Golden rules for successfully negotiating law-firm mergers

The merger process can be a long and gruelling experience for all concerned, making employees fearful, clients cautious and the press inquisitive. Finding the right partner, covering all the potential problem areas and keeping everybody on side can prove far from easy, but at least firms can now learn some tips from the many successes, and failures, that have gone before. Stephen Denyer, regional managing partner for Europe at Allen & Overy, provides the voice of experience, with some practical guidelines for navigating the all-important merger negotiations.

Over the past ten years we have witnessed the globalisation of the market for legal services. Law firms that used to operate in one or two jurisdictions now operate in 20 or 30. In this context, law-firm mergers have become a relatively common phenomenon, sometimes allowing geographic expansion at a faster pace than organic growth and delivering an instant market position.

If mergers achieve real synergies and are followed by meaningful integration, they can deliver a very positive result (a one plus one that equals three). However, many mergers fail to live up to expectations and many planned mergers are aborted before consummation. Of course, any merger will end in tears if the strategy is the wrong one, or if its implementation has not been thought through. However, even in those cases where merger is the right strategy and where a merger partner has been carefully chosen on the basis of strategic fit and potential synergies, many things can still go wrong. Frequently, this is because the parties to the merger have not correctly identified the pitfalls that are likely to be encountered during the merger negotiations and have not planned in advance how to deal with them.

Based on my experience of successful mergers involving law firms in Europe, I have identified ten golden rules for those negotiating a merger between law firms and ten issues to consider when negotiating a merger. These are outlined below:

Do not present an unduly rosy picture. Promise blood, sweat and tears. Only do the merger if both sides are really ready for it. Any merger is bound to be a relatively painful and difficult exercise. If one party simply attempts to seduce the other party into merging on the basis that it will be wonderful in all respects, disappointment and disenchantment is likely to ensue long before the merger negotiations are completed;
To begin with, focus on synergies, culture, values and vision. Do not just discuss the financial aspects of the merger. Get prominent and influential partners from both firms to spend quality time talking openly about wider issues. Also involve senior and influential support staff if you have them. If you begin negotiations just focusing on financial aspects, you are likely to negotiate a relatively good deal, but end up making the wrong strategic step with the wrong partner because insufficient attention has been paid to the real fit between the two firms from the perspective of culture and aspirations;
Try to get substantial experience of working together before making a final decision. This can take years, and should do if possible. Secondments of fee-earners (including partners) and support staff can help both firms to gain some real insights into the way the other one operates. Mergers with firms you do not know really well, as a result of working together in the heat of many transactions, are always bound to be significantly more difficult. Where you do have people who know the other party well, ensure that they are given a prominent role in the merger, because they will know where the real synergies are as well as where the pitfalls are to be found;
Ensure that each firm has clearly defined teams responsible for exploring the merger. The teams should be small, but should include key opinion formers (including prominent partners who are sceptical about the merger). These teams should meet regularly with a clear agenda. Consistent participation in these meetings will be important, and it will be essential that they delve into some of the difficult issues that will arise post-merger, rather than just re-enforcing a wholly positive message, which may be a little unrealistic;
Members of the merger task forces should talk to key clients of both firms. If at all possible, these discussions should happen in an open and structured format, in which clients are encouraged to make sceptical comments and ask searching questions as well as describing positive benefits they would expect to arise. Listening to your clients is a key pre and post-merger activity, and it is a good idea to adapt your strategy and its implementation in the light of client comments, concerns and suggestions. A positive client attitude towards a proposed merger will go a long way to reassuring sceptical partners;
Rigorous financial due diligence should be carried out on both firms. This should happen before the merger terms are agreed. It can involve either external auditors or in-house finance people. These should be given appropriate access to the books and financial records of the other firm, and provided with historical financial data. As far as possible, the financial terms for law-firm mergers should be broadly neutral. Thus, for example, it is preferable if neither firm pays for the goodwill of the other. The benefits to partners in both firms should arise from sharing in a larger pot and enhanced business arising from the synergies created by the merger;
Any restructuring required should be agreed in detail in advance. If possible, it should be concluded before the merger. If not, a clear and tight timetable will be required. It is a great mistake to conclude a merger with a firm that you know will need substantial restructuring, on the basis that all of this will be sorted out afterwards. It is much better to identify what needs to be done in advance, ensure that there is a clear and common understanding about this, and that steps are taken to implement the restructuring before or immediately after the merger. This way you get all of the pain out of the way upfront, ensuring that everybody involved has clear and realistic expectations and that they are then able to face the post-merger environment with a positive outlook that encourages everybody to exploit the benefits arising from the merger. Post-merger uncertainty must be avoided at all costs;
Agree in advance who is going to have what managerial role after the merger. Try to promote rapid integration and avoid having joint heads for everything. This also applies to senior support staff. These issues will be important, and if the merger is going to be successful, you will need to create a structure post-merger that does not just involve two parallel management and support teams cohabiting within the same firm. A truly integrated approach from day one, involving clear leadership from people best able to create a positive post-merger environment is what you should aim for;
Entrenched rights for partners in either firm are a bad idea. Try to ensure that all partners in the merged firm are treated on the same basis from day one. Special rights for particular partners or particular groups of partners will come back to haunt you in the future, and will frequently not stand the test of time in any event. It is far better to get everybody to accept that in the merged entity they will all just be normal partners, whatever that may mean in the context of a particular firm;
If either side has serious doubts at any stage, do not complete the merger. Any embarrassment arising from an aborted merger will be a small price to pay for avoiding a serious mistake. Nowadays it is almost impossible to avoid press speculation and comments about intended mergers, but until the deal is done, it is never too late for either side to pull out, and it would be a mistake not to do so if you are no longer convinced the merger is a good idea.

Ten issues to consider during negotiations

Having described my ten golden rules, I will now outline ten issues that I think need to be considered during the course of the merger negotiations. These are as follows:

Regulatory issues The bars of each jurisdiction involved will have all sorts of rules and requirements to be adhered to. There will also be a variety of tax questions to address. The final structure of the merger will be heavily influenced by these issues, but, if possible, the underlying commercial substance of the merger should remain the same, regardless of the regulatory environment. You should try to avoid regulatory requirements giving rise to a wholly different commercial result from that originally intended.
Conflicts Inevitably, there will be conflicts of interest. Some of these will be legal conflicts arising from the rules of the relevant bars, while others will be commercial conflicts arising from special relationships with particular clients. These conflicts need to be clearly identified and assessed. Where appropriate, client reaction needs to be gauged in advance. A reasonably thoughtful approach is needed to ensure that both parties end up with a realistic view of the likely conflict consequences of the merger and really do feel comfortable with the amount of work likely to be lost as a result. To achieve this position, each firm needs to go through the client list of the other in some detail. However, to try to form a balanced judgement, try to determine work likely to be gained as well as that likely to be lost. Do not allow a small minority of partners worried about conflicts to kill a deal that makes broader sense.
Name Try to avoid simply ending up with a very long name after the merger, which is just an amalgamation of the names of the two firms. Mergers provide a real rebranding opportunity. The participants should consider the strength of the existing brands represented by the firms to be merged, and also should consider any rebranding they wish to achieve in the context of the merger. Regulatory issues relating to the name should be dealt with but, as far as possible, in a way that does not undermine the overall brand recognition being sought.
Capital and remuneration structure Of course, during the merger negotiations each firm will need to look at the capital and remuneration structure of the other one. If possible, it is desirable for the partners in one of the firms that is merging to become partners in the other firm, so that there is some continuity and they are joining an existing legal and tax structure. Each partner in the merged firm needs to be very clear about what they are contributing by way of capital, and, if appropriate, the timing of this contribution needs to be linked with the withdrawal of any capital they have in one of the component firms of the merger. As regards remuneration, lockstep firms are likely to simply want to fit everybody onto one lockstep structure, while those with a merit-based element to their pay will need to consider in advance the issues that will decide how the remuneration of each partner is positioned. For lockstep firms, it is worth bearing in mind that a merger does present a rare opportunity for making some adjustments to the relative position of people on the lockstep, if appropriate.
Retirement dates and pension obligations Frequently, different firms will have different retirement dates for partners. It is undesirable to continue these post-merger. If at all possible, all partners in the merged firm should end up with the same retirement date. Unfunded pension obligations can be a very major liability, which have been responsible for preventing quite a number of mergers. The position relating to pensions needs to be clearly identified at the beginning of any negotiations and the parties need to be clear about the extent of any potential unfunded liability. Independent advice may be required on this point.
Restrictive covenants Many partnership deeds contain restrictive covenants, which prevent partners from taking clients or staff with them if they leave. Clashes between the restrictions applied in the parties to a merger need to be resolved as part of the negotiations. The parties also need to consider whether any of the covenants should be relaxed in the context of any partner who leaves during the merger negotiations or immediately after the merger. The enforceability of restrictions may also need investigation.
Past rights and obligations Many aspects of the two firms prior to merging will have an impact for a long period following the merger. These include all of the debts due to each firm in respect of work undertaken before the merger, as well as payments they are obliged to make in respect of the continuing business of each firm. The parties need to agree how these will be dealt with and accounted for. Dealing with old obligations and liabilities may well be a time-consuming and complex matter, so each party should be clear about the arrangements being made and the amount of time likely to be absorbed. Obviously there can also be reputational risks if past liabilities or claims come back to haunt one or other party to the merger so a PR strategy will be needed in respect of such claims.
Systems compatibility Many law firms now invest a huge amount of money, time and effort in their computer and related systems. Unless you are very fortunate, some or all of the systems of the merging firms will be incompatible. Incompatible systems will present substantial practical barriers to an integrated approach post-merger. The firms involved need to clearly identify what steps will have to be taken to achieve IT compatibility as soon as possible after the merger, and the likely costs. It is essential that the relevant technical people have a direct dialogue with each other in the context of these aspects.
News management Hopefully, the merger will be a big story. It will be a source of great concern to the staff of both firms and to some clients. It needs to be presented to both groups in an appropriate context. Internal messages are likely to include the longer-term commercial benefits and the impact on partnership prospects. As regards clients, any merger is a significant marketing opportunity, which you will want to exploit to the full. However, clients will want reassurance that service levels can be maintained and fees will not go up. There is also the legal press to consider, which will undoubtedly seek to sniff out the proposed merger and obtain a scoop. All of these aspects mean that a clear news-management strategy needs to be agreed and adopted at an early stage in the negotiations.
Creating a “feel good factor” Obviously, you would not be doing the merger unless you were convinced that there were substantial benefits. Once those involved in the negotiations have identified the benefits and generated the appropriate level of enthusiasm among themselves for the merger, they then need to consider how to transmit this feeling more widely. Social events are likely to play a part in this, but they need to be carefully structured to make sure that relationships within the newly merged firm get off to an appropriate start. At the same time, practical experiences of working together on deals should be encouraged at an early stage. However, those responsible for ensuring the merger is a success should be alive to the risk that early bad experiences of working together could create a negative image for the merger, which will be difficult to shift in the future. Thus, the period immediately after the merger is a critical phase.

All of the above observations are of course primarily common sense. However, it is remarkable how often some or all of the principles I have described have not been applied successfully in the context of real mergers. This is partly because merger negotiations can take on a life of their own. To guard against this, I would suggest that all those likely to be most closely involved in the merger spend time considering the issues I have described right at the outset of the merger negotiations, so that they have a clear and shared understanding of the points that are likely to arise, and they have some initial ideas on how to deal with each of them.

Stephen R. N. Denyer is regional managing partner for Europe at Allen & Overy. He can be contacted at: stephen.denyer@germany.allenovery.com.