Legal Due Diligence
While the assumption may be that law firms are compliant, it is prudent to review the legal and compliance aspect. Review the law firms’ articles of incorporation, bylaws, corporate minutes and any information that would reflect changes in the law firms over time. In addition, review the law firms’ contractual relationships including clients, business partners, employees and other third parties to understand their terms, obligations and potential risks. This includes, if applicable, past professional liability disputes or litigation. It is important to identify potential exposures and reputational risks.
Financial Due Diligence
The primary goal of financial due diligence is to assess the accuracy, reliability and sustainability of the law firms’ financial data, identifying potential financial risks and opportunities. This process provides a clear picture of the law firms’ financial health and performance. As a start, historical audited financial statements should be reviewed to assess past performance trends, followed by a review of the law firms’ current financial statements, balance sheets, income statement and cash flows. Cash flow statements are powerful in that they reconcile the balance sheet and income statements and can determine if the law firms can meet their financial obligations and support continued growth. Equally important is to look at law firm debt and other financing agreements to confirm the law firms are meeting their respective debt obligations, as well as sustaining capital. Other key areas to review include accounts receivable, accounts payable and work in process. Various performance metric ratios should be used to determine accounts receivable and work in process turnover to ascertain how efficiently the law firms convert accounts receivable and work into cash and profit. Law firms with significant unbilled time and past due receivables could be a potential red flag.
In addition to reviewing actual performance, the budgeted revenues and expense projections should be reviewed to determine reasonableness of the projections as well as ascertain the accuracy and alignment of the performance with historical performance and practice area trends.
Operational Due Diligence
Operational due diligence allows for a comprehensive evaluation of the law firms’ core business operations, evaluating internal processes, technology infrastructure, human resources and other operational elements. The goal is to identify operational strengths, weaknesses, risks and opportunities that could potentially impact the success of a post-merged firm. One of the most critical areas to review is the law firms’ technology platforms, systems, software applications, data management practices and IT infrastructure. Review their cybersecurity protocols; in the event of a breach, it is essential to ensure client data protection standards are at the highest level as well as compatible for a post-merged firm. Identify potential IT-related risks, vulnerabilities and compliance issues that could impact the security of sensitive data, the continuity of operations and the success of the merger.
From a process improvement perspective, internal processes and workflows should be evaluated to identify efficiency levels, areas of constraints and areas for improvement. If the operations in a post-merged firm can be streamlined for maximum efficiency and value add, it allows the post-merged firm the competitive advantage of improved pricing strategies that work well for the client and potentially improve the revenues and profitability of the post-merged firm.
Another key component to consider from an operational standpoint is the cultural fit and integration of the two law firms. While due diligence focuses a great deal on financial due diligence, again, culture comes back into play. It is not always about the economics or the added value obtained from strategic revenue and profitability growth. Law firms must consider the cultural alignment, taking a deep dive into the compatibility of values, management styles and employee engagement.
In line with cultural fit, plan for a comprehensive review of the law firms’ human resources policies, procedures and employee benefit plans, including health insurance, 401K and other incentives to understand each firm’s compensation/benefits packages. This will allow the firms to better access the post-merged firm impact on the combined workforce and identify potential HR-related risks, resulting in a smooth transition for all employees during and after the firms have successfully merged.
Acquiring or merging a law firm is a huge undertaking and requires a high degree of due diligence. Mitigating risk, assessing financial, operational, and market strengths, weaknesses, and more importantly, opportunity, and taking extra steps to ensure a compatible culture in a post-merged firm is essential.
