Why Both Sides in Law Firm Mergers Must Check the Evidence First

October 13, 2017

This year has seen a blazing pace of law firm mergers, fast approaching the annual record of 91, according to one legal consultant.

But mergers are a little like dating. While many firms ultimately benefit from uniting, both sides need to understand what they’re getting into before committing.

Most deals see bigger firms taking on smaller ones. But regardless of size or perceived advantage, before inking the contracts, both parties must conduct due diligence to avoid potential downsides. Here are some key aspects to consider.

Review Conflicts of Interest

Areas of expertise between merging firms can overlap. Merging firms should review potential client conflicts. The legal industry is enormous, but as any lawyer can attest, it’s also something of a small world.

Ethics rules prohibit lawyers from representing clients on opposite sides of a legal dispute. If you discover a conflict, your firm can ask a client to waive it. If it declines, you might have to drop that client or reassign the lawyers involved.

Determine Vulnerable Clients

Evaluate the other firm’s client list to determine the possibility of losing a major client. Does your potential partner have any clients that represent a large share of revenue? Explore every avenue to learn if any outstanding issues put those clients at risk.

Investigate to see if the vulnerable clients feel the other firm has been unresponsive to their needs.

Relationship flaws typically push clients away. If it looks as though any of the other firm’s clients might soon walk, then establish the costs of such a loss.

Look for Contingent Liabilities

A thorough review of law firm mergers requires looking beyond the obvious items on balance sheets. Assess the other side’s contingent liabilities.

Determine how many open issues exist and how much the other firm typically spends on defense. Learn the amounts of legal contingencies and the facts and circumstances behind them. Discoveries here could reveal a poor work culture and ongoing risk behavior.

Also look at:

  • Pending obligations not on the balance sheet
  • Unfunded retirement obligations
  • Exposure to unpaid tax liabilities
  • Employees located in multiple states

Finalize Billing Methods and Strategies

A merger ideally advances the best practices of each firm. You’ll need to reach clear consensus on revenue.

Firms that charge by more than one method can be a good fit for any merger because clients have varying needs and means of payment. Accommodating more than one type of payment will lure more clients.

Before a merger, check if the firms’ hourly rates are similar and how the professionals at each compare. A firm with several generalists should have different billing rates than a firm with specialists.

Compare Malpractice Histories

Defense, damage and settlement costs of legal malpractice claims may be significant. Merging firms have to disclose any possibility of future claims so the other side can review them.

Compare the rates of professional liability policies. How would a merger affect the cost of insurance? Would there be any possibility of cancellation?

Assess the New Talent

Gaining capable lawyers is one of the biggest advantages of a merger, but get to know the people you could be joining.

Who are the rainmakers? Are any key attorneys nearing retirement? Is the other firm comprised of specialists or generalists?

Study the following areas of the other firm’s talent:

  • Partners: Check bios and compensation. Run background checks.
  • Employees: Know titles, functions and salary histories. Run background checks.
  • Benefit plans: Including retirement and deferred compensation.

Many times, firms evaluate only one or two key people, and issues arise later with professionals who weren’t vetted on the front end.

There will be personality clashes after any merger. There will also be attorneys with declining business and efforts. Avoid or mitigate those shocks by preparing beforehand.

Know The Bottom Line

Law firm mergers and acquisitions often make perfect sense, but there are many factors to consider first.

Make sure you engage a CPA firm with deep expertise in the legal profession to go over financial details of both parties in advance.

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