Best Practice Tips: Law Firm Merger Pitfalls to Avoid

Asked and Answered

By John W. Olmstead, MBA, Ph.D, CMC

Q. I am a partner in a 12-attorney firm in Rockville, Maryland. We are a first-generation corporate transactional and litigation firm. The firm was founded by the four equity partners twelve years ago. We have been very successful over the years and this is borne out by our excellent financial performance. While we have done well in our core practice areas, we are considering diversifying our practice into government sector work due to our proximity to Washington, D.C. We are considering merging with a six-attorney (three partner) firm in D.C. that is totally focused on such work. Can you share with us any pitfalls that we should look out for?

A. It sounds like this might be an opportunity if the cultures and people are compatible, the practice area makes sense for your firm, there are no conflicts, the billing rates, and other factors are in line. Start getting to know the firm and its people. Then move to conflicts checks and ask for five years of financial statements and tax returns, internal financial reports, attorney and staff compensation data, partnership agreement and other partnership documents, schedule of billing rates, client lists, copy of building and equipment leases, and malpractice applications. Assess the stability of the revenue stream, repetitive ongoing clients, client dependency, etc. Make sure there are no pending malpractice claims or other liability issues.

Obviously, you will want to do all the due diligence that you can. Initially examine and make the following calculations:

• Headcount by the number of equity partners, non-equity partners, associates, of counsel, and other attorneys, paralegals, secretaries/assistants, and admin staff
• Fee revenue 
• Total revenue
• Total expenses
• Net income available to equity partners. (Add back guaranteed payments and other income that equity partners received)
• Profit margin
• Fee revenue per lawyer
• Fee revenue per equity partner
• Expense perlawyer
• Net income per lawyer
• Net income per equity partner
• Schedule of billing rates (current only)
• Compensation ranges by equity partner, non-equity partner, associates – past five years
• Current malpractice insurance coverages and with whom
• Current lease obligations – office space and equipment

Examine the balance sheet items such as bank debt, large tapped out credit lines, equipment leases and other liabilities. Take a look at the partner capital accounts. Then examine the items that are not recorded on the balance sheet—namely unfunded partner retirement buyouts and long term real estate leases. What are the ages of the partners in the candidate firm and are there partners close to retirement? What are their provisions for retirement of these partners? These are often major deal breakers in mergers and scare away potential merger partners.

Keep in mind that the financials are only part of the equation—the other part your gut feel. Does the potential deal make sense? Will one plus one equal three—will a synergy result? Do you feel comfortable with the people (partners) in the other firm? Do you share common vision and philosophies and will you make good partners?

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John W. Olmstead, MBA, Ph.D, CMC, (www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics and author of The Lawyers Guide to Succession Planning published by the ABA. For more information on law office management please direct questions to the ISBA listserv, which John and other committee members review, or view archived copies of The Bottom Line newsletters. Contact John at jolmstead@olmsteadassoc.com.