeted number of billable hours, whereas the larger firm had established billable hourly expectations and personal business plans for its attorneys. It was brought to light that certain income produced by partners in the boutique firm, i.e., commissions, executors' fees, etc., were excluded from the arrangement that all income from the practice of law should come into the firm. Retirement arrangements for members of each firm differed and had to be reconciled. One firm considered all net income as profit for the partners. The other firm counted net profit after salaries (or draw) to partners had been deducted. Resolution of these and other differences had to be made.

Benefits Recognized

With all of these differences, the members of the two firms were already getting assistance from each other, including enhanced representation in more difficult cases and representation in more complex client situations. Recognizing that they were able to gain benefits of organization and specialization, they now found it easier to resolve differences. They were ready to move on to other considerations.

More attention was given to balance sheet items of the two firms; the assets, liabilities, and capital arrangements. Capital requirements considered an assumed interest in the assets of the firm, including cash on hand, unbilled work and accounts receivable, costs advanced, library, furniture, and equipment and leasehold improvements. The thoughts of each firm, turned toward assets in inventory of work that were as yet unbilled or cases not yet consummated. There was now an opportunity to complete or partially bill major matters, or settle or complete major cases, and perhaps exclude these from the assets of the enlarged partnership.

A major point to be discussed was the income improvement that was particularly sought by all the partners as the result of this potential merger. Agreement was then needed on income objectives of the new firm, policies in terms of hourly fees, as well as how the income would be divided. The firms decided to include considerations of such factors as business obtained, work done and profitability, and appropriate records were developed for the enlarged organization.

The attorneys in the boutique and the larger firm turned their attention toward the firm name that would include in the "institutionalized" name of the larger firm the name of one of the attorneys in the boutique. This was an especially sensitive issue since none of the names of partners in other firms that were acquired by the larger firm had been included in the firm name. The matter of retirement disability was settled, and, with this treated, the firm found ready agreement on other things. The firm determined its administrative organization, and many other problems then solved themselves.

An especially "hot" political issue that had to be addressed in the joining of the boutique and the larger firm was how this deal would be presented to the former's clients and the general public. The partners of the boutique firm perceived the integration of their practice into the larger firm as the joining together of equals, rather than an acquisition by the larger firm. However, other similar deals consummated by the larger firm with other attorneys and groups of attorneys were considered to be acquisitions.

With the assistance of the author's management consulting firm, a committee of partners from the boutique and a committee of partners from the larger firm held many meetings, and were able to set target dates for accomplishment, which led them to the date for the "merging" of the practices.

Due Diligence Issues - for the Acquiring Firm

An acquisition/merger is a methodology employed to assist the participants to achieve some of their immediate and longer term objectives. To merge with/acquire an attorney or group of attorneys is typically not the answer to resolve problems. Neither is growth, for the sake of growth. A thorough evaluation should be made by the partners of a firm desirous of merging with/acquiring another firm to assess the need for the merger/acquisition. This evaluation calls for the partners to first assess their firm's strengths and weaknesses. Individual practice areas and areas of specialization need to be examined. The firm should develop a matrix of its attorneys and depth and breadth of its expertise. The firm's client base and financial health need to be analyzed. If the result of this evaluation is affirmative, the former partners need to perform research to identify, apply logical thinking and a detailed evaluation of possible candidates.

For a merger/acquisition to be successful, a level of synergism should exist between the acquiring candidate attorney(s). Each of the parties should realize some benefits. The relationship must be more than a combination of the two firms. Two plus two should equal five or six.

One of the most serious problems that may damage irreparably the successful integration of an acquisition/merger candidate are unfulfilled expectations based upon pre acquisition/merger commitments by either of the parties. "Due diligence" should be the mantra of both parties in anticipation of any acquisition/merger. Below are a representative number of suggested areas in which appropriate due diligence should be performed by the acquiring firm:

1. Reasons for Leaving Firm

Although it may appear to be obvious, why is an individual or group of attorney candidates leaving their present firm? Considering all that you may know about the practice of law, the current legal marketplace and the reputations of other members of the candidate's firm, how comfortable are you with the articulated reasons? Do they make sense? How likely is it that the same conditions may resurface at your firm?

2. Practice area and client base

The candidate's practice area(s) and client base need to be analyzed. Who are the candidate's clients - by name and by industry? It has been the author's experience that a candidate may be a risky choice if one particular client accounts for more than 15 percent of that candidate's gross revenue. What specific types of work are performed for each of the candidate's top ten or fifteen key clients? If the type work is litigation, for how long will this litigation matter(s) continue? What will replace these pieces of litigation when they "go away?" Is the candidate the principal contact for these clients? How much of the work does the candidate perform himself or herself, as opposed to work performed by other partners or associates? Will clients follow the candidate when he or she changes firms? If so, which clients does the candidate expect to follow him or her? What are their annual billings? How dependent is the candidate on these particular clients? How will the candidate complement the firm's practice? To what extent will conflicts of client or business interests affect the candidate's contribution to the firm?

3. Candidate's Financial profile

It has been the author's experience that financial data and management information about a candidate is usually available, nevertheless, partners in many firms overlook the candidate's historical performance and focus their attention on the current year, especially if it is especially profitable. We endorse reviewing the candidate's three year track record in order to discern trends in their financial profile. For example, what have been the candidate's actual performance statistics over the last three years? What has been the candidate's realized hourly rate over the past three years? How do these realized rates compare to those charged by your firm? How will the candidate's clients react to these hourly rates? Is it realistic to expect that the candidate's lower hourly rates may be increased to be compatible with rates charged by attorneys in your firm? How much work in process does this candidate currently have? Has this amount been increasing or decreasing over the last three years? What are the candidate's total and aged accounts receivable? Have these amounts been increasing or decreasing for each of the last three years? How much of the candidate's recorded time does he or she usually write down or off? How much of other partners' or associates' time does the candidate usually write down or off? How much pro bono does the candidate perform? How much new business has the candidate generated within the last three years? How much repeat business has the candidate generated within the last three years?

4. Financial Health of the Candidate's Key Clients

The financial health of the candidate's key and continuing clients is of particular importance. Has the candidate's practice from these clients been growing or declining? Have the amounts of work in process and accounts receivable from these clients been increasing, leveling or declining? Have the aging of work in process and receivables from these clients been increasing, leveling or declining? What is the economic future of the candidate's practice area from these ongoing clients? What is the economic future of the candidate's key clients?

5. Candidate's Personal Background

To the extent feasible, the larger firm should do its best to check the candidate's personal and professional background. For example, does the candidate have the credentials listed on his or her resume? From discussions with members in the same specialty area of the larger firm, does the candidate possess the actual experience that he or she purports to have? Are the members of the larger firm competent to make this judgment? Does the candidate have a reputation or is he or she working on types of client matters that may be perceived as damaging to the larger firm? Are there any pending, known or complaints or proceedings against the candidate? Are there any known complaints or proceedings pending against other parties with whom the candidate has been associated in any capacity? Is the candidate aware of any ongoing investigations involving himself or herself?

Appraising Gains

It has been possible for the author's management consulting firm, at a relatively early stage, to develop information on the organizational and economic strengths and weaknesses of the acquiring firm and the candidate. It is also possible to provide projections, as the merger study proceeds, of the probably gains in income, expenses, and organizational aspects of the proposed acquisition/merger. A pro forma picture of the combined organization should be projected. Comparisons are now available to the consultants for other like organizations, so that we can set and appraise economic targets, and recognize what is realistic and what is not.

Internal Communication

Needless to say, as soon as it becomes apparent that the merger will take place, communication to all members of those in the organizations concerned should be made on a continuing basis. All have a need to know of either major or lesser decisions, and should be kept informed. Such actions as those concerned with space, equipment, systems, organization, committees, file control, and many others are of interest to almost all members of the enlarged organization.

You don't want anyone to leave or become emotionally upset because of unfounded rumors. Lawyers and non-lawyers can unwarrantedly assume that the purpose of the merger is to consolidate positions or eliminate "deadwood," which will result in the discharge of certain persons. There generally will be personnel gains, gains by consolidation of libraries, gains in the efficiency of bookkeeping, billings and more effectiveness in the operations of the specialized areas of law in which the firm will be engaged. However, this can usually be done without disrupting the personnel relationships in the organizations which made each functioning entity for so many years. Generally, a growth probability is part of the merger action and experienced personnel are needed to handle the energized organization.

If possible, the organization, forms and systems should be provided in written form. They can then be readily reviewed by members of the enlarged organization and will be available for new members who will come into the merged firm.

Time to Accomplish

All of this process does take time. The ordering of special equipment, the construction of appropriate quarters, the design and purchase of necessary forms, stationery and announcements, the drafting of new agreements, and the problem of client notification and notice to members of the bar, need a carefully worked out timetable. A merger of well established forces can be accomplished generally within three to six months, and most find that many aspects of the merger take place gradually during this period.

The benefits from a well organized merger can often be apparent even before the physical merger is consummated. Again, for an increasing number of individual or group of attorneys, this may be the only way to accomplish rapidly, or at all, their professional and organizational goals and their desired continuity of existence.

Joel A. Rose is a certified management consultant and president of Joel A. Rose & Associates, in Cherry Hill, N.J., which works with the legal profession. Rose can be reached by e-mail at jrose63827@aol.com.

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