Joined-up Thinking

Andrew Roberts gives his analysis of the current state of the law firm merger market in this article for The Law Society’s Managing for Success magazine.

It has been 18-months (at the time of writing) since the country emerged from the third coronavirus (COVID-19) lockdown, vaccination rollout started, and we were able to start working towards getting ‘back to normal’. That period saw an explosion in law firm mergers and acquisitions (M&A) activity, and in this article, we will explore the various causes of this.

Key drivers

One of the fundamental drivers in merger activity has been the reporting of mergers that happened in this 18-month period. Pre-COVID-19 there was less activity and less media interest, meaning that firms weren’t thinking about merger, or even wishing to consider it should they be approached. Now, rarely a month goes by without at least one merger being announced in the legal press, and this level of activity has percolated into partner’s strategy meetings. Merger has now become almost a set agenda item for partners with the realisation that ‘other firms are talking to each other so shouldn’t we’. The effect of this has been that when we make a merger approach on behalf of a client, it is generally well received, and many managing partners now see it as part of their role to enter into preliminary merger discussions, if approached.

Another major driver is that the attitude of solicitors to their employers has fundamentally shifted. The biggest COVID-19 effect was the loosening of staff ties to the office and showing that it is possible to work remotely on an ongoing basis. This has led to an exponential increase in solicitors moving to consultancy-based firms, who were set up to work remotely long before the pandemic. Before COVID-19 hit, many solicitors were tempted by the consultancy model for the high remuneration offered by these firms but were concerned with the practicalities of remote working and what their clients might think about them working from home. Post-COVID-19, these concerns have proved baseless.

Suddenly, law firms are finding their home-grown associates or salaried partners leaving for these operations, and it is not just the well-known operators, such as Keystone and GunnerCooke; a large number of copy-cat firms have sprung up and even the smallest ‘typical’ firm often fields two or three consultants. Consultants are paid up to 80% of fees generated and it is not hard to understand why a good associate who feels overlooked but has a reasonable client base would move to one of these firms and more than double their earnings. This model is also particularly attractive to solicitors with other responsibilities outside of work, such as childcare. The consultancy model was a relatively slow burn until COVID-19, but it has exploded since and has the potential to syphon away a whole generation of potential future equity partners.

While the attraction of the consultancy model has affected the succession plans for a lot of firms, this is compounded by employed senior solicitors who remain loyal to their firms, but generally do not wish to take on the risks of ownership. This cohort grew up in law during the 2008/09 financial crash and saw equity partners suffer sleepless nights then, and again during COVID-19. They are also very aware of the increased professional indemnity insurance (PII) and regulatory burdens that owners face on top of the usual business pressures. It is not hard to see why they do not wish to step into the equity, and if the market was the same a few generations ago today’s owners might have agreed with them. The impact of succession is massive on merger activity because if there are no internal candidates, owners have no choice but to sell, merge or close.

With just under 10,000 firms in England and Wales (this is the first time in a generation that there have been less than 10,000), it would be wrong to generalise on the other motivations to merge, apart from to say that succession cuts across all but the very largest firms. The law firm market does break down, however, into sub £2m turnover high street firms – who form the bedrock of the profession – to the ‘next level’, with approx. £2m to £8m in fee income, then onto firms with income up to £20m and, lastly, those firms over this figure who are well into the top 150.

Small firms

For this segment (smaller, high street firms) the market always develops a solution, and the consolidator route can be the easiest, or maybe even only, option. These consolidators, set up by interested investors to acquire a number of good local high street practices, inject efficiencies into them and, by bringing them together, form a large firm that has a value. With the consolidator model, it is very unlikely the owner would receive a goodwill payment and they will need to ‘earn out’ over 12 or 24-months, but they should be able to have their insurance and other liabilities taken over, which has real value.

Mid-size firms

The last 18-months has been the busiest period for deals since Ampersand Legal began concentrating solely on law firm M&A a decade ago, and what has struck us is that firms in the £2m to £8m bracket are now prepared to be taken over. We always say that there are two types of firm who look at M&A, either the predator or the prey. A firm either wants to take over and be dominant or are happy to be acquired. Before COVID-19, over 90% of our clients wanted to be the predator, but now a number of firms in this segment have instructed us to find them a firm to roll into. We believe this is caused by the realisation that even if they are, say, a £6m firm and wish to merge with a £2m firm, this would only create an £8m firm and would probably still be too small to compete for better staff and clients. Therefore, rather than going through a number of small mergers to get to a reasonable size, it can make more sense to swallow your pride and merge with a firm twice your size so that the owners, staff and clients all have increased security. Post-COVID-19, 50% of our current clients are the willing prey, which is a perfectly understandable and valid strategy.

Large firms

The third segment, those with an income up to £20m, still generally wish to remain the dominant party and they are finding it easier to attract good, smaller firms to solve problems. Profits in this segment have held up well, and often they will target smaller firms in specific practice areas (intellectual property, for example) to bolster their client offering. As mentioned previously, managing partners are now far more prepared to enter into discussions, and smaller firms are now more attracted to the security of a larger parent than the risk of remaining independent.

Finally, for larger commercial firms with incomes over £20m, there has been a trend in the US, and increasingly now in the UK, for these firms to embark on a merger project to get access to good staff. Previously, the merger target’s clients were the motivation and staff were seen as secondary, or even as a potential area for cost savings, but that is no longer. Recruitment has been cut-throat over the past 18-months, again, not helped by consultancy firms and merging to get good staff suddenly makes a lot of sense.

As we move into 2023, it is unclear whether the current recessionary pressures will lessen merger activity, but as COVID-19 debt starts to bite and succession remains a growing issue, it is hard to see why it would.