Career Development  -->  Law Firm Economics

Consolidation of the legal profession has heated up over the past several years. The push to merge, acquire, and grow is fueled by the breakup of financially weaker firms and by partners who believe that their clients would be better served by a larger platform. There have been approximately 300 mergers between U.S. law firms with five or more attorneys since 2000. Merger activity seemed to increase during the economic boom of the late 1990’s, and slow down in the following recession, but the numbers are climbing again with the improving economy. From 1998 to 2004, the median lawyer headcount in the AmLaw 100 firms grew by 34%. Now over a dozen U.S. law firms have grown to over 1000 attorneys each. The largest firm in the world currently is U.K.-based Clifford Chance with 3500 lawyers, which has several offices in the U.S. Even with this dramatic growth, no U.S. firm has more than 1% of the market share, so there is plenty of room for more consolidation.

 

Mergers are successful when they implement the strategies of the participating firms; they are not an end in and of themselves. The resulting firm should create a platform for further growth, and may require the shedding of partners and practice areas that do not contribute to the ultimate vision. The impetus for law firm mergers usually is geographic or practice expansion, either adding new capabilities or deepening existing ones. The combination should create opportunities that did not exist for either of the firms previously.

 

Before seeking a merger, the individual law firms should identify their own strengths and weaknesses. With that information, they should look for a merger partner to fill in the gaps. The firm may determine that it needs to increase its specialization, add complementary capabilities, enhance its ability to attract clients or industries not currently served, add areas of practice its current clients now need or will need in the foreseeable future, or solidify relationships with clients served by both law firm merger partners. This last situation is becoming increasingly important as corporate clients are winnowing their lists of approved firms to which they will send business.

 

There are several advantages to expanding through an acquisition or merger with an existing firm or group of attorneys rather than by adding one or two lateral partners at a time. It immediately brings “critical mass” and an existing client base as well as making a splash in the marketplace. The group of attorneys already is cohesive and work well together. If a stand alone firm is acquired en mass, rather than adding only a part of a firm, it often brings a turn-key operation, which is important if the acquiring firm is opening an office in a new geographic location. From the financial side, adding an up-and-running law firm brings work in progress, which cuts down the lag time for collection of revenues to offset the costs of the merger.

 

A smaller firm may wish to merge in order to grow along with its clients, especially if a client is more comfortable with a larger law firm with more expertise, breadth of practice or a particular specialization, or the need for critical mass to staff large matters. Public company general counsel may feel more comfortable using larger, “name brand” firms especially after Sarbanes Oxley. Furthermore, larger firms with a more diversified client base, more resources and, possibly, higher billing rates and salaries, may have an advantage in recruiting the best and the brightest partners and associates to its ranks.

 

A merger might be especially attractive to a smaller firm where the rainmakers are senior and there is no clear “next generation” or “heirs apparent” for succession purposes. Law firms should not use the merger strategy to cure financial problems, however.   The combination of two financially weak firms does not make a strong law firm; it merely results in a larger problem. Usually, those mergers to not succeed and both firms end up dissolving. The key to becoming an attractive merger partner is to strengthen your existing firm first.

 

Practice groups or a single rainmaking partner with associates may be attractive acquisition targets if they are profitable and have the desired practice and client base. The advantage to such a group is that the acquiring firm only needs to add those attorneys that fit its vision, and leave others behind. The disadvantage at the outset is that revenues from the group’s work in progress at the time of the acquisition may not follow them to the new firm, resulting in a longer lead time before collections come in to the merged entity. There may be further start-up costs if additional staffing, space, equipment, library, and other resources are needed for the new attorneys.

 

In recent years, mid-sized firms have been under tremendous economic pressure as the megafirms continue to grow. They cannot compete directly with the large firms, so many have grown through mergers themselves, downsized and became boutiques, or gone out of business. It is the conventional wisdom that a mid-sized full-service firm cannot be successful as a full-service large firm; it must find its niche and specialize. Some firms have bucked this trend, but have settled into a particular geographic, industry, or smaller-to-mid-market client niche. The upsides to a smaller practice environment include more personal attention to clients, a tighter-knit culture, the ability to be more flexible regarding fee arrangements attractive to smaller clients, and a higher profile and deeper involvement in the community. Some partners have left the megafirms to return to the mid-sized firm environment, feeling a loss of identity and uniqueness as the firm grew. They cite the larger firm’s bureaucracy, impersonal attitude, and disenfranchisement of the acquired group if they were part of a merger.

 

The mid-sized firms also have grown over the past couple of decades. That definition now fits firms with 50 to 300 or so attorneys while, in the past, firms on the upper end of that range would have been considered large. In addition to acquiring lateral partners or groups who have spun off from the megafirms for various reasons, mid-sized firms have been very active in the merger market. Many of them have pursued a regional, rather than national or international strategy, however. For example, of the 47 law firm mergers in 2004, 20 were between firms with main offices in the same state, and nine involved firms in the same geographic region. 

 

Some small firms have bucked the huge growth trend and see themselves as alternative business models of success. The most successful have repeatedly rebuffed approaches of larger firm suitors for a merger. A primary survival strategy is to create a boutique firm by concentrating on one or two practice specialties and doing them very well. These firms develop deep expertise in their specialties and strong relationships with their clients, where they really get to know their clients’ industries and the players, engendering great loyalty and trust. They have another advantage over the larger firms: they often get referrals when the megafirms are conflicted out, which occurs more often at the larger firms continue to grow.   Moreover, the smaller firms often have lower overheads and, by necessity, staff matters more leanly than the larger firms. Therefore, they have more flexibility to offer their clients lower and more attractive rate structures.

 

Another strategy mid-sized and smaller law firms have adopted to compete with the national and international megafirms is to join networks. Such networks include Meritas with 165 business law firms, International Lawyers Network with 4,500 lawyers from 85 firms in 61 countries, Lex Mundi -–the largest—with 15,000 lawyers from 161 law firms in 99 countries, Terralex with 10,000 lawyers in 93 countries, and Multilaw with 4,500 lawyers in 130 locations. Membership in some of these organizations is by invitation or referral only, but all cost thousands of dollars to belong. For those who benefit by the networks’ cross- referrals and quality control measures, the membership costs are a reasonable price of doing business, and allow them to maintain their independent identities yet compete on a national or global scale. Megafirms believe, however, that their business model is superior to that of the networks in that they provide seamless client service. They argue that they offer more quality control and a stronger relationship with the client with more shared knowledge and easier movement of information and documents.

 

Virtually every large, mid-sized, or small law firm has flirted with the idea with merger at one point or another. Many have engaged in exploratory talks, but most such talks do not result in a deal. Unfortunately, a completed merger does not necessarily mean strategic success, as some unravel over a relatively short period of time. Some fallout in the form of attorney defections is to be expected, however, even in a successful merger, and some practices and attorneys do not fit with the new vision. Like any building project, a merger takes longer and costs more than the parties expected at the outset. Nevertheless, these obstacles seem to neither dampen the merger mania nor slow the growth of megafirms.

 

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