October 23, 2012

MERGERS FOR MIDSIZE FIRMS Applying the Culture and Strategy Tests

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September/October 2009 Issue | Volume 35 Number 6 | Page 53


Applying the Culture and Strategy Tests

Law firm mergers continue to be a hot topic for the legal profession, but most literature on the subject seems to adopt a one-size-fits-all approach. In other words, they assume that the same process and methodology that should be followed in a peer-to-peer merger of firms with 500 or more lawyers should also be followed in a merger of much smaller firms.

But the experience of the midsize Denver-based firm Brownstein reveals an alternate lesson: As we embarked on our decision to grow our presence in other Western markets, we quickly discovered that mergers of small to midsize law firms may follow a methodology far different than mergers of much larger firms. Here’s the story of our journey and the lessons it revealed.

Looking at the One-Size Route—And Detours From It

In 2006, Brownstein began merger discussions to establish a presence in Las Vegas, a market where we had already been very active. We read as much material as we could, talked to some of the leading consultants in the industry, and identified several consistent merger themes, including these:

  • Culture is the single most important factor in the success of a merger.
  • You don’t merge to fix problems in your firm—you fix them first, before you merge.
  • If the merger means a move into a new geographic region, you move one or more key partners from the larger firm into the offices of the smaller acquired firm.
  • Financial enticement is often the key to winning a competing merger battle, so you should be prepared to offer financial incentives up front to win that battle.
  • You must identify conflicts early and avoid merger candidates that present complicated conflicts.

The Las Vegas discussions ultimately led to our merger with Schreck Brignone, the leading gaming licensing law firm in the country. A year later, we merged with Hatch & Parent, which had the largest water practice in California. The two mergers caused our firm to grow from 145 lawyers and lobbyists as of December 31, 2006, to 250 lawyers and lobbyists as of December 31, 2008.

The mergers gave us a broader geographical footprint, diversified our clients, industries and practice areas, and contributed to the firm’s growing profitability. Plus, we brought on a talented group of partners and associates who are building the firm’s brand name and have helped us to establish national market leadership in two key areas where it did not exist before—water and gaming—which have been a good fit to our traditionally strong market place in real estate and government relations. By our measurement, the mergers have been very successful—although, most notable to other midsize firms considering similar moves, we did proceed with each merger while ignoring many of the pieces of advice we received.

What Was Disregarded

First, we didn’t ignore culture—it is the key—but we realized we didn’t fully appreciate what “culture” is until we went through a merger. We had to experience it and learn what aspects of it were critical to our merger success. Importantly, culture is your single biggest strength in competing against an international or global firm in a merger.

Second, we didn’t fix all of our problems prior to the merger. One of our key weaknesses, for example, was dependence on real estate as a percentage of gross revenue. The mergers, though, allowed us to reduce real estate as a percentage of gross revenue from 42 to 22 percent in only 24 months and to practice more actively in other states in the West.

Also, no partner from an existing Brownstein office moved to Las Vegas or California. However, we adopted an open travel policy, and in the first quarter following the Las Vegas merger, over a third of the existing Brownstein partners and management team went to Las Vegas to meet with their new partners and develop strategies for successful integration. No approvals or business plans were required—there was just a requirement to spend time together. A similar strategy was employed in California. It’s expensive, admittedly, but it’s far more productive than relying on the move of a single partner to a new office in the hope it will fully integrate the merger.

In addition, no cash or other compensation was paid up front to either merged firm, despite the fact that significant offers of up-front cash had been previously offered to them by other national or regional competitors.

Lastly, we identified significant conflicts in our merger with Hatch & Parent but were unwilling to allow those conflicts to deter our success. We worked with outside ethics counsel, clients and the affected partners to develop a strategy that was acceptable to all and allowed our clients to understand the benefit of creating one of the country’s largest water law practices.

Key Differences from the Midsize Perspective

Our firm has hardly developed the perfect model for how to accomplish law firm mergers, and we are confident that we have much to learn when we tackle our next one. But we have certainly found that the rules of large firm mergers don’t necessarily apply to midsize mergers. Read everything you can, of course, but don’t be afraid to discard the advice if it doesn’t fit your firm or situation.

Brownstein particularly found that midsize mergers are different based on the following:

  • Culture is important—whether it’s a big or small merger—but you have a distinct advantage in a midsize merger because the people in the merged firm can more easily “touch and feel” the culture of the firm they are merging into. In each case, we invited all or most of the partners of the potential firms to a portion of our annual retreat, before they held their vote on the merger. They were able to spend considerable time with our partners and make sure that we not only work similarly, but that our culture of social interaction fit their tradition and culture.
  • Cash compensation does not make sense in a midsize merger. It will only breed resentment among existing partners and hardly builds a team spirit of collaboration for common good. If you cannot engineer a true merger—that is, bring all or most of their partners in as equity partners in exchange for a contribution of their accounts receivable and work in process—that may in itself be a reason not to complete the merger.
  • Conflicts can be a problem and an opportunity in a merger. In our case, it made us evaluate which clients were truly important to our firm and gave us a basis to discuss with a number of clients the need to grow our relationship with them or part ways. That can be a painful discussion, but it’s critically important and a merger can provide an excuse to have that conversation you had been meaning to have, but had postponed.

The only steadfast rules we now apply in looking at opportunities are culture and strategy.

Core Culture Indicators

Few things can better define the culture of a law firm than its compensation system. In each of our mergers, the compensation structures of the firms we merged with were subjective, mirroring our subjective compensation system with only subtle differences. While it’s important to never erect barriers to future mergers, a merger with an objective formula compensation system and a subjective system may be the biggest culture clash of all.

There are, of course, other key indicators of culture that can make the difference between failure and success. Properly gauging how any two firms’ cultures will mesh means answering questions like these:

  • Do the partners and shareholders interact socially, or is there little social interaction between them apart from official firm functions?
  • Is there a tradition of sharing institutional clients across multiple practice areas, or are most client relationships controlled by individual partners?
  • Are community contributions a significant expense at the firm, or are they largely expected to be paid by a partner out of his or her personal funds?
  • What role does diversity play in the firm and in its leadership?
  • Is it a revenue-driven or an expense-driven culture?
  • Does firm leadership love their jobs?
  • Is the firm dominated by transactional or litigation practices?
  • Is political fund-raising part of the history and tradition at the firm?
  • Are alumni a significant source of work for the firm?
  • Do the people in the firm gather frequently as a firm, and are spouses and families welcome at such events?
  • Is the firm dominated by a younger or older generation?
  • What is the level of productivity expected from senior partners, and how is it measured?
  • Does firm leadership have specific terms of two to three years, or are they in open-ended positions? Also, how long has the managing partner held that position?
  • Is the firm run as a democracy, dictatorship or somewhere in between?
  • H ow diverse is the firm’s client base (i.e., what percentage of revenue is generated by the 5, 10 or 20 largest clients), and how consistent is that base (i.e., how much has their top-20 client list changed over the past five years)?
  • ▪ What is the firm’s track record in recruiting and retaining laterals?
  • ▪ What was the firm’s biggest crisis and how did the partnership respond to it?
  • ▪ What is the overall level of pride in the firm?

This list of cultural factors is by no means exclusive, and certainly there is no right or wrong answer to any question concerning them. But the list gives you a tool to compare across several key indicators of how each firm fits the culture of the other. While identical cultural characteristics are not a must, broad disconnection across several factors makes merger success difficult, if not impossible.

The “Monday Morning” Strategy Test

If the cultural fit seems right, or at least intriguing, the other critical question from our perspective is strategy.

Most firms think of strategy from an internal perspective. As in, does this merger fit our strategic plan? Is it consistent with our mission statement? Does it allow us to cross a certain size threshold? Does it put us in a market that we always thought we should be in? But those questions, while relevant internally, are completely irrelevant to clients. So instead the only strategy question that is truly relevant is what does this mean to our clients ? Will they care? Does it allow us to serve them better? Do they understand what we are trying to achieve?

It’s good to note that once a firm has embarked on one or more mergers, the frequency of calls about merger opportunities sharply increases. And because there can be a certain level of excitement around a deal, it’s often easy to get caught up in the momentum of acquiring a new firm and the related satisfaction of knowing you are the suitor picked to make it to the altar. Over the past two years, we have received calls on over three dozen interesting merger opportunities. And while we are always flattered to get the call, we have a straightforward initial test the opportunity must pass.

What is it? It’s simple. Every time a merger or expansion opportunity is presented, I ask myself or the partner who hears of the idea this: “On the Monday morning after we close the merger, when you call your top five or ten clients to tell them about the merger, what are you going to tell them as to why the merger is important to them? Did we add a level of expertise that is relevant? Did we add depth in a key area? Did we add a region in which they conduct business?”

If the answer to all of those questions is no and is likely to be similarly answered for most clients, and the only answer is “we’re bigger,” then the merger does not pass the test and proceeds no further.

The “Monday morning” test is critical to midsize firms because the risks and opportunities of mergers are greater the smaller you are. An unsuccessful acquisition of 50 lawyers to a 1,500-lawyer firm has little impact. A similar result at a 200-person firm is a disaster. But the success of a 50-person merger at a 200-person firm can be huge and propel that firm on to many great accomplishments.

So the bottom line? If the culture and strategy tests are satisfied, then it may well be appropriate to begin more serious merger discussions. But if you are at a midsize firm or smaller, do not be afraid to break the mold of merger checklists and use your size as a strategic advantage to succeed in a merger opportunity against much larger competition.

Bruce A. James became managing partner and CEO of Brownstein in 2003. Since that time, the firm—now Brownstein Hyatt Farber Schreck—has expanded from a Denver-based political firm to a nationally recognized law firm in the areas of real estate, corporate, natural resources, litigation and lobbying.