Recently, FMRC has seen an increasing number of firms involved in a merger or acquisition. This isn’t a surprise considering the turbulent few years the profession has faced.
The ability for firms to achieve economies of scale or fill excess capacity, be it office space or management structure, is far from certain. Many firms need to do something substantial, as chipping away at the edges is not yielding the desired results (quite as often).
Purchase price or merger terms in a ‘Heads of Agreement’ document is usually relatively straightforward – this isn’t the problem. Most firms have a realistic assessment of what they bring to the table and what they’re worth.
One risk is that the parcel of fees in the acquired or merging firms are retained. This can be mitigated by ensuring the terms have sufficiently motivating financial handcuffs, helping retain partners and encouraging them to properly tend to their clients.
Due Diligence goes both ways
In recent months I have been working with a number of firms involved in a merger or acquisition, and, whether they’re buying or selling, there’s one area that is often a little haphazard – the due diligence process.
It goes without saying that partners from the acquired firm will be coming across (I’m yet to see a deal where this isn’t the case). As such, it is essential that both parties conduct their own due diligence. Often, one party will sit meekly on the sidelines providing the information requested by the other.
The following checklist is a simple due diligence outline I recommend you use, whether buying or selling a firm. Some steps can be achieved by simply reviewing documentation, others will require more detailed meetings.
You may well have more to add, but I would recommend you follow this outline as a starting point.
1. Strategic Considerations
It is important to completely understand where the business is heading. This can be achieved on paper, but you might get a better understanding of people’s ambitions and motivations by meeting and talking about the future.
Information required:
- Records of capital expenditure – past 5 years and planned future expenditure
- Planned future acquisitions
- Business Plan
2. Partnership
You should analyse both the contractual obligations of the partnership and the current performance of existing partners. As well as this, ensure you get some face-to-face time with the partners – you might have to work side by side after all.
Information required:
- Current partnership agreement
- Demographics of partnership – age, practice area, and tenure of all partners
- Equity share of all equity partners, as well as the pathway to full equity partnership – e.g. admission criteria and process
- Management roles of partners and their performance
- Partner voting rights
- Partner drawings from the past two financial years
3. Financial considerations
This is a step that can (and should) be mostly done on paper. If you aren’t very familiar with business finances, I would recommend you enlist the help of a professional. After you’ve analysed the list below, you should also perform financial modeling to predict the profitability of the merged entity.
Information required:
- History of consistent earnings – financial accounts and cashflow for the past two years, as well as current year budgeted
- Inter-company transactions – Monthly WIP and debtor balances by practice group for the past two years, as well as Aged WIP, debtors and creditors list for the current month
- External funding – Terms and security for all loans, borrowings and debt
- Extraordinary (or non-recurring) expenditure and income
- Taxation Depreciation Schedules for the past three financial years
4. Management/Other
You should ascertain who has a hand in running the firm outside of the partners. How much impact do they have in day-to-day operations and how will this change post-merger?
Information required:
- Management organisation chart – discuss management structure and how the change will impact this
- Role of individuals in management – their job description and experience
- Role of the board in running the business, as well as their compensation
- Premises – the lease details for all work sites
- Professional indemnity claims
5. Performance Management
Every firm has its cash cows and passion projects – you should understand the particular strengths and weaknesses within the firm.
Information required:
- Assessment of practice areas – Income by practice area and office for the past two years, as well as hours, rates, writeoffs and expense allocations
- Originator reports – Fees by responsible partner
- Structure of practice groups – Organisation chart for each practice group
6. Personnel
Metrics such as staff satisfaction can often give you a good insight into how a business is run, yet are often overlooked. By taking the extra time to look at the little details, you’ll often better understand the bigger picture.
Information required:
- Workplans / budgets / performance criteria for fee earners
- Total FTE personnel by office – fee earners and non fee earners
- Restraints for all key personnel
- Internal and external training curriculum
- Details of bonus or incentive plans, and who is covered
- Staff satisfaction surveys or exit interviews
7. Client Base
It is well worth evaluating the firm’s clients to get a more granular picture of revenue – for example, ask if the firm could afford to lose a bigger client.
Information required:
- Spread of clients – fees generated by the top 50 clients as well as their rank over the past three years
- Details of all panels – duration, other firms, fees from panel clients, rates, relationship to partners
- Departmental marketing – evaluating past effectiveness and future plans
8. IT Capability
IT infrastructure is often forgotten during initial discussions. This leads to a very difficult problem that only becomes apparent after the merger has been agreed to on paper – how will digital information be handled during the merger?
Information required:
- List of all IT systems used – evaluate ease of integration of practice management systems, databases and other IT
- Lease commitments for all IT – amount and duration
- Proposed new systems
Summary
While this list may seem exhaustive, it is truly only scratching the surface of certain issues you may face during a merger or acquisition – issues that will change depending on your firm’s practice areas, size, structure and more.
If you think I’ve missed anything, let us all know in the comments and I’ll add it to the list. Good luck!
About FMRC
FMRC is a specialist consultancy firm providing research, training and management advice to law firms. Sam Coupland’s client facing role as a director of FMRC spans direct consulting and management training. Sam’s consulting work is predominantly providing advice to smaller partnerships. Sam is considered the foremost authority on law firm valuations and would value more law firms than anyone else in Australia.