Mergers: A Practical Handbook, Part I

By Michael J. Anderson


This handbook is intended to be a catalyst to stimulate the thinking of you and your partners and to be a reference source detailing what is involved in such a complex business strategy as a merger...

INTRODUCTION

Why do some professional service firms consider a merger? After all, by training most professionals are risk identifiers, not risk takers.

A select few Managing Partners have had the courage, determination and vision to lead their firms into the future through the strategy of a merger. They have come to realize that for a merger to be successful, the synergy must make the whole truly greater than the sum of its parts; or more efficient; or more beneficial to clients. They have appreciated the fact that the market demands a great deal more from their firm than it ever has in the past.

This handbook is intended to be a catalyst to stimulate the thinking of you and your partners and to be a reference source detailing what is involved in such a complex business strategy as a merger.

We hope you find some thought provoking suggestions that will help you to determine if a merger this is a viable course of action for your firm and whether or not you have the commitment required to make the vision a successful reality.

The goals of a successful merger are simple. To become more efficient. To become more diversified in the services you can offer your clients. To become more able to attract BETTER business (not just more work). To provide the challenges needed to stimulate continued growth among your professionals. To open new markets for your services. And finally, to increase profitability.

Michael J. Anderson

MERGERS: A PRACTICAL HANDBOOK

Mergers are like marriages. There is the courting, the going steady, the marriage and the realities of day-to-day sharing to make the marriage work. As in life, most merger discussions go through the first two stages without the marriage as the result. More merger dialogues are abandoned than are consummated. That is not necessarily a bad thing. In order to even consider a merger, a firm must first examine its own long term goals, its culture, its methods of operating, and its own strengths and weaknesses. This exercise alone is worth the effort. Far too many firms still are operating without a detailed strategic plan and consideration of a merger should cause them to examine every facet of their firm.

Mergers can be a gut wrenching exercise that will consume vast amounts of time and, even if unsuccessful, will have an emotional and psychological impact on all of the people involved.

ALTERNATIVES TO A MERGER

Before running off in search of a merger candidate, professional firms should first review the alternatives to a merger. Some of the alternatives may be more appropriate to their circumstances.

1. Lateral Hires:

If you are considering a merger to add new specialties, create greater diversification or improve marketing you may wish to consider lateral hires first. The greatest advantage of lateral hiring to a strong, happy firm is that there is no melding of two different cultures required. You can retain your firm culture and expect the laterals to adopt it as their own. Many mergers fail because the cultural styles of the two firms involved never properly mesh.

An added advantage is that you only acquire those people that you want and need (rather than those you want and some you don't really want or need). It is also a lot easier to handle one step in the growth process at a time and to re-evaluate the success of your policy after each step.

If major growth is one of your goals, lateral hiring will probably be too slow a process for you. Even when it is combined with bottom end growth, it is much slower and often more time consuming, than a merger.

2. Boutique Firm

Some firms would be better not to grow. Firm's having a strong practice area expertise with a matching reputation, may be better advised to consider becoming or remaining a boutique firm. In most cases this will allow it to earn more, on a per partner basis, than a full service firm which must handle many areas that have a lower profitability factor due to the nature of the profession, the competition in those areas or the lower demand for those services.

It should also be noted that some firms are trying to be both larger, full service firms, and boutiques at the same time. They develop strong departments with high profiles within their firm and cross sell the practice areas like one would market a boutique firm. This isn't easy but, if a firm can pull this off, they may realize the best of both worlds.

3. Dissolution

Too often a weak firm will look for another weak firm to merge with in the hope that the synergy will create one strong firm. This almost never works. A better approach is to dissolve the firm and let each member market himself/herself on his/her individual strengths to those firms seeking lateral hires. While it may be painful to contemplate dissolution, it may be in the best long term interest of everyone to go their separate ways.

4. Association

For some firms geographical expansion can be accomplished on a more limited scale by developing and association with firms in other locales. Some of these arrangements are quite a loose confederation, while others have developed rules that govern how they operate. Creating or joining an existing association will be less costly but will also probably be less profitable than a full fledged merger.

Well, if you are still reading and still think that a merger is what your firm wants and needs, let's look at the reasons why you might consider a merger.

WHY CONSIDER A MERGER?

1. Growth

Many knowledgeable people believe that only the larger firms will survive the next ten years with reasonable profits intact. The most profitable part of the market will then be comprised of small boutique firms and larger firms. The medium sized firms that do hang on will see their profits attacked severely, to the point where their partners will earn considerably less.

Eventually, even the larger firms will not be safe from the emergence of national and international firms who are able to steal their best clients by servicing them on a continental or global basis. (Later we'll discuss how the larger firm can out perform the medium sized firm).

2. Diversification and Specialization

Larger clients are now less than satisfied with firms that can only do some of their work. There is a demand for firms to be able to handle all aspects of their legal requirements. Firms will have to have expertise over a much broader range of practice areas. If the boutiques don't get you with their specialization, the larger firms will get you with their depth, ability to market and more advanced technology.

Mergers allow firms to broaden their client bases as well as broaden areas of practice which, in turn, allows them to compete more efficiently by offering more comprehensive services and greater expertise to current and prospective clients.

3. Marketing

The more professionals a firm has means that more people are out in the market place selling the advantages of their firm. A firm that has 500 professionals acting as rainmakers will easily outperform a firm of 100 professionals. Clients always seem to know who the largest firms are. There is the added IBM Factor - no manager ever was fired for choosing to buy from IBM. Some clients, rightly or wrongly, see security in size.

The larger firm can also afford to have specialists in the marketing area. If a firm has 200 partners they can better handle the lost billings from having some of them concentrate substantial hours to marketing in the hope that they will generate even more billings while the smaller firm cannot take that same risk.

4. Technology

On a cost per partner basis, larger firms can usually afford more and better technology. With cutting edge technology a firm can stand out from its competition. Up to date technology will be one of the keys to gaining new clients and retaining current clients, by efficiently and effectively meeting their demands. Because larger firms can more easily afford this technology, they will continue to widen the gap between themselves and smaller firms, or firms who resist upgrading their technology.

5. Strategic Planning

Even if the merger exercise doesn't work out for your firm you should have gained a long range plan and analyzed your strengths and weaknesses. As noted earlier, too many firms operate on a day-to-day basis with little attention to where they are going over the long haul. Often these firms wake up too late to save themselves. To be the best that you can be, you must first decide what it is you want to be.

Firms that plan ahead often find themselves re-evaluating many of the facets that make up their current firm. Before going into a merger, every firm should have discarded their deadwood. If you haven't, merger candidates may reject you as a suitor or, even worse, you will take your problems into the new firm where they can jeopardize the entire merger. Mergers are expensive and difficult to put together, but they are even tougher and more costly to unravel.

The only constant in these times is that everything is and will continue to change. Firms must be prepared to ramp up, ramp down, diversify, re-align practice areas and practitioners and market in new and creative ways. The World Wide Web is an example of marketing and research that none of us would have thought of fifteen years ago.

6. Financial

Financial considerations have purposely been left until last because too many people have the mistaken impression that the financial rewards from a merger are vast and immediate. That just isn't the case.

First, let's repeat that two poorly performing firms seldom meld into one good performer. Secondly, while there is a reduction in risk for each partner, there are fewer economies of scale than most people expect from a merger and almost none of them will be realized immediately. In fact, in order to get a merged firm off the ground, more expenses are incurred than are reduced. The initial costs of data and word processing conversion, tax advice, consulting fees, possible leasehold and premises expenses all contribute to a greater first year cost.

Having said that, let's also add that a merger can save a firm with fiscal problems. If a firm that is being caught in today's economic squeeze of rising costs and stagnant billing rates merges with a stronger firm, the resulting synergy can add a new dimension to the new firm that will allow them both to prosper and grow. One of the best results of this type of merger is that the weak firm, which usually is weak due to poor management and planning, gains considerable viability from the imposition of the stronger firm's good management practices.

WHY SOME MERGERS FAIL

Don't for one moment think that a merger is an easy exercise. If you ever get into one you'll ask yourself countless times why you decided to merge. In the long term it can be a very gratifying process and may have been an absolute necessity for your firm, but you will have to overcome many hurdles before you reach the finish line.

There are almost as many reasons why mergers fail as there are reasons to merge. Among them are:

1. Culture

Probably the most common reason that a merger doesn't work is that the two cultures cannot blend into one stronger unit. A firm with one-on-one, or even one-on-two secretaries will find it difficult to coalesce with a firm that uses secretarial groupings. Similarly, firms that have tight financial controls will resent firms with a laissez faire approach. A firm with strong practice groups will have a problem with a firm where everyone tries to be everything to all clients. A democracy will have a problem with an autocracy, and a team styled firm will not tolerate mavericks. Always look before you leap. Discuss as many of the policy items that often define a firm's culture before getting into bed with each other.

2. Leadership

If neither of the firms have a strong leader or, if both of the firms have a strong leader, there will probably be problems down the road unless they are addressed and understood before any merger takes place. Wandering aimlessly or having a power struggle has destroyed many a merger before it has had a chance to get off the ground.

3. Commitment

There is no point in proceeding with a merger if there is not near total commitment by all participants right from the start. If they're indicating that they'll go along for the short haul and then decide whether this is right for them, you will almost certainly be in trouble. We'll deal with the signals of commitment later, so that you'll have a way of measuring the various parties involved at the various stages.

4. Client Conflicts

There is no point in proceeding if one of the firms will have to relinquish some valued clients because of conflicts of interest. This can only generate resentment. One of the firms or some of the partners will be starting off with a portion of their client and billing base missing.

5. Planning

The new firm must have a strategic plan in place. Among the considerations are a pro forma budget of what the financial impact of the merger will be, marketing goals, future growth, compensation, manpower and general firm policies. Without these, you are doomed.

6. Communications

Many firms fail to realize that they can hurt their chances of success by failing to communicate their plans and goals to non-partners and staff so that they can buy into the whole process. Lack of communication can result in the creation of a negative attitude that can eventually permeate the entire firm. There are as many fears and egos in a merger as there are people involved. Address them up front and continue to address them throughout or they will start to pull your firm down.

Each and every professional will be concerned about ego factors, like who will head the departments, who will form the firm management, what is their own status within the new firm, how much of their independence will they have to surrender, do their new partners respect them, will they have to become more specialized and, if so, is it in an area that they want and how much will they have to change the way they practice to fit into the new firm? Just to complicate it even further, many of their concerns will be tied, either directly or indirectly, to how the compensation matters will be handled.

STARTING THE MERGER PROCESS

As stated previously, the strategic planning must be in place before you start the merger process. Have you asked yourself the following questions:

  • How do we want our clients to perceive us and how do they perceive us now?
  • How does the profession view us and how do we want them to view us?
  • How do our non-partners and our staff perceive us and how do we want them to perceive us?
  • What are the things that we don't like about our current firm and how can we change them?
  • What are the things we value about our current firm and how can we protect them?
  • What clients do we wish to attract and how will we go about attracting them?
  • How do we view our management structure?

Once you know the answers to these questions you can begin the search for a merger prospect. Develop a profile of the perfect candidate which might include; firm size; geographical location; relative ages of their professionals; areas of practice; estimated compensation of the partners and firm attitudes and culture. With the profile and your long range goals in mind the search can begin.

Perhaps the easiest way to find a merger partner is to simply ask. You can discretely talk to friends in prospective firms by relating the results of your strategic planning exercise to see if they have had a similar experience. If a firm indicates that they too have drawn the same conclusions, then mention can be made of your interest in merging. Most firms will respect the confidence of any of these discussions.

Before you get very far along with your discussions with a potential merger candidate, you should be creating a list of possible deal breakers to which you add new items as they arise and delete items as they are resolved. Wherever possible these items should be dealt with as soon as possible. Some pitfalls that you may encounter are:

1. Firm Name

You may be tempted to leave this until later because you do not see it as a potential deal breaker. It can be. The new firm name will be very important to some people because it reflects their own and their firm's history, ego and potential marketing. This should be dealt with first. Obviously, if you can't agree on something as basic as what you will call yourselves, you have real problems. Since you have not exchanged financial information, this can be a good point to discontinue discussions.

Because you will want to market the new firm extensively, a one or two name firm name, like Smith & Jones is recommended. The more names you have, the tougher the name recognition will be for clients and potential clients.

2. Financial Information

Do not exchange financial histories directly. This can only lead to presumptions, biases and misinformation. Some professionals have a great deal of difficulty analyzing financial statements and this becomes even more pronounced when they must only consider those income and expense items that will be carried forward to the new firm. Sometimes a problem in one of the firms will be removed by the merger, but the knowledge of that past problem may take on an unwarranted importance in the minds of some of the partners of the other firm if they become aware of it. Each firm should give three year's financial history to the chosen Executive Director or Administrator, an accountant or a consultant to develop a pro forma budget (of where the new firm can expect to go financially. This process should reveal any major financial hurdles that you will have to deal with before successfully completing a merger.

3. Location (local mergers only)

If at all possible, avoid having multiple locations. This can lead to retaining old firm practices and cliques in the new firm where they will not be appropriate. Communications will be a vital part of making the merger work and that becomes a lot easier when everyone is in one place. There may be a cost involved in avoiding multiple locations but it will be a lot less expensive, in the long run, than if the merger doesn't take hold.

Also, if possible, a new location is better than either of the old ones. It is better to have our (the new firm) offices rather than their (either of the old firms) offices.

4. Compatibility

If there appears to be any lack of professional respect, personal respect or a severe clash of personalities you must stop and evaluate the situation. Resolution of this problem can be best handled through discussions with the professionals involved. This may result in them just requiring a better understanding of each other or, at its most severe, result in one or more partners leaving before the merger. It is imperative to identify any possible compatibility conflicts immediately since, if they fester, the negativism generated can bring down the entire merger process.

5. Compensation

If one group of partners or non-partners are in the position of making considerably more money than another peer group, this inequity must be resolved. Sometimes it can be done by simply making everyone aware of the rationale behind those incomes, but more likely, it will require some adjustments to compensation. Since no one likes to have their earnings reduced, the obvious solution is to raise the incomes of those who have fallen behind. That's easier said than done until you know what kind of profit the new firm can expect to make. If the gap is too wide, the discussions will be in serious jeopardy and probably are not worth saving because the resentment will linger for years to come and almost surely destroy the merger from the inside.

Partner compensation systems can also be a serious problem when firms merge. For example, if one firm has a mainly subjective system while the other has a more objective system you have a dilemma. How will partner compensation be handled in the new firm? In addition to how compensation is calculated, many firms differ in how they get there. Some have a Compensation Committee, others rely on the Executive Committee and still others have total democracy. Be sure that you know the answers to the compensation system questions early in the process.

6. Administrative Staffing

The various members of the administrative staffs will be responsible for vast amounts of the merger process and are therefore an integral part of the merger plans. A professional firm should never use billable professional time when salaried staff can do the work cheaper and often better by virtue of being more devoted to the task at hand.

If there is a duplication of administrative staff, the first decision will have to deal with who will be doing what through the merger process and what roles each will play in the merged firm. To create a position for a member of the administrative staff that is less than what they desire or feel they should have would be a mistake that will cost everyone. It may sound ruthless but you are better off to free up their future by letting the unnecessary staff go as soon as possible. This may save you some money, will remove a person who is bound to be a negative influence on the merger and will show support to the person you have retained.

Download Mergers: A Practical Handbook: Part I in [pdf].