The 1990s could well be called the “golden age of mergers.” In many industries, businesses merged in record numbers. Nowhere was “merger mania” more noticeable than in the financial and service sectors. Banks, insurance companies, brokerage houses, accounting firms, consultants, hospitals and even medical practices merged and then remerged during a period of unprecedented economic growth, easily available capital and minimal federal regulation.

For law firms, merger consideration became an essential part of strategic planning. Internationally, firms like Clifford Chance and White & Case quadrupled in size and found themselves in dozens of countries, seemingly overnight, through a rapidly executed series of mergers. In the U.S., regional firms such as Holland & Knight, Foley & Lardner and Greenberg Traurig became national institutions through mergers across the country.

Even with their frequency during the past few years, it is arguable that law firm mergers are not yet even close to peaking. No one law firm is close to commanding one tenth of one percent of the U.S. legal market or even a specific segment of it.

Although conflicts of interest are cited as having a dampening effect on mergers, corporate general counsels are becoming increasingly liberal in their waiver of technical conflicts and law firms’ leadership seems more willing to sacrifice some clients in order to achieve the strategic benefits of an important merger.

On their way to this level of merger acceptance, law firms gave nodding consideration to other forms of consolidation. Law firm collectives such as Lex Mundi and U.S. Law Firm Group became popular as an alternative means of achieving firm growth without mergers. There have been examples of successful joint ventures among law firms in opening new offices, but, as an industry, law firms have overwhelmingly preferred to merge, as opposed to options allowing a lesser commitment.

Given the legal profession’s traditional risk-adverse nature, the high degree of risk inherent in mergers and the surprisingly little due diligence that is done, it would seem highly worthwhile to take a look at other forms of alliances before defaulting to the next round of law firm mergers.

Strategic Objectives of Consolidations
In order to rationally consider options to merging it is necessary to understand the strategy behind a merger and what objectives are to be met through the merger. In other words, firms must ask why are they merging and how will they know if it was successful. There are four, and only four, legitimate merger strategies:

Building of Capacity. Whether it is to establish preeminence in an area of practice strength or to shore up an area of weakness, a well-conceived merger can improve capability more quickly — with less capital at risk — than lateral hiring or internal development.

Establishment of a Geographical Footprint. Legal services are purchased on a highly geographic basis. Therefore, to enhance existing client relationships or create new opportunities, many firms find it necessary to enter new locations.

Creation of Critical Mass. It is well understood that sheer size does not mean capability or success. Yet, in the marketplace, relative size does matter and is often the measure by which clients and law school recruits make decisions.

Acquisition of Leadership. Some firms lack partners with the training, disposition or interest to fill leadership roles. Increasingly we see firms pursuing mergers with firms that have clear leadership vision and implementation capability.

Amazingly, a lot of the mergers between law firms do not appear to advance any of these strategies. Of course, one could argue that any time a firm adds more lawyers it increases its capability and its critical mass, and a merger anywhere other than a firm’s current location(s) expands its footprint. But does the result – in even the most optimistic assessment of the outcome – justify the cost and the risk?

The Downsides of Mergers
It is not surprising that lawyers would look to mergers as a means of accomplishing a strategic objective. A merger is very clear and unambiguous. It involves a change of a legal entity brought about through negotiations that are documented by a formal agreement.  Unfortunately, it is precisely this formality that gets in the way of some alliances that make the most strategic sense and offer the greatest potential. There are three issues that must be resolved before any merger can move forward:

Cultural Compatibility. Appropriately, the biggest concern in any merger is whether the cultures of the two firms are compatible. This goes beyond whether the partners like each other and could get along in a merged firm. Culture determines what the organization “values” and “permits” and how decisions are made.

Profitability Differences. Even though profitability is as much a function of a firm’s leverage and policies on partnership admissions as it is its core economics, profit comparability is the litmus test for most mergers. Experience indicates that it is almost impossible to put together a merger between two firms whose profits differ by 20% or more.

Conflicts of Interest. Conflicts blend business decisions with ethics and the personal interests of individual partners. If a merger is truly worth doing, it is rare that a conflict is of sufficient magnitude (in terms of lost profits) to outweigh the benefits of the merger. Law firms find themselves balancing ethical concerns for their clients’ best interests with concerns about what will happen to the billing partners for clients connected to a conflict.
It is easy to envision situations where the benefits of a merger could not be pursued without running afoul of one of these three “merger mine fields.” For example, an aggressive New York corporate law firm represents a European medical device manufacturer whose future strategy is built on taking advantage of the development of cloning technology. It is clear to this firm that in order to continue its representation of the client and establish a “first mover” advantage in the industry, it must develop a bioethics practice. But the law firms with the greatest expertise in bioethics are filled with lawyers who are scientists and theologians. Worse, they are located in sleepy places (from a New Yorker’s point of view) like Rochester, Minneapolis, Cleveland and Raleigh-Durham. If the only way to take advantage of this opportunity is a merger, how can they cross the cultural divides and what would they do with an office and lawyers in a city where they have few synergies?

There are other merger issues. Mergers are forever. Untangling a merger is almost impossible and to put the functional provisions in place that would permit a rapid rewind of the merger would all but assure the merger’s failure. Accordingly, firms miss tremendous opportunities to avoid the risk of a bad outcome.

Mergers usually come with excess baggage. To obtain a practice capability or an office in a specific city, a firm may have to accept some unproductive partners, an undesirable practice area or an office in a city that makes little strategic sense. Corporations that merge almost always “cull the herd” – the cultural costs in a partnership structure make that quite difficult in a law firm, if not practically impossible.

Options to Mergers
There are numerous options to mergers but the two most prevalent are joint ventures and strategic alliances. These terms are often used interchangeably but they are really quite different.

Joint Ventures
A joint venture is an arrangement in which two businesses join together for a specific and limited purpose. The typical driving interest in creating the venture is to reduce risk. For example, several years ago the San Francisco firm of Brobeck, Phleger & Harrison and the Boston firm of Hale & Dorr entered into a joint venture to open offices in New York City and London, England. Both firms believed that its clients had sufficient interests to justify offices in those cities, and they each believed that having a presence in the cities would permit them to generate new work from other existing clients. They also believed that there was a strategic value to having offices in New York and London listed on their letterheads. But New York and London are two of the most expensive cities in the world in which to open an office. The joint venture allowed them to open offices at 50 percent of the overhead cost of going it alone. Each firm certainly had the capital and reputation to have opened its own office or to have pursued a merger with a firm in each city. However, through a joint venture they were able to avoid the cultural, financial and conflict issues that would have been present in a merger.

At the same time, they were able to enjoy the advantage of offering clients enhanced capabilities. Hale & Dorr’s primary interest in New York was litigation and Brobeck’s was transactional. Each staffed the office with their own attorneys but they were able to refer work back and forth. Additionally, the joint ventures were well-publicized at the time and both firms made more of a public relations “splash” than either could have hoped to achieve on its own.

Because joint ventures are designed to avoid risk, they have some characteristics that may or may not be beneficial to the participants. Joint ventures tend to be carefully and rigidly structured. To avoid risk, there is typically an agreement that spells out every detail of the relationship, including the expectations of risk and reward. Such agreements may result in cumbersome decision-making procedures. For example, it is not uncommon for participants in a joint venture to fear that the proponents and active participants in the venture will change or dilute key protective provisions of the agreement. To protect against changes, the agreement may provide that changes require approval of the Executive Committees of both firms or, in the worst case, the entire partnerships. Such protections often render the venture too inflexible to succeed in an entrepreneurial marketplace. This also can cause the firms’ highest management to involve itself in minute details of the venture that may not be the highest and best use of their attentions.

The structure of joint ventures, together with burdensome decision-making, also can make it difficult for the venture to pursue unexpected opportunities. In the New York Brobeck/Hale & Dorr example, suppose one firm succeeded to a greater degree than the other. Unless it wanted to open a second office, the successful firm could be constrained by a lease and the joint venture agreement. At the same time, while it would be appropriate for their joint venture agreement to cast the two firms as co-tenants with “Chinese Walls” to limit the risk of shared liability or conflicts of interest, these carefully constructed protections could also effectively eliminate opportunities for joint marketing or cross-referrals.

In short, the very aspects of a joint venture that limit risk also tend to limit the potential for reward.

Strategic Alliance
Strategic alliances are a “touchy-feely” version of joint ventures. In their purest form, a strategic alliance is like kids building a tree house. Someone brings surplus wood from their garage, another brings a hammer and another some nails. There is only a vague vision of what the tree house will look like. No one worries about keeping track of who is contributing what and there is no agreement about how much each participant gets to use the tree house. If someone new shows up, they make the tree house a little bigger or each participant uses it a little less. If a participant leaves to do something else, the tree house alliance may or may not continue to exist.

However, several important things happen in the process of building the tree house.
Alone, none of the tree house builders had access to all the tools and materials necessary, but together they were able to pool their assets. The investment of each party in a strategic alliance typically involves assets they already possess.

Among the children building the tree house, one may have learned carpentry skills from his father and another may intuitively know how much weight can be put on a tree branch without support. A key value of a strategic alliance is the sharing of knowledge and skills, often involving proprietary knowledge or core competencies that are not readily available in the marketplace.

By working toward a common objective of building a tree house, children who previously did not get along have had the occasion to work together. They may not become friends and they may return to being rivals when the tree house is built and the alliance is over. Strategic alliances tend to bring together parties that may have been competitors and co-opts them into allies.

Parents or neighbors who might have been concerned about the tree house may be mollified by the participation of children they trust. In fact, that trust and positive recognition may carry over to things outside or in addition to the tree house alliance. Often the value of a strategic alliance is that the parties can benefit from each other’s market presence and reputation.

Unfortunately, the most widely recognized examples of strategic alliances in the legal profession have not been particularly successful. Law firm affiliations such as Lex Mundi and U.S. Law Firm Group were designed to meet the primary objectives of referring business among law firms and permitting mid-sized firms to present themselves to clients as having a broader geographic capability to better compete with large national firms. While most of the members of the affiliations are satisfied with their participation, many admit that the actual referral of business has been less than their original expectations.

If there is a degree to which these alliances have been less than fully successful (and it should be pointed out that most members are satisfied that they receive sufficient value to justify their contribution), it is because they find themselves being a cross between a strategic alliance and a joint venture. The relationship between the firms is rather carefully defined and structured as in a joint venture and their risk is limited. While they hold annual meetings, there is relatively little sharing of knowledge or benefiting from each other’s assets except by their respective physical locations. There is no mandate that all business being referred to a city must go to the alliance member because that could represent a risk to the referring firm. Therefore, in a classic joint venture form, maximization of reward has been sublimated by risk avoidance.

A contrasting organization is “the Seven Sisters” group. While not truly a strategic alliance, seven large law firms – six from the U.S. and one from England – created an informal organization with little structure. It is designed to gather lawyers from seven firms in reasonably non-competitive marketplaces. The managing partners meet from time to time, as do the senior staff members and practice group chairs. The result is the informal sharing of knowledge, informal co-opting of rivals and some degree of asset pooling. And, while not an objective of the group, a significant referral of work occurs among the members.

The real value of strategic alliances may be as an alternative to, or perhaps a first step toward, mergers; particularly mergers designed to enhance capabilities. For example, suppose a products liability defense law firm sees food additives as being a significant potential liability for businesses throughout the food chain. The firm has the legal skills to manage a large-scale national tort defense. What it may lack is technical knowledge and client and industry relationships with major food producers, wholesale distributors and retail chains. To engineer mergers or lateral acquisitions to obtain the appropriate capability would be difficult and expensive. But, for example, joining a major Washington FDA law firm that has significant corporate representations of food chain companies with a genetic engineering consulting firm, would create a strategic alliance that could lead to incredible opportunities for both firms.

One rarely mentioned but extremely important value of joint ventures and strategic alliances is the ability of law firms to work cooperatively with non-law firms to approach the same marketplace. As law firms consider ancillary businesses and the creation of multidisciplinary practices, they are frequently hindered by law firm ownership limitations. In all states (other than the District of Columbia) non-lawyers are prohibited from owning law firms. This limits a firm’s ability to merge with a non-law firm in an effort to provide their clients with a broader range of professional services. Joint ventures and strategic alliances could be used to obtain the synergy desired without violating bar ethics.

Can Strategic Alliances Work with Law Firms?
Despite the advantages that could be available to law firms through strategic alliances, there are some powerful reasons why they could be a difficult vehicle for law firms: It is the nature of lawyers to crave specificity and structure in their relationships. Strategic alliances are, by their nature, ambiguous. They tend, therefore, to be distrusted by law firms.

Most lawyers’ basis of value is time. It is difficult to gain consensus for involvement in an activity with no specific reward for the investment of their time. Strategic alliances work best when the participants do not have overlapping capabilities, i.e., when everyone brings something different to the table. It is rare that large law firms don’t have common capabilities. Strategic alliances require leadership and vision. These are in short supply in many law firms.

Strategic alliances are typically focused on the result of competitive pressures. Most legal marketplaces are not yet viewed by lawyers as being sufficiently competitive to motivate strategic cooperation.

In the final analysis, both joint ventures and strategic alliances could be valuable structures for law firm growth, particularly as an alternative or prelude to a merger. Their viability depends on the parties involved, the precise circumstances and the degree to which they view the marketplace as being highly competitive. In any case, the argument for joint ventures and strategic alliances is sufficiently strong that their consideration should be a routine part of the due diligence process in any law firm consolidation.