Dancing With Elephants: Acquiring Smaller Law Firms

Mergers continue to be a front burner topic for virtually every law firm.  While much of the publicity that helps fuel that interest focuses on the “mega mergers” between international giants, in truth, the vast majority of mergers involve relatively small firms.   In fact, of the 25 U.S. mergers that have taken place so far this year, in all but two at least one of the firms had fewer than 25 lawyers and18 involved a firm with ten or fewer lawyers.

So, while it is fascinating to read about Big Law consolidations, most of the real action involves smaller firms, particularly the consolidation of small firms into larger firms.  The distinction is important because the issues and sensitivities of small and large firms in a merger are dramatically different — as are their objectives in considering a consolidation.  And, at the risk of overextending the metaphor of dancing with an elephant, just because the smaller partner is at risk of being crushed, the elephant has to take responsibility for watching where it steps.  The following are some thoughts for larger law firm merger suitors on how to do that.

1.  Be careful with the terminology.  Mergers where a smaller firm joins a larger one are often referred to as acquisitions.  While the term “acquisition” is descriptive of what the transaction looks like to the casual observer, it is a bit of a misnomer. In the service industry, particularly with law firms, true acquisitions are rare.  Mainly, consolidations are pure mergers where the partners in the smaller firm become partners in the larger firm and their assets are melded.  The point is that there are no buyers and sellers.  The owners of the two firms are joining together and will hopefully spend the remainder of their working careers in partnership with each other.

So, while there is nothing wrong with calling a merger between a large and small firm an acquisition, it can bring along some undesirable connotations.  The worst of these is a “sellers mentality.”   This mentality sometimes occurs when the smaller firm takes on the role of a victim seeing itself being involved in some form of hostile takeover plot.  Victims whine and get so worried about minor details of the merger that they sometimes self-destruct the greater opportunity.  Even worse, a firm seeing itself as a seller may attempt to aggressively negotiate the deal.  Its not unusual for the “seller” to see its larger merger partner as a “buyer” with an infinitely deep pocket who will see their demands as  “deal dust” – the cost of putting the transaction together.  As a result, it is increasingly common to see smaller firms ask for a “good will buyout” or a “kicker payment” at the last minute to close the deal.  The thought process of the smaller firm is that the larger firm has so much time invested that they won’t walk away from a merger over a comparatively small amount of money.  And…they’re often right.

2.  Understand objectives and motivations.  An unpleasant development that frequently occur late in merger discussions is the realization that the parties dramatically misunderstand each others’ reasons for considering a merger.  The most common example is the small firm that believes the large firm wants their clients or their capability.  While some mergers are about building capability or seeking leadership, most mergers between large and small firms are about geography (for example only 3 out of the 25 mergers this year involved two firms in the same city).  The lawyers and the practice come along like the prize in the CrackerJack box.

By the same token, large firms tend to believe that there smaller merger partner is eager to be part of a firm with a national reputation and move their practice onto the next plateau.  In reality, smaller firms are often motivated by fear – fear of not having leadership, fear of losing their clients to larger firms or fear of survival.

The point is that candor, by both sides, can make the process go much more smoothly and eliminate some embarrassing problems later in the discussions or implementation.

3.  Limit Promises.  Mergers between a larger and a smaller firm almost always overspend their first year expense pro forma, in large part due to overselling that occurred during the discussion process.  In some cases the problem is incorrect inferences by the smaller firm, e.g., a comment that partnership meetings are sometimes held by video conference translates to a promise that they will have a video conferencing facility.

But more often, promises are the result of multiple points of contact.  Having lawyers from the smaller firm meet as many possible partners at the larger firms is valuable in their decision making process and helps the larger firm get a head start on integration.  But, partners who are only peripherally involved in the merger often want to be supportive and end up making comments that overreach what the firm is prepared to do.

4.  Move slowly.  The management of larger firms may have multiple mergers on their plate simultaneously, so it is a natural reaction to want to move deals along as quickly as possible.   While it makes sense to keep the discussions moving, a lot of the implementation problems with small mergers can be traced to inadequate time spent in the courtship process.  Of course, it’s important for the larger firm to key on a timeline that’s comfortable for the smaller firm but, on balance, if things seem like they are moving too quickly, they probably are.

5.  Have an agreement.  There is a bit of a trend in mergers between larger and smaller firms to draw up a terms sheet but never quite get around to signing a merger agreement.  While it is recognized that mergers are forever and its unlikely that anyone is going to sue if the agreement is violated, having a formal written document resolves some of the problems of misunderstandings and inferred promises, and serves to slow the process down a little.

All in all, mergers, regardless of the size of the participants, are technically very similar and largely involve the same process and similar problems.  But in a consolidation where one firm is clearly going to be the dominant successor, that firm, by virtue of its experience and resources assumes more responsibility for guiding the outcome than does the smaller firm.  And like the elephant on the dance floor, its up to them to watch their step.