Sealing the deal

By Catherine Wahlberg, managing partner, Alsters Kelley

Commercial pressures are forcing some weaker firms to look for merger partners. However, while pressures in the current market may seem endless, extreme caution must be exercised when looking for a merger partner. Two poorly performing firms will rarely make a good one. For stronger firms, on the other hand, there are some real gains to be made, and now is a good time to be looking, perhaps, for what might be termed the 'not so perfect' perfect partner.

It might seem an obvious point to make, but whatever your reason for wanting to merge or acquire, never be afraid to walk away.

In today's economic climate, banks and other funders are cautious. They have been left with significant amounts of bad debt from failed law firms. Underestimating a new working capital requirement could spell disaster. Banks will want to see robust projections to fund mergers and acquisitions. It isn't something you should take a punt on. It could cost you your practice and much more besides.

Investing in due diligence, strategic and operational planning and funding models are essential. Even if you walk away, the cost of these exercises will be small compared with the cost of rectifying problems or the consequences of a failed business.

Why merge?

Whether to merge is a simple enough question. The answer might be to increase market share or geographical spread, or perhaps to enhance the range of services offered. This is all fine, but if the answer is that you think you can merge your way out of difficulties, you will probably need some extra help, and a key issue will be finding a suitable acquiror. Business support and intensive care divisions of banks are full of firms who thought they could merge their way out of difficulties.

Structure and culture

A firm in difficulties needn't rule out a deal, but if you are acquiring such a firm, understand and appreciate exactly what you are taking on and minimise any risks. Structured properly, it may bring real benefits to your practice. You will need experienced advice on structuring the deal, however '“ if necessary to take only the assets and leave liabilities behind. The objective must be the success of the practice going forwards.

Remember that changing the name over the door doesn't change or unify a culture though. Sharing a common culture and strategy is essential. If you lack a clear and common vision, you
will struggle to move forwards. Focus gets lost, along with partners, efficiency and profitability. The staff pick up on it and leave, and without a positive culture, staff turnover is high. That has a huge cost to it and is also damaging to reputation.

Every individual will have their own motivation and goals, but if not broadly aligned, this can cause serious problems. Redefining and rebuilding a culture is expensive, so it should be talked about upfront. Are you really suitable to be in business together?

Get merger ready

It's a buyer's market right now. Whether you are hoping and praying to be acquired, or feeling acquisitive yourself, preparation ideally needs to start before you are talking to anyone.

If you want to maximise your position, you must be prepared to make changes where needed, even if that means restructuring the business. If you don't feel you can take steps to strengthen your position, don't expect the best price if you are selling. Equally, if you are seeking to acquire, remember there may be other more attractive options around.

High-level accountancy support and advice can sometimes be regarded as an expensive luxury in smaller and medium-sized practices, but a good accountant can transform a business. That doesn't mean 'cooking the books', but helping to analyse and understand the business. With this knowledge you can quickly respond and strengthen your financial position. Small changes can make a big difference to the bottom line.

Any skeletons in the cupboard need to be sorted out wherever possible. If you can't resolve all the issues, don't try and hide them. If uncovered prior to merger, these could well end all talks, and if discovered afterwards it could really sour relations and end in expensive litigation.

While not always possible, you need to get your house in order to present yourself as a well-managed and profitable business, with a clear understanding of your strategic objectives.

What might go wrong?

An insight into what might go wrong hints at the issues that need to be addressed before a merger. There is a clear link between turnaround strategies and mergers that have gone wrong. The following can be consequences of poorly planned mergers:

• Financial instability '“ cashflow problems, lack of profitability and a weak balance sheet, with consequent enquiry and disciplinary proceedings from the Solicitors Regulation Authority (SRA);
• Culture clashes, where vision and objectives for the future are misaligned;
• Staff and partner/member departures as they get fed up or nervous;
• Loss of strategic direction, particularly if the focus turns to survival;
• Inadequate infrastructure;
• Inadequate management;
• Insolvency or bankruptcy.

Due diligence

Surprising as it may seem, some mergers take place without any due diligence at all. Unsurprisingly this can lead to disaster. There can be a temptation to merge on trust, but it doesn't matter how well you know or think you know your suitor, that does not necessarily make them a good business proposition.

Due diligence is an investment and a small price to pay, particularly if you do discover something untoward. Do a full and thorough due-diligence exercise so you know what you are getting and how it will impact on your business.

If it doesn't look good, I repeat, be prepared to walk away. You don't have to do the deal. If you don't understand what you are being advised, or don't think it is correct, go back and speak to your accountant. Get a second opinion too if you feel you need it.

It is essential to test the robustness of assets, particularly work in progress (WIP), debtors and unpaid disbursements. WIP may well form the main asset of the business. Make sure that you understand the basis on which it is recorded. When doing comparisons you will want to be comparing like with like. It needs to be assessed for recoverability. A quick look at the aged WIP profile can be revealing, but a manual file audit is also essential. If there are significant amounts of irrecoverable WIP or debtors aside from the balance sheet value, this will have an inevitable impact on anticipated cashflow, with potentially disastrous consequences.

Working capital requirement and funding

If you decide to take talks further, a significant exercise will be assessing the working capital requirement of the business in its merged form. Exercise particular caution with new areas of work you are not familiar with. A jointly-instructed accountant might
be particularly helpful, with this task testing the assumptions made by both firms, and comparing the performance in each. Both firms will have an appreciation of their particular areas of work, lock-up cycle and anticipated response to market forces.

Once the working capital cycle and cashflow forecasting have been prepared, a strategy for funding can be planned with a view to obtaining agreements in principle.

Without robust planning and forecasting funding could prove difficult in the current market. The price of getting it wrong could also be high, so this is a significant exercise to undertake and should not be taken lightly.

Don't ignore compliance

Neither are compliance with the SRA Code of Conduct, and money-laundering regulations matters to be taken lightly. Just because you may not have created a problem, that doesn't mean that it is not yours. If you inherit a problem you can still be held responsible for it, particularly if you then do nothing about it. There are a multitude of sins that could be going on, and not necessarily within the knowledge of all the partners. Ensure that you make suitable enquiries and cover these off thoroughly in your due-diligence exercise.

Operational planning

You will also need to decide when you may need to involve employed staff from both firms in planning, but there are many aspects of the practices that will need to be knitted together, not only to achieve operational functionality, but also to realise efficiency. IT is one example of an obvious area that may require significant planning or investment to ensure systems and offices talk to each other. You will need to agree how and when accounts information is to be merged. Every aspect of the practice will need to be considered and planned. There are facilities provision and management; premises; library resources; archiving; client relationship management; staffing levels and the impact of TUPE; human resources; telephony; reception; and cleaning. The list seems endless, but finding 20 years' worth of unmanaged archiving is the last thing you want to discover post merger. If you discover it pre-merger, you will want an outline plan to deal with it and know the cost. Planning for post-merger efficiency is time consuming but will prove to be time well spent.

You will obviously also want to review the professional-indemnity claims history for persistent offenders who may still be in the business, or repetitive claim types that may suggest a failure to address supervision or procedures.

Depending on the circumstances you may be able to avoid becoming a successor practice, but take advice. It is very easy to become a successor practice by accident. It may be not so much a case of what to do as what not to do.

A note on legal aid

There is nothing wrong with legal aid, as long as it is an appropriate strategic fit, well managed and suitably profitable, but when looking at the working capital requirement, appreciate that this has a long lock-up period that will need funding. You should also check for overpayments, unreconciled payments on account (UPOAs) and debit notes. These issues mean money will be owing to the Legal Services Commission and it will need to be paid back. It could involve substantial amounts of cash, eating into cashflow. If your firm is acquiring a legal-aid practice and you are not familiar with it, consider engaging an expert on a consultancy basis to assist you. It is a complex and political area of practice.

Done deal

There is clearly a significant amount of consideration and planning that needs to be given to post-merger issues too, including unifying policies and procedures for risk management; strategic development; communications, and so on. There will be a lot of work to do after tying the knot, not least in investing in your staff. They are a precious resource and may need some serious attention, particularly if there have been redundancies or redundancies are planned. Keeping good staff on board is important. New policies, structures and cultures can be unsettling. You will need to have buy-in and communication is key.

What if it goes wrong?

Problems, particularly if unpredicted, unplanned and significant, will unsettle the bank. There is a point at which even a healthy client account balance isn't
that attractive.

Minimising risk and planning are the keys to success. If it does go wrong, however, you'll probably need some or all of the following:

• A supportive bank;
• Accountancy advice '“ is there a viable future at all?
• Cash '“ don't necessarily expect all of it or any of it from the bank;
• A thorough understanding of what has gone wrong so that you can prioritise;
• Strategic advice '“ how to analyse and understand what has gone wrong and how to put it right;
• High-level management accountancy assistance to help you plan from day to day;
• Management resource. Just because you have a strategy and a plan, that doesn't mean it's going to happen. It will take a lot of management time, particularly if there are cultural or people issues.

Solicitor practices are not immune from disastrous commercial transactions.

Ask yourself what you want out of the deal, but also assess whether you are being realistic.

Catherine Wahlberg is the managing partner of Alsters Kelley. She can be contacted at: catherine.wahlberg@alsterskelley.c