The recession provides an excellent opportunity for law firms to achieve strategic objectives through a series of small mergers that are effectively acquisitions.  Increasingly, smaller firms with less than 50 lawyers see “being acquired” as the best means of surviving the economic downturn.  For larger firms, picking up lawyers in small groups enhances the likelihood of a successful integration and a lower financial risk exposure of individual laterals.  And, a series of smaller transactions typically has a greater potential of actually occurring than trying to put together a single large merger. The problem for both sides is finding an opportunity that fulfills the firms’ respective strategic objectives.

Understanding Objectives
For smaller firms being acquired is typically an issue of survival.  As the economy tightens, larger firms expand their business development efforts to including “emerging clients” which is generally code for businesses being served by small law firms.  At the same time, as larger firms become more competitive for lateral hires, smaller firms’ lateral candidates are generally limited to lawyers who have practices that are sufficient to support themselves but can’t spin off work that builds profit for the firm.  In short, the opportunities for smaller firms are contracting at a time when economic demands are more stressful.  Being acquired by a larger firm is often viewed not only as a viable solution but, sometimes, the only option.
Conversely, the objectives for larger firms are often less defined – in fact, I call it “shopping at Sam’s Club”  (in fairness, I should confess that my wife hasn’t allowed me to shop at Sam’s Club since I came home with a five pound can of black olives and a 240 roll pack of single-ply toilet paper).  Like me at Sam’s Club, large law firms often approach small mergers as “too good a deal to pass up.”  As a result, they end up with a lot of stuff they don’t need.

The answer, of course, is to predetermine the firm’s needs rather than reacting to opportunities that become available.  There are basically four – and only four – valid reasons for acquiring smaller law firms:

  • Increasing the depth of capability.  A merger with a smaller firm, especially a firm that is fairly specialized in its practice, can provide critical mass in a practice area.  This is especially true in a smaller office of a large firm where focus is required to gain recognition in the marketplace.
  • Expanding the breadth of capability.  Merging with a boutique may be an excellent means of adding a practice area without the baggage involved in merging with a larger firm.
  • Establishing positioning.  Small firm acquisitions are often an excellent means of moving into a city or publicizing the firm’s capabilities.
  • Gaining access.  Often, acquiring a small firm’s access to trade associations, a specific client or a regulator may be more cost-effective than building from scratch.

Small Acquisition versus Large Merger
There are some significant advantages to growth through the acquisition of smaller firms in comparison to large scale mergers and singular lateral hires.  For starters, they are typically easier to put together.  Smaller size diminishes issues of surplus real estate and, because they are often more frugal in their management, smaller firms usually have fewer liabilities and redundant employees than in mergers among larger firms. At the same time, political issues are typically less complex than in mergers of equals because the assumption is always that the “acquirer’s” name, compensation system and processes will prevail.  And, while the addition of any personnel has an impact on culture, it is unlikely that a smaller firm acquisition, or even a series of them, will have the jolting impact that a large merger does.  The financial and reputational risk involved in the merger’s potential failure to achieve its objectives is lower and, therefore, the transaction is easier to sell to the larger firm’s partnership.  And, because the acquiree’s financial records are available for due diligence and their work in progress and accounts receivable come with them, there is less risk and lower cash flow impact than with laterals.

There are, of course, some downsides.  Partners from smaller firms are usually accustomed to fewer restrictions and procedures than are in place with larger firms and practice group leaders may have some difficulty coaching their acquisitions in functioning in a collaborative environment.
The greatest difficulty, however, may be for the larger firm’s partners to accept that an acquisition will usually mean the expenditure of some capital.  Small law firms are almost uniformly more efficient in sending out bills and collecting receivables and they usually carry much lower capitalization than larger firms.  At the same time, typically their statistics – revenue per lawyer and profit per partner – are lower than those found among larger firms.  The result is that it is hard to make a small acquisition the cash neutral transaction that firms usually seek in mergers.  This means that there is a price attached to most acquisitions of smaller law firms.

Making Acquisitions Work
Acquisitions, particularly in the current economically stressed environment, offer some wonderful opportunities. The bottom line is whether the strategic objectives of an acquisition truly justify its price or whether the deal just seems too good to pass up for something you don’t really need (like shopping at Sam’s Club).

Here are four questions law firm managing partners and boards should be asking themselves before they go shopping for an acquisition.
1. What are the three to five top strategic practice areas where the firm needs to grow?  What are the parameters surrounding that growth, i.e., in what sub-areas should the growth occur and what is the minimum amount of growth required (by number of lawyers or dollars of revenue) to reach critical mass?
2. What, if any, practice areas does the firm need to add in order to meet its strategic objectives (simply not having a practice does not necessarily make its addition of strategic importance)?
3. What geographic locations are of strategic importance and what is the necessary practice and minimum size to meet the strategic objectives?
4. What is the price tag the firm would be willing to accept to achieve each specific strategic objective?

Once a firm has come to grips with these issues, even in a comparatively informal way, they are at a tremendous advantage in considering acquisitions.  First, they have a measuring stick with which to evaluate opportunities.  And, perhaps most importantly, they have the information and confidence to actively seek acquisitions that meet their criteria rather than just waiting for opportunities to come to their attention while roaming the aisles at Sam’s Club.

As the economy tightens we see an increasing number of law firms seeking to take advantage of the recession as an opportunity to “acquire” smaller firms.  In some situations, firms want to add to their critical mass in their existing locations.  In others, they want to use a small merger as a means of entering new markets.  At the same time, many smaller firms have an interest in considering a merger with a larger firm to provide them with the stability and expanded capability to compete for more sophisticated legal work but they have no means of identifying firms that might have an interest in their lawyers and practice.