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Competition from new entrants such as foreign operations, accountancy firms and alternative business structures (ABSs) – combined with increasingly cost-conscious clients – continue to put pressure on law firms to differentiate their businesses through mergers and acquisitions.

Everybody, it seems, is looking for a merger – not least a central London firm which recently placed a half-page advert in The Lawyer seeking a merger partner.

Could this be the start of a trend? Attractive global law firm WLTM boutique, London-based investment funds practice for lasting and meaningful relationship? This may well be the future. Most firms continually strive to improve their businesses and, within the top 200, that often means through growth as firms seek to position themselves to meet market demand.

Off to a slow start

In such a fragmented industry, with c 10,200 law firms in England and Wales, there has been relatively little merger activity to date. There have been a few major international mergers – such as Hogan Lovells and SJ Berwin with King & Wood Mallesons – but few strategic moves within the UK.

Most lawyers are reluctant to change the status quo, and the pressures to do so just aren't there. Banks are fairly benign. Interest rates are low. Compared to some other sectors, law is still a very profitable business, so why merge?

Things are beginning to change, however. The market is recovering, but pricing pressure is mitigating the increased levels of work, leaving firms feeling as if they're running to stand still. Firms are therefore starting to ask: What piece of the market do we defend? Who can we act for? What work can we do and how can we organise ourselves to make that work? The answers to these questions will help firms pursue a merger for strategic reasons, rather than a defence mechanism.

Merger musts

Many feel that the legal sector is overdue for consolidation. However, firms looking to merge should only do so if 1+1=3, not 2. After all, if two smaller firms combine to create something with no added value for their clients, it is unlikely to be a successful venture.

It is vital to examine the 'must' considerations and potential pitfalls of the merger process from the outset. Financial and cultural assessments should be made at an early stage, for example, with roles mapped to ensure uniformity within the new entity. Deal-breakers also need to be identified: will the merger fall apart, for example, because one firm insists on retaining its name?

Above all, clients should be consulted before, during and after the merger – and the same quality of service maintained throughout. The merged firm will need to provide the same level of service – or better – so firms need to make sure that they don't 'marry down'.

One major sticking point – which can easily stop a potentially lucrative merger in its tracks – is the 'heir and spare' syndrome, where it dawns on one of the firms' duplicated department heads carrying out the due diligence that the merger could put him or her out of a job. As a result, rather than facilitating the merger, the department head may attempt to sabotage it.

Other potential pitfalls include differing management styles or profit-sharing models, liabilities stemming from redundant premises, partner annuities and final pension schemes, and a lack of available funds.

Money money money

Lack of funds is rarely the reason why firms are unable to press on with their plans, as banks generally view law firms favourably. Mergers between two law firms often don't require any extra finance, and although banks have spent more on debt facilities to law firms in the last six months than they have in the last five years, much of this has gone to support post-merger activity such as IT, premises, support staff duplication and so on.

It's important to remember that banks take their financial risk management role seriously. Too often, when a merger is being considered, the level of due diligence and financial analysis among law firms is too shallow.

The way to an insurer's heart

Banks and insurers focus on the due diligence firms undertake prior to a merger. For an insurer, it is critical to understand how a target or acquiring firm compares to its peers, and any regulatory issues or claims liabilities that could affect the successor firm.

The combined firm may not be attractive to either of their current professional indemnity insurers.

Each insurer has a different appetite for risk and will have identified profiles of firms that they would like to insure. They will look at the combined firm's:

• fee projections,
• type of work undertaken, and
• its client base.

This information will form their base price for the firm's professional indemnity insurance premium. Other factors that will impact their analysis include:

• the claims history of both firms,
• the post-merger integration plan, and
• the financial stability of the new entity.

It is important to highlight how your supervisory processes and risk management procedures will be integrated.

Whatever strategy a law firm chooses to embrace, it needs to think ahead in order to anticipate future challenges and opportunities.

Talk to us as part of your due diligence process.

Contact your Lockton representative at or call 08450 501 471.