What's in store for 2023 remains anyone's guess, but uncertainty prevails, and such an environment could make for favorable circumstances for a merger.
No one really anticipated the challenges following the 2009 recession nor the economic growth of 2021, but through both the recession and the COVID-19 era, large and small law firms alike explored merger opportunities, with boutique firms in particular seeing successful results.
Throughout the up and down cycles, we saw some common themes emerge for these boutique firms that pursued merger opportunities. In particular, successful boutique firms invariably fell into one of three camps:
These firms are doing very well, love the autonomy, and have a solid succession plan in place. Their long-term strategy can best be summed up as, "the last one out the door will turn off the lights."
Firms in this camp rarely look to combine, and those that do tend to because a unique opportunity presents itself.
These firms are doing very well, but some cracks are emerging, such as:
Firms in this camp are often receptive to hearing what's out there.
These firms are doing well, but when looking down the road — often with founders in the later stages of their careers — they see that there might not be enough people in place to continue providing the exacting level of service that their clients have become accustomed to or to drive the requisite revenue to continue to grow.
Succession planning for leadership within the firm and for maintaining client relationships perhaps has not been properly put in place. Firms in this camp have a bit more sense of urgency as they tend to be losing value as time progresses. The melting ice cub" is an apt analogy.
Camps Two and Three present existential challenges, regardless of the state of the economy, which tend to be exacerbated in times of uncertainty. With larger national firms better-resourced to spread risk, a combination into a larger platform during times of uncertainty can prove to be a synergistic win for both sides.
Regardless, one adage holds true across the board: It's best to explore opportunities when you want to, not when you have to.
Of course, the devil is in the details, and finding a strategic fit requires a real understanding of the market, locally and nationally, especially if a firm wishes to combine with another firm not already in its geography. This can be a real stress point for firms because this is not the sort of intel the firm can readily find on their own.
When contemplating whether a merger is even an appropriate strategy to consider, a boutique firm should first ask themselves which camp they are in and what challenges they are looking to solve. If they find they are in Camps Two or Three, a combination may be a more viable avenue to pursue than if they fall into Camp One.
The process of then getting to the point of having meaningful conversations, however, can take considerable time. If a firm is not guided properly, it can result in much wasted effort and missed opportunities.
For that reason, before embarking on an exploration of opportunities, consider these pivotal questions.
1. Is a preexisting local or state presence desired, and what is the geographic reach of the platform?
This is important because some firms are so used to their autonomy that they fear losing it, especially when joining a larger firm with an office in their locale. Being the only game in town can help lessen that feeling. On the other hand, some firms may want their new partner to have a local presence as a way to offload managerial or administrative responsibility.
Additionally, practices and clients dictate the sort of platform that would be best. Firms need to look at their client base and the type of work they are doing on behalf of those clients — and could be doing on behalf of those clients if they were part of a larger firm — and determine what their ideal geographic reach.
2. How important is culture?
While culture is always very important, it is often very difficult to quantify, but we encourage the firms who are meeting to get a sense of each other's culture by having a detailed discussion about firm philosophies and their approaches to client service, associate mentoring, partner promotion and partner compensation.
In addition, it is important that both sides make a personal connection. In one of the recent mergers that we worked on, one of the partners in the boutique firm had what he referred to as "the beer and pizza rule," meaning, he'd ask himself, "Are these the sorts of folks with whom I'd like to go out and have a beer and pizza?"
As conversations progress, a telltale sign of a cultural fit is when cross-selling opportunities begin to take root even before a merger closes. We have seen that in several of our deals, and the amount of referral activity going both ways can be astonishing.
3. What practices and conflicts may be stumbling blocks?
The last thing anyone wants to do is spin wheels and waste time. We've seen it happen when boutique firms enter conversations, only to realize after several meetings that there are major practice area conflicts, such as payor versus provider, branded versus generic, insurer versus insured, etc.
We highly recommend that the conflict vetting process begin very early in the relationship between the firms so that issues can be identified and solved sooner rather than later.
4. What are the firm's metrics regarding rates, etc.?
Another place where we see early inefficiencies is where boutique firms explore opportunities where economic metrics are not in line. Having a strong grasp of rates, hours, revenue per lawyer, profits per partner, etc., will help ensure that a firm is not overextending its reach.
Economics rarely ever line up exactly, but they need to make sense for a successful deal to be done.
5. Is there enough revenue to cover costs and partner compensation?
Upon the closing of a merger, there are typically three major expense items: taxes, tail coverage and capital contributions. Analyzing the boutique firm's revenue streams and the anticipated costs will help avoid any 11th hour surprises. For example, the cost differential between limited and unlimited tail coverage can be substantial.
Additionally, spend time early on discussing compensation expectations pertaining to equity versus nonequity partners.
6. What about administrative support and systems, leases and other financial obligations and organizational entity?
Finally, a few catchall items that should be top of mind include compatibility of — or challenges with — accounting and billing systems; office lease issues; corporate structure; such as corporation, partnership or LLC; and any other financial obligation that the firm has entered that may be an issue for any potential combination partner. For structuring, note that there are inconsistencies among states as to the entity structures that are permitted by bar rules.
Being able to answer these questions will help ensure that the right avenues are explored. Then, once conversations with potential suitors commence, especially heading into an uncertain 2023, spending a little time addressing these key points ought to provide added clarity.
Again, though, it's best to explore possible mergers on your own timeline — and for many boutiques, 2023 could be an opportune time to consider whether such a move is strategic for your firm.