Feature

posted 7 Dec 2004 in Volume 7 Issue 7

Winning combinations: Making a success of a law-firm merger

It is said that preparation is the key to success, but in the merger process, it is only the beginning of a long process that requires foresight, commitment, communication and decisive leadership. Giles Pugh, European head of Hildebrandt International, provides a holistic insight into the ongoing process of change that comes with any agreement to merge.

Mergers have powerful advantages. For instance, the Freshfields/Bruckhaus combination is a well known example of the use of a merger to build a significant presence in a major market. Similarly, the combination of Coward Chance/Clifford Turner helped transform a firm’s market position, and there are other examples among the mid-tier firms. Mergers can deliver both revenue benefits, through access to a broader range of clients, and some cost benefits from increasing scale and reducing duplication. They can also free up a firm from many of the internal constraints on change. But mergers are complex and can go seriously wrong. It is therefore important to get the process right.

Merging for the wrong reasons and in the wrong way

Where do mergers go wrong? One problem is in the initial motive. Mergers are too often used as evidence of management activity or used to break an internal log jam where partners cannot arrive at a consensus for change. When a firm is struggling, merger can be seen as a panacea, notwithstanding that the vaunted synergies between the two organisations are at best doubtful on close examination.

Then there is the way a merger is executed. It is not unknown for the firm selected as a merger partner to have been identified during the course of a congenial dinner between the two senior partners. The process of merger can rapidly acquire an excitement and life of its own. Members of the firm who are initially excited by the unfolding events become concerned about their own future. Competitors capitalise on the growing uncertainty to lure away both clients and partners. The focus is on completing the deal, resolving any tax and conflicts issues... and then carrying on very much as before. With poor integration, few if any of the benefits are captured and the merged firms continue in an uneasy relationship, deeply conscious of their differences.

Mergers merit preparation

Mergers are expensive. This is not only due to the cost of integrating systems, policies, procedures and teams of people, but also because of the distraction from client work. When a merger is unsuccessful, it can set the progress of the firm back by a number of years, damage its reputation and impact profitability. Mergers, therefore, merit considerable preparation to ensure that they create genuine value for the firm.

Key success factors in achieving a successful merger

Experience suggests that the following seven factors for merger success are particularly worth highlighting:

Creating a clear strategic rationale;
Establishing a dedicated merger team;
Identifying the right merger partner;
Having a clear focus in the negotiation process;
Communicating to create and sustain commitment;
Leading decisively from the top;
Structuring an integration process to deliver the benefits.

Strategic rationale

It is sometimes forgotten that a merger is not in itself a strategy, but a powerful strategic tool. Yet mergers are often ‘bet the farm’ events – they are not without risk. For this reason alone, it is surprising how often the underlying strategy behind a merger is poorly developed and the benefits insufficiently identified.

The starting point is to decide which clients a firm wants to serve, what it would like to offer them and how it can be delivered in a way that is superior to competitors. Merger is one route for achieving the position in the market to which the firm aspires. Its value as an option should be assessed in terms of the potential benefits. These can come from the additional clients served, the new areas of legal advice offered to existing clients, some cost savings from combining a shared infrastructure and from the restructuring of the combined firm around the new market direction.

Dedicated merger team

Once it has been determined that merger is a serious option, it is important to identify a small merger team that has sufficient time dedicated to the activity to ensure its success. Mergers are not only complex, but at times laborious and, at others, hugely exciting. It is therefore crucial that the rest of the partnership is shielded from the day-to-day distractions so that they can retain their focus on the success of the core business.

Identifying the right merger partner

Before entering into merger discussions, the best possible candidates should be identified through a systematic process of appraisal. It is not uncommon part of the way through a negotiation with one firm for a better firm to appear. A lack of prior due diligence on potential candidates can then prove highly disruptive to the negotiations.

The appraisal process starts with a broad screen to identify those firms with market positions that are broadly compatible with the firm seeking a merger partner. This should be followed by a fine screen that identifies a shortlist of firms that meet the core merger criteria, which come directly from the strategy, determined at the outset of the process.

The final stage is a thorough analysis of the most attractive candidates on the shortlist. With a combination of fact finding in the public domain, interviews and analysis, the amount of information one can obtain can be considerable; sometimes it is even possible to be in the fortunate position of understanding more about a firm than they know about themselves.

This analysis allows the merger team to rank the potential of the leading merger candidates to create genuine value. The success of a merger is in large measure predicated on the degree of alignment of the two firms. The merger team should use the analysis to assess the degree of alignment between the firms on four principal dimensions.

The first is the candidate’s implied strategy, as indicated by the nature of its clients, its principal areas of practice and the nature of the business model that it operates. If partners in the target firm are pursuing different types of clients, with a clearly different approach to running their practice, then achieving a genuine consensus on direction in a democratic partnership can be problematic and lead to later fracturing.

The second dimension is the candidate’s financial performance. Wide variations in performance imply that parts of the merged business operate in a different way, serve different clients or focus on less remunerative legal work. While this may present the potential to deliver a merger benefit, from reforming and changing working practices – it may, however, imply the firm is a poor fit. Poorly aligned financial performance will make agreeing the profit-sharing arrangements more challenging. It will also make it difficult to establish a sense of a collegiate, co-equal equity partnership post-merger.

The third dimension is brand. Will merging with the candidate effectively dilute the firm’s market reputation, or will the two firms in combination be perceived as a credible new force in the marketplace?

Finally, and in many ways most crucially, how will the cultures of the two firms fit? There are a number of partial windows into a firm’s culture. One is through understanding the target firm’s governance structure. Another is through its remuneration structures. A third is through building an understanding of the firm’s values and behaviours. Some of this more intangible flavour can be acquired from talking to people with experience of the merger target. However, in the final analysis, the most important test of compatibility is for partners in each practice area to meet and understand how the other operates.

Understanding the relative fit of the shortlisted merger candidates will reveal the degree of restructuring that needs to be negotiated before the merger, or carried out afterwards, to make the combination viable.

Focus of merger negotiations

From the appraisal process, a clear picture can be formed of the relative benefits of a merger with each of the primary candidates. Merger benefits are through a two-way process. In preparing the approach to the merger target, it is equally important to have compelling arguments for why the target firm should contemplate merger.

While circumstances differ, the approach will often need to be handled as a part of a graduated process. This is the point where the senior-partner dinner has real value. The initial contact should be informal, with the discussion centred on developments in the market and getting to know each other’s firms better. Subsequent discussions should be more specific, culminating eventually in a full explanation of the mutual benefits to both parties.

The preparation of an initial business case will demonstrate to both firm’s executive committees the value of proceeding to the next stage.

Merger discussions need to concentrate on four principal areas:

The basis for profit sharing in the merged firm;
The governance and management structure of the combined firm;
The branding of the merged entity. The brand at the outset does not need to involve a significant change. What, however, is altogether more important is agreeing how the brands will alter as the goodwill in one brand migrates to the other or to a joint brand;
The fourth topic is the realisation of the benefits of the merger by agreeing some of the main mechanics of the integration process.

As with any transaction, the negotiation team needs to have established the optimal terms they are seeking, the minimum they will accept and a series of potential trades and concessions to exchange with the other side to reach agreement. If the terms are acceptable, then the outcome should be projected as a win-win for all parties, as those on the other side will soon become colleagues.

Thorough due diligence is then a prerequisite to manage the risk of the transaction. Not only will it identify any potential black holes, but it will also produce further guidance on how best to conduct the subsequent integration of the two organisations.

Communication

An old saw of mergers is that you can’t over communicate – and it’s true. It is crucial to keep control of the information agenda. Otherwise rumour replaces fact and suddenly support for the merger starts to evaporate. Mergers are periods of considerable uncertainty, so it is best to be open. Issues should be addressed as they arise rather than risking the discovery, when it comes to the partner vote, that support has ebbed away.

Communication needs to be targeted at each internal and external constituency. Partners and the marketing function have a particular role in maintaining a dialogue with clients throughout the merger. However, if the deal is to succeed, the firm’s partners deserve particular attention.

They will usually be persuaded by a strong commercial logic: in essence, the benefits that will accrue to their practice or to the firm as a whole. The necessary investment of time for partner meetings needs to be factored into the negotiation process. Persuasive advocacy is required and a genuinely participatory approach.

The aim should be to foster open discussion, hold regular meetings and establish a process based on mutual respect. However, it is important for the process not to be derailed by a few vocal individuals: there will come a time when tough decisions need to be made, and then it is time to move on.

Mergers of all types go through a well established cycle. An effective communication programme will anticipate and adapt to each stage.

Decisive leadership

While part of the merger process can be delegated in larger firms to a merger team, there is no substitute for clear leadership from the top of the firm. A small team of the firm’s leaders (people who will carry the partnership with them) should act as a policy-making body. They should form the reference group for the negotiation and integration teams. And there should be a clear process of escalation to the reference group of material issues throughout the merger process. In smaller firms membership of the reference group and negotiating team will overlap, or be the same group of people.

Speed is important as it is in everyone’s interests to minimise the period of uncertainty. However, the reference group must judge the correct balance between rapid and effective decision making, and devoting sufficient time to address the concerns and gain support from all the key stakeholders.

Post-merger strategy and successful integration

The merger teams on both sides need to be able to come together to articulate a clear post-merger strategy for the combined entity. The remit for the integration team should prioritise those areas necessary to capture the major sources of economic value from the merger. Realising the benefits of the merger sets the agenda for the whole integration programme.

Roles and responsibilities for the integration teams must be determined and priorities agreed. At the start of the integration process, plans should be put in place to cover, inter alia:

The integration of client relationships across the combined firm;
The management structures and appointments for the combined practices and business functions;
The make-up and responsibilities of the new management and partnership committees;
The operation of the firm’s main planning, control and people processes;
Integration of the combined firm’s systems, marketing, signage, HR policies and financial reporting.

Against the integration plans, there should be a defined resource requirement, a schedule, milestones and a budget that are constantly monitored and acted upon by the integration team. A range of cultural integration activities need to be designed to give members of each firm a chance to meet and interact. Quick wins should be implemented as fast as possible and early successes celebrated to give a sense of positive momentum.

Measuring success

Finally, the benefits the merger has aimed to create should be tracked, at least for each quarter over the first two years. If the merger achieves the value it originally set out to deliver, then that will be reflected in a sense of achievement across the combined firm. Mergers are higher risk than organic development, but a bold move well executed can bring about a step change in the fortunes of a firm.

Giles Pugh is the European head of Hildebrandt International, which advises professional-service firms. He can be contacted at gsapugh@hildebrandt.com