The Swiss Verein – Time for a Closer Look

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By Sean Larkan

 

The Swiss Verein structure, so commonly used between firms that align within countries, or between countries, has recently received some searching analysis.

This arose through the problems experienced by King & Wood Mallesons (KWM), a Swiss Verein (SV), and its relatively young European operation, also a SV, which resulted in KWM EUME being dissolved and going into formal administration.[1] This was covered quite extensively in a recent Lexpert article to which three Edge principals contributed comment: http://www.lexpert.ca/article/swiss-miss/

There are a number of different possible causes for the collapse of KWM EUME: Was it due to the verein structure? Or poor choice of target firm in Europe? Inadequate leadership and management of the new expanded structure? Insufficient time and effort put into building trusted and respected relationships and collaboration between the old and new merger partners? It was probably a combination of all of them.

A sad end to a potentially powerful merger, the KWM EUME collapse has provided a timely wake-up call to all other SVs to review and stress-test their own structures. More importantly, they should carefully consider the leadership and management of their SV, as well as the cultural and other factors that provide the necessary glue between member firms.

It is also timely to revisit some of the attractions but also some of the potential downsides of this popular structure.

The Swiss Verein: an attractive alternative?

  1. Firms in different jurisdictions, often with different structures, can present themselves internationally as a single entity without complying with all the regulations and tax codes of each country in which the SV functions. For instance, an SV can help firms to avoid the need to deal with differing regulations around the legal qualifications of law-firm owners, and the necessity of member firms or their members to file multiple tax returns;
  2. Arguably the greatest attraction for merging firms is that financial matters (unless agreed otherwise) largely stay within each jurisdiction, including liabilities for financial debt, contributions to capital, sharing profits and the like. This is obviously attractive to sceptical partners in a larger, more dominant and successful firm tying up with a smaller firm that earns lower profits per partner. It also avoids issues around exchange rates, differences or fluctuations in profitability, charge-out rates and partner-compensation schemes. So, the SV can be attractive where the parties do not feel that financial merger is an unnecessary step too far;
  3. SVs work well for firms in different jurisdictions that feel they want something more than an alliance (which are notoriously challenging to ‘make work’), so that they can exert some measure of control – e.g., around branding and other agreed standards – but are nervous about a full financial merger (with all the attendant challenges and concerns a merger brings with it);
  4. Vereins have proven to be flexible structures, with each verein reflecting its own distinctive characteristics and personalities. Some successful vereins give the appearance of financially integrated entities, while others look no different from looser alliances or networks;
  5. Indicative of this flexibility, an SV can function between firms within a country (e.g., in major centres) or between firms in multiple countries;
  6. Structurally, legally and procedurally, the SV structure can be somewhat easier to unravel than a full financial merger, should this unfortunate need arise;
  7. The SV is also ‘tried and tested’ in various international jurisdictions, both in the accounting world (e.g., the ‘big four’, albeit they have moved on to other structures) and legal services, where it has been the structure of choice for many mergers. This will often be enough to put querying partners’ minds at rest. The Lexpert article points out that over 30% of the top revenue-producing firms are vereins;
  8. Subject to the caveats mentioned elsewhere, SVs are somewhat less complex to manage. For instance, one or other member firm is not subjected to the upheaval of changing all systems and processes to comply with a centralised one, although of course not changing can also create challenges;
  9. In large measure, the SV can accommodate different cultural, political and economic issues in each jurisdiction without them impacting other member firms;
  10. Still on the question of management, provided ‘other firms’ in the arrangement are well led and managed, other firms in the SV do not have to put as much time and investment into detailed management of others in other jurisdictions. However, this also can be a danger and can result in issues not surfacing in time (see below);
  11. Depending on what they may choose to do from the point of view of effectiveness and consistency, firms can largely leave current management structures in place in each jurisdiction;
  12. Members of SVs do not share commercial or professional liability for the debts or actions of other members (however, pre-merger due diligence on this is advised);
  13. SVs can reap real benefits from well-managed and led business, and brand integration – which can prove a profitable alternative to full financial integration;
  14. The verein structure can be a safe, speedy and less complex stepping stone to later financial or alternative types of closer integration;
  15. Typically one or other of the merging entities does certain things really well or has implemented leading-edge systems in certain areas – clever leadership, flexible attitudes, good management and sharing can result in the benefits being moved around for the benefit of all;
  16. SVs can give comfort to partners (who ultimately vote on such matters) and get them ‘across the line’ in regard to issues which typically worry them:
    • What if they don’t perform to our level?’;
    • ‘Will we ever have to bail them out?’;
    • ‘We won’t have to do multiple tax returns’;
    • ‘It doe ‘ sn’t look like it will be much hassle for me – I can get on with my work and servicing my clients but there may in fact be some upsides with referrals to me’;
    • ‘There will be a limit on inter-firm liability’;
    • ‘We won’t get bogged down in their regulatory issues’;
    • ‘So, in light of the above, Why not?.’

Swiss Vereins: a cautionary note

  1. The relatively less tortuous path to merger provided via the SV structure, and the structure’s characteristics, sometimes causes member firms to overlook some fundamental pre-merger steps, like undertaking stringent due diligence. We advocate that such due diligence should be no different to a traditional merger;
  2. The passion and excitement with which firms enter into merger discussions and negotiations, coupled with the flexibility and other advantages of the verein structure, can paper over the complexities and uncertainties of international legal practice. This can be exacerbated by different styles and cultures brought to bear to consider them;
  3. The verein structure can mean that issues that arise in one member firm, which may even have the potential to damage the overall firm, can sometimes, at least initially, be ‘left to the troubled firm to sort out’. This is assuming the other member firms are even aware of them. This can prove disastrous, as we have seen recently;
  4. Depending on how they are structured and run, SVs can be fairly loose affiliations, not far removed from law firm networks, and such networks are notoriously difficult vehicles through which to extract full potential. This is mainly due to a lack of buy-in from key partners who want any upside, but don’t want the ‘hassle’ or time investment in getting to know or working with the other entity;
  5. SV advantages (e.g., the independence of member firms) can also be disadvantageous, causing difficulties in achieving consistency in standards, systems, cultures, structures, contributions and brand understanding and support;
  6. The so-called cultural glue and loyalty that sometimes keeps mobile partners in an integrated firm is not usually present to the same extent in a SV, particularly where financial and other structural issues arise;
  7. Vereins don’t necessarily bring about shared culture, the sharing of clients or knowledge, nor standardised practices. Because of the lack of financial integration and the type of focus and ‘glue’ this brings with it, the SV requires exceptional leadership, management that includes the time and commitment to provide active and ongoing involvement from both sides, coupled with some alignment of cultures. This can be hard to come by;
  8. Vereins can hide real issues in member firms. A startling fact that emerged out of the KWM EUME fall-out was that the London office had expended $47m on refurbishing its office, something partners in neither member firm seemed aware of;
  9. Unless they are exceptionally well managed, vereins will struggle to match financially integrated entities in regard to seamless service and technical standards, which are important to international clients;
  10. Bearing in mind that strategy should determine the correct structure for any firm, firms can find that they outgrow the SV structure (but this can be an advantage, in that it can be a transitional step to full financial integration);
  11. Problems can arise in less powerful member firms where, despite the verein structure, more powerful members exert cultural and strategic pressures (e.g., on particular industry sectors or practice areas) on the weaker members;
  12. Because of the lack of profit-sharing, there is not always as strong an incentive for member firms to collaborate and share expertise or clients. This seemed to be a factor at the heart of the KWM EUME break-down;
  13. An oft-overlooked underpinning for strong international brands is seamless operational and business integration between branded entities in different jurisdictions. This is particularly difficult to bring about in law firm vereins, where locally entrenched views around such matters can get in the way, and indeed member firms are sometimes encouraged to continue to do things ‘their way’. Instead of addressing differences and building seamless services, these issues can harden differences. As a result brands suffer.

Practical considerations

  1. While there are clear differences between mergers based on Swiss Vereins and those involving financial integration, there are important areas of commonality that centre, for instance, around brand and people, key assets of all firms.
    • In both structures organisational, employment and individual brands are influential on and directly impacted by the outcomes, good or bad, of the outflow of these arrangements. The KWM EUME meltdown in Europe and Slater & Gordon’s problems are two recent examples.
    • Similar challenges arise in relation to people in both structures – it matters not that a structure is a SV as it is still possible, in fact it may be more likely, to lose good people if those people ‘don’t like what they see or experience’, financial instability is in question, extraordinary capital contributions are sought, colleagues get head-hunted away, the firm is ‘re-structured’ and colleagues are let go, the style of leadership or management is inappropriate or is being imposed by the ‘global entity’;
  2. A Swiss Verein can be a good stepping-stone to a full financial merger, and this may even be contemplated in early strategy documentation. Having practiced under the same brand for a couple of years with committed and effective management and leadership, the firms could transition to a more fully integrated model with a deeper understanding of the relative strengths and weaknesses of each business and a clearer understanding of legal and regulatory issues;
  3. Because a merger is based on a verein structure, it does not mean it cannot and will not result in integrated business functions, systems and procedures, nor encourage collaboration. There are many successful vereins where these have been achieved;
  4. Each firm involved in a Swiss Verein will need to contribute equitably to the international management of the merged entity. This is a big, significant investment as it should involve high calibre personnel. This could involve the appointment in each office of an international managing partner, or designated partners of each entity tasked to achieve cultural alignment, collaboration and communication. The choice of personnel is important, as is providing them with enough budget relief to get the job done. In our experience, this is a key area where such arrangements can stumble. Wherever possible, early integration of practice management systems, partner structural matters and expectations and client management protocols will be an advantage, and should be prioritised;
  5. We recommend to clients that a brand strategy be developed for the merged entity and that all merger partners and their staff understand this. This ensures understanding of the brand implications of the merger and how each entity can contribute to strengthening and using the brand. It is also important that parties to the SV have an appreciation of the risk to brand value and strength of a failed merger. Even a supposedly bullet-proof brand like KWM can suffer;
  6. There is invariably a lot of passion and excitement about putting such merger deals together, but firms often do not take proper account of the hard work and time commitment required after the honeymoon period is over. This is particularly so in the case of a SV where each entity is more or less expected to run its own operation;
  7. It’s sensible for each firm to develop a short-form business strategy outlining its strategic key business objectives in further developing its international presence, and how these verein arrangements and the designated strategies will assist them to achieve these objectives. This usually focuses the collective minds of the firms and helps identify key issues at an early stage;
  8. Notwithstanding the presumed protections provided by the Swiss Verein structure, we counsel clients to obtain legal advice to ensure the structure is tax effective to ensure partners are only taxed in their own jurisdictions;
  9. The wheels can quickly come off the merger cart if things do not go as planned. Exits of key partners and key practice groups impact organisational brand and employment brands and the underlying trust that should support them. Firms can find themselves with a remaining stock of lower performers which in turn makes it harder to attract top performers – a classic vicious circle quickly develops and the sharks circle to pick up the choicest morsels;
  10. Advice should be sought to ensure the structure provides for regulatory clarity; e.g., the common issue that arises in some jurisdictions that only practitioners from that jurisdiction can be partners in local firms. It is also worthwhile considering limiting cross-border liability of partners to ensure legal problems in one country do not impact the merged group;
  11. Some jurisdictions have particular requirements which may be peculiar to them, such as diversity requirements – these need to be unearthed in a due diligence;
  12. The merged entity must not be allowed to become simply a loose association of independently run law firms operating under an umbrella brand. This depends to a great extent on the calibre and style of leadership and management of each party to the merger, and this determines success or failure.

Swiss Vereins are very attractive alternative structures to financial mergers in some circumstances, but they require exceptionally good leadership and management from each entity, and the building of a strong merged entity culture of trust and collaboration to ensure they work well. This should be coupled with a genuine interest and committed effort by these key players to ensure the success, well-being and strengthening of their fellow merger partners. In essence, firms must look beyond structure when weighing up and implementing such mergers.

[1] A spokesperson from KWM’s Australian office in Sydney reiterated that “There is no direct impact to the firm here”.