At a recent law firm retreat, one of the partners asked me, “Is it true that most law firm mergers fail because they don’t make strategic sense?”  My immediate reaction was to agree.  Indeed, the strategic value of a lot of mergers is backfilled after the deal is done to justify it to clients and the media.  But, as I thought more about it, I was hard-pressed to think of a large merger that I would characterize as a failure.

Not being able to think of a failure is not a ringing endorsement of mergers’ success.  We (both consultants and law firm managers who have done several mergers) have lots of experience in the process of creating mergers.  Very little, however, seems to be known about what makes a successful merger (apart from the combined firm not imploding).  That is, we understand what qualities must be present to get a merger approved by both firms, but we have little data on whether those mergers are actually successful in the long term.

Our lack of information about merger success is, in large measure, the result of the lack of a definition of what success is.  Every so often, the Wall Street Journal runs a story on how relatively unsuccessful corporate mergers are based on the companies combined market capitalizations or stock prices compared to their individual numbers before their mergers.  With law firms, however, the numbers are almost always up, simply because the business of law is a growth industry and profitability tends to increase from year to year.  Of course, we have no measure of what would have happened to the firms had they not merged.

I made it a point over the past couple of months to talk to managing partners and executive directors of merged firms to get a feel for their evaluation of the results.  Overwhelmingly, they enthusiastically felt they are better off as a result of the merger.  Now, since the people I’m talking to were typically the architects of the merger that created their current firm, of course they have a positive view of the results.  But when I press law firm leaders about why they believe their merger has been successful, they rarely talk about profits per partner or how much their personal earnings have gone up.  Instead they invariably seem to point to three indices of success:  Size — the firms ongoing growth in the number of lawyers; Gross Revenue (Turnover) — the creation of new and expanded revenue streams as evidenced by revenue per lawyer statistics; and Partner Satisfaction – post-merger “happiness” levels of the partners in the combined firm.

It’s meaningful that most managers seem to not define the success of their mergers in terms of profitability.  By observation, mergers often result in a slight up-tick in profits per partner during the first year following the merger, a down-turn the second year (which we have nicknamed the “sophomore slump”) and then profits generally continue at pre-merger levels for several years.  Profits per partner are the product of four functions: the average hours timekeepers work, their average billing rate, the number of non-equity timekeepers for each equity partner and expenses as a percentage of total revenues (utilization X rate X leverage X margin in David Maister’s well-known formula).  Typically, there is nothing that occurs in a merger that has a significant effect on any of these variables.  Of course, differences in profitability between the firms that would significantly raise the profitability of one firm would also dilute the profits of the other firm, so such mergers rarely get past the talking stage.

As a result, the issues of size, name recognition, leadership, opportunities to expand practices and partner happiness end up being greater driving forces behind many mergers than increased compensation – at least in the short run.  And, if firm size, gross revenues and partner happiness are, in fact, the criteria for a successful merger, then I suspect I understand why it is so hard to find a merger failure — the structure of most mergers are hardwired to bring about these results.  That is, the following five results tend to occur as a natural part of most law firm mergers, and those results end up creating the outcomes that firms value:

1.  Spreading risk.  Growth in the size of a firm involves risk and a merger allows the firm to spread its risk over a broader base.  Lawyers and their firms are, by nature and training, risk adverse.  It is the lawyers’ job to minimize risk for the clients and they bring that attitude and skills to the management of a law firm.  Rarely, however, do we see a strategic plan that doesn’t call upon the firm to “become more entrepreneurial.”   Often, however, law firm partners use the word entrepreneur without appreciating that the definition of an entrepreneur is “one who is willing to take risks in order to make a profit.”  This entrepreneurial bent is necessary because the day-to-day decisions firms make involve greater risk: acquisitions of lateral partners with portable business; the creation of practices in emerging areas; and the sharing of risk with clients through various forms of fixed or contingent fees.

As anyone accustomed to insurance understands, risk can be managed if it can be spread over as large a base as possible.  Eventually the law for large numbers comes into play, and the risks that result in losses can be hedged with risks that attain success.  For law firms, a lot of risk management is simply operating on a large enough playing field and mergers provide a means of doing that.  As a result, growth decisions take on less risk as they are spread over more lawyers.

2.  Firm Self-esteem.  Lawyers, and by extension law firms, tend to be pessimistic.  When we do internal surveys within firms, partners’ aspirations are always comparatively low.  In fact, many firms purposely underestimate revenue budgets to avoid the risk of false optimism about the feature.  When firms merge there are conversations about opportunities and aggressive estimates about the future.  A merger, particularly if it involves a name change, requires partners to talk to their clients which often generates new work and referrals to potential clients.  There are articles in the newspaper, cocktail parties to meet the new lawyers and new marketing material.  The whole process moves lawyers, at least temporarily, out of the doldrums and causes them to be proud of their firm and think positively about the future.

3.  Consolidated leadership.  Law firms have plenty of smart lawyers but, typically, they are very short on leaders.  As law firms grow, the demand for partners to lead practice groups, industry clusters and client service teams has expanded well beyond the number of individuals with the capability and interest to accept such leadership positions.  Accordingly, in many firms what passes for leadership are census takers who count noses to determine consensus and then lead the firm in the direction of the lowest common denominator.

But the number of leaders required generally does not increase with the number of attorneys, so a merged firm provides the potential for having more leaders without requiring more leadership positions.  Further, a merger, with a clear implementation action plan, gives aggressive leaders the mandate and latitude to take decisive actions while enjoying a “honeymoon” period.  No one likes to say it out loud, but the lack of strong leadership in some firms is what makes their partners eager to consider mergers.

4.  Forcing Synergies.  “Synergy” is probably one of the most overused words in the management vocabulary.  But, whenever you put together two sets of client bases and two partnerships with different contact networks, magic seems to happen.  When people talk about “two plus two equaling five” in a good merger, synergies are what they are talking about.  But the synergies are not necessarily created by the merger.  In fact, some of the best opportunities have often been lying dormant within one of the merger partners.  What is taken for granted by one firm turns out to be exciting gold for another and a synergy is created.

In fact, the most common examples of post-merger success given by law firms seems to involve anecdotal evidence about new clients obtained and industry contacts no one had anticipated.  The win, it seems, is not so much the result of the business case but more a serendipitous series of successes brought about by the synergy of new opportunities and renewed enthusiasm.  For law firms mired in the doldrums of complacency, taking action, accepting risk and evaluating every aspect of how a firm practices law (the process of merging) stimulates positive things.

5.  Fixing Stuff.  The merger process brings to light issues that have long been swept under the carpets of the separate firms.  Unjustifiably low special billing rates, underproductive lawyers, commoditized practice areas and other issues that are deeply rooted sacred cows in one law firm are easier to correct with the support of a merger partner who doesn’t share the history that made them deeply rooted and sacred.  Providing law firm management committees with a backbone is a temporary but important benefit from a merger.

So are the successes cited by law firm managers about their mergers simply spin control or wishful thinking?  No, I believe that most law firm’s are sophisticated enough to recognize that the positive results of mergers are long term and can achieve profit improvement.  Certainly the five merger actions listed above should be a catalyst for higher profits and, typically, eventually are.  At issue, therefore, is not so much whether a merger is successful, but whether the partnerships have the patience to appreciate and accept the long term perspective required to achieve that success.

Now, don’t get me wrong.  Even though most mergers are successful, I’m not suggesting that law firms run out willy-nilly and merge with the first firm they see.  I still believe that the truly winning mergers are strategic, i.e., those where the combined firm will enjoy a marketplace position that allows it to leap frog competing firms and develop a level of dominance that is unassailable.  But, at the same time, we must understand that such mergers are few and far between and may in fact be out of the realistic reach of some firms.

Every law firm’s situation is unique as are the results they can realistically achieve from a merger.  They are almost never the perfect fit that the firms envision when they start the process.  But the results can set the groundwork that permits the eventual achievement of the profitability level the firms want.  In considering opportunities, make sure you don’t make the perfect the enemy of the good.