What's Behind a Wave of Healthier, Faster Law Firm Combinations?
Market conditions and a more proactive approach may be driving a shift in the law firm merger scene.
January 22, 2020 at 06:55 PM
8 minute read
It seems a tide has changed in the law firm merger market.
For the past several years, many of the biggest law firm combinations—some call them quasi-mergers—involved at least one firm in dire trouble, looking for a lifeline in the wake of big defections, financial troubles or both.
Morgan, Lewis & Bockius took on several hundred lawyers from debt-ridden Bingham McCutchen, which then dissolved. Blank Rome added more than 100 lawyers from struggling Dickstein Shapiro, whose head count had plummeted by more than 68% in five years. Andrews Kurth hired 55 lawyers from quickly shrinking IP boutique Kenyon & Kenyon. Squire Sanders acquired 325-lawyer Patton Boggs after that firm pursued downsizing and other attempted combinations. Arnold & Porter merged with Kaye Scholer after both firms' profits dipped in 2015.
In contrast, several recent deals of note have involved firms with relatively healthy finances and reputations on both sides. They may have been burdened, like most firms, by market pressures and uncertainty about the future. But when the partner vote was cast, they were not drowning.
So far in 2020, five law firm combinations involving firms that each have more than 50 lawyers have taken effect or will become official soon.
Two that finalized Jan. 1 were the mergers of Taft Stettinius & Hollister with Briggs and Morgan, creating a 610-lawyer Midwest firm, and Kansas City's Lathrop Gage with Minneapolis firm Gray Plant Mooty, making a nearly 400-lawyer firm.
Faegre Baker Daniels and Drinker Biddle & Reath will become one firm Feb. 1; Troutman Sanders and Pepper Hamilton will become Troutman Pepper Hamilton Sanders in April; and Duane Morris expects to finalize a deal with 65-lawyer Satterlee Stephens in New York by the end of this month.
(Dentons also announced two deals that take effect this month, with midsize firms Bingham Greenebaum Doll and Cohen & Grigsby, but those combinations were not legally mergers, and each of the midsize firms will retain their legacy brands and some key aspects of their business models.)
"These were all firms that were performing well, have good rates and strong balance sheets and all those things," Lisa Smith, a consultant at Fairfax Associates, said of the recent mergers. "These firms are operating from a position of strength in that they didn't have to do anything."
"These firms, most of the deals are driven by opportunity, not some particular anxiety," said Tom Clay of Altman Weil. He said law firms are "without a doubt" being more proactive about strategy and growth, and in addressing challenges the market presents.
Marcie Borgal Shunk, founder of The Tilt Institute, said some of the latest mergers are akin to combinations in the early 2000s—the firms are coming together "not just for the sake of growth, but also for having similarities within their client bases and wanting to expand their geographic footprint." In general, she said, law firms are thinking more strategically than they ever have before.
Law firm consultant Kent Zimmermann, of Zeughauser Group, said he's familiar with the strategies of both Troutman Sanders and Duane Morris specifically, and that their recent mergers were tied to specific goals and priorities.
"These deals accelerated the achievement of their strategic plans," Zimmermann said. "Not all deals you read about are as strategic."
Just because a firm thinks merging is necessary doesn't mean it's in imminent financial trouble, said Midwest-based legal recruiter Dan Scott of Angott Search Group.
He gave the example of a midsize law firm that lacked a key practice offering. When it referred that work out to a full-service firm, the firm started to lose clients who enjoyed the one-stop shop. The ability to cross-sell drove a search for a merger partner, even though financial performance was not yet suffering.
"There is a fundamental dynamic difference between, 'We're in trouble and we need to be acquired to save our bacon,' as opposed to, 'We're two healthy firms and we see competitive advantages to this merger,'" Scott said.
Both kinds of deals have taken place in various economic cycles, he noted. But one potential explanation Scott gave for the latest string of mergers between healthy firms is quite simple: "Given the length of the recession we went through, there aren't that many unhealthy firms left."
The Great Recession, he explained, lasted nearly a decade, rather than being a blip on the law firm income statement.
"Firms really had to look at how they were running their business, and in many cases change. And the ones who didn't change went out of business," Scott said.
|Appetite for Growth
During the Recession and the slow economic recovery, the population of lawyers at large firms didn't change much, even as some firms grew and others took hits.
Clay noted that in the 10 years leading up to the Great Recession, the largest 250 law firms saw their collective head count grow by more than 70%. Among the same group of firms, and not accounting for international additions, the growth rate has been a measly 0.7% post-Recession, he said. Now, that stagnation may be reversing.
"I think people are beginning to pick up and look around at some of the better ways to grow," Clay said. So the law firm tie-ups are likely to continue, unless a downturn in the overall economy slows them, he said.
Zimmermann said aside from the most profitable players—those with over $2.5 million in profits per equity partner—nearly everyone is thinking about combinations.
"It's extremely rare that I come across a firm that doesn't already have a list of firms that they want to evaluate or want to develop that list," he said. "Firms are generally coming to appreciate the benefits of scale and profitability."
That scale can also be achieved organically or by hiring lateral partners, but a piecemeal approach has "a high margin for error," he added. Simply put, firm leaders increasingly want to consider all the possible paths to meaningful growth.
Smith, of Fairfax Associates, agreed that law firms are more frequently recognizing that competing without scale is a struggle.
"Just hiring organically and hiring laterals means you're almost just treading water," Smith said. Between regular turnover and partner retirements, hiring individuals is necessary just to stay the same size, let alone grow, she said.
For smaller firms in particular, even organic and lateral growth won't make up for the scale back and retirement of longtime rainmakers. "The solution for them is to be acquired," Scott said.
Meanwhile, growth for one firm begets growth for its competitor. With increased competition from other law firms and alternative service providers, "some firms are becoming more proactive," Borgal Shunk said.
And oftentimes, younger partners are more willing to consider combinations. As they continue to gain influence at their firms, the deals will likely continue.
"The younger partners are much less worried even about things like culture. I think they're just more business-minded about it," Smith said.
Younger partners grew up in a more challenging legal industry, Borgal Shunk said, so they are more open to making necessary changes to address the challenges.
"Newer generations of partners are quicker to buy in to the need for change, and some more senior partners are demonstrating a willingness to 'get out of the way' so to speak and allow firms to consider options and changes they may not have entertained a decade ago," Borgal Shunk said.
With all of those forces at play, consultants largely agreed that law firms of significant size will continue to pair off this year. Smith said her team knows of other "discussions of this scale" currently in progress. And when firms engage in these talks with a healthy balance sheet in hand, things come together more quickly.
"It makes it easier to do a deal when a firm is performing well economically. It lets you do a better deal," Smith said.
|Read More
Under Pressure From All Sides, Law Firms Are Responding by Scaling Up
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