Due Diligence for Law Firm Mergers

Due Diligence for Law Firm Mergers

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According to legal consultants Altman Weil, law firms in every section of the market are interested in mergers. They said that, in 2018, there were 106 mergers, which exceeded the previous record of 102 in 2017. The reasons firms merge vary, but they include such objectives as increasing size or geographic reach, acquiring or expanding a specialty practice and succession planning.

Due Diligence

Even if your firm isn’t ready to think about a merger just yet, it’s important to understand what firms look for when they conduct due diligence. The goal of examining the financial records of both firms is twofold: (1) objectively ensuring that the numbers align and (2) identifying any potential problems. Essentially, these goals are the same as the goals for any business merger.

Once a preliminary agreement is signed, the firms should perform due diligence examinations in the following areas:

Review of historical financial performance

  • Examination of current financial status
  • Future projection analyses
  • Entity structure
  • Tax implications
  • Outstanding liens and litigation
  • Existing contracts or leases
  • Quality of work product

The firms should also talk through the following:

  • Analysis of systems being used and how to align them (e.g., research, document management, client relationship management)
  • Personnel policies (e.g., performance management, annual raises)
  • Overlapping roles
  • Severance packages, if any
  • Nondisclosure and confidentiality agreements, if needed
  • Announcements of the merger, both internally and externally
  • Campaign for notifying clients
  • Changes in any locations, including closures or combinations and how and when this will be done

Sticking Points and Projections

Each of these elements is important, but a particular sticking point is how the new entity will be structured. The rules are complicated, but the result may be that individual partners or shareholders may find themselves with an unexpected tax bill. Consider these examples: suppose two partnerships merge. When the deal is consummated, taxable income might be accelerated for some or all of the partners because partnerships are pass-through entities that are not taxed at the partnership level. Now suppose the merger is between a partnership and a professional corporation. The rules in this case are different because corporations are taxed at the entity level. If the new combined entity is a partnership, the tax implications of liquidating the corporation need to be considered.

Pay close attention to future projections because they estimate the financial health of the combined entity. The analysis includes partner ages, the cost of existing partner buyouts, number of partners expected to retire in the next 5 to 10 years, the buyout structure going forward, projected rate of client retention and partner billing rates.

When firms merge, the best-case scenario is that the merger goes smoothly and everyone comes out feeling like a winner. Part of what reinforces that feeling is cultural fit. Cultural fit is hard to define because it is intangible. It encompasses things like how the firm values its employees and its clients, whether it values corporate social responsibility and what its overall growth goals are. Sometimes, firms need to meet with several potential merger partners before they meet a firm with which they feel comfortable.

Call us today to prepare your firm for a possible merger.

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