Andrew Roberts speaks to Law360 about Legal Sector M&A

Blockage In Partner Pipeline Could Drive Legal Sector M&A

By Najiyya Budaly on Law360

Blockage In Partner Pipeline Could Drive Legal Sector M&A – Law360

Most sectors are ripe for consolidation, given the distress caused by the current economic downturn, but experts say that the legal sector faces another source of merger activity — partners who are struggling with planning for succession.

There has been some merger and acquisition activity among law firms recently. Cartwright King, a legal aid provider, was bought out of administration by AWH Acquisition Corp. Ltd. in a deal which shows that M&As during an economic downturn are sometimes no more than a bailout.

But observers in the sector believe there might be something unique in play when it comes to consolidation in the legal sector. Partners at law firms are finding it more difficult to pass on the baton and are looking to merge their business to help them avoid problems with succession planning.

“The next generation of lawyers [isn’t] necessarily wanting to become equity partners,” Andrew Roberts, director at Ampersand Legal, a law merger advisory business, said. “So the next owners of law firms aren’t guaranteed to be there, meaning the only option may be to merge.”

Consolidating From A Position Of Weakness

The legal sector is exposed to economic storms, like any other industry. But distressed law companies have even stronger reasons to avoid becoming insolvent, attorneys say, as there are drastic consequences for partners.

“Law firm partners could end up losing all the money they put into the business and potentially be liable for some of the debts of the firm,” Zulon Begum, of CM Murray LLP, said. “It could also go on their regulatory record and, if they are found to have acted improperly, they may even be disqualified from being a director or LLP member in the future.”

Partners in a distressed business must therefore prioritize finding a safe harbor, which could push them to merge with another company that can take on their assets, liabilities and people.

Tony Williams, principal at Jomati Consultants LLP, said that law firms are more willing to have merger talks during economic downturns.

They can “sometimes struggle to develop a compelling business case to convince their partners that this is worth doing,” Williams said. “That can be helped when you’re in a downturn, when partners are jittery about the future. In some cases a concern about … weakness can make a merger more acceptable.”

But the current financial crisis does not seem as troublesome to some as the 2008 recession: many employers took protective measures during the COVID-19 pandemic, such as delaying distribution of rewards to partners and conserving cash.

“In some respects, law firms are more prepared for a downturn as most … tightened their belts and reduced or withheld partner distributions during the pandemic,” Begum said. Those that are likely to struggle are “those that can’t really differentiate themselves in the market.”

This includes smaller full-service offices that do not have a niche in the market, Begum said — particularly if they are forced to reduce costs, as this could affect the quality of services they offer.

Succession Planning Difficulties

Merger activity might not be confined to practices that hope to weather the economic storm, experts say. The legal sector in particular could be ripe for consolidation because of difficulties in planning for who takes over.

“Becoming an equity partner is no longer the ultimate goal for lawyers,” Roberts said. “Because it’s like a marriage — you’re locked together financially with your other partners, and you also have to sign leases and personal guarantees on debt.”

There is also competition for talented lawyers as practices lose potential successors to competitors.

“There’s a war for talent,” Begum said. “Organic growth and succession planning becomes much more difficult for firms that can’t attract and retain the right lawyers. This is made even more acute due to the remuneration that top-tier firms are willing to pay their associates and lateral partners and this puts a lot of stress on the ‘squeezed middle’ tier.”

New classes of companies that provide more flexible business models, such as Keystone Law, might also be enticing future partners away too. Its business model allows lawyers to work flexibly and remotely using a technology platform rather than in a physical office.

“You’ve got a group of very good partners who can now go to diversified firms such as Keystone and pocket the majority of their fees while essentially running their own business,” Roberts said. “That model is taking out the natural succession. Why would they want the hassle of owning a firm and dealing with compliance and regulation?”

The only real option is to merge with another practice, because of the risks that come with closing down if partners cannot pass the firm down internally to lawyers who know the business.

Merging with another firm is another tactic that companies use to “make sure their business remains attractive to potential employees, given both heightened competition and the mobility of partners,” Williams noted.

Opportunistic Acquisitions

But the legal sector could also consolidate because some practices are becoming more opportunistic in the current climate, observers say. Some businesses have maintained good profitability and carved out a niche in the market throughout the pandemic.

For example, legal heavyweights Hogan Lovells and rival Shearman & Sterling LLP are in discussions to merge, according to speculation in a German legal publication.

Listed law firms, such as DWF LLP and Knights Group, could also consider using their external funding to buy out rivals.

“They have war chests of money they have raised,” Begum, of CM Murray, said. “Their prospectuses show they want to acquire and invest. And Knights has already been buying smaller firms and consolidating the market.”

There might also be heightened consolidation when the legal businesses of the Big Four accountancy firms, which may be forced to split their auditing and consulting services, weigh whether to Hoover up other law firms.

Deloitte, KPMG, PricewaterhouseCoopers and EY reached $1.5 billion in revenue, of the total $20.5 billion made by alternative legal service providers during 2021, according to research by Thomson Reuters and the University of Oxford’s Saïd Business School. T

he authors of the 2023 report said that EY could triple the number of its lawyers in the U.K. and Ireland. PwC might double its headcount as it seeks to become more competitive in the market for legal work.

Firms could also use acquisitions in a strategy to seize a larger share of the market, experts say.

“The Big Four firms have made some small acquisitions: for example, Deloitte’s acquisition of Kemp Little,” Begum noted. “But there hasn’t been a significant ‘market-moving’ acquisition as yet. What would change the dynamic of consolidation in the legal market would be if a Big Four firm acquired a top 50 full-service law firm.”

–Editing by Joe Millis.