Continued economic uncertainty forcing law firms into defensive moves
According to Wilkins Kennedy LLP, one of the UK’s top-25 accountancy firms, the number of law firm mergers in the UK jumped 31% last year, to 220 in 2011* from 168 in 2010.
According to Wilkins Kennedy, the increase took mergers between law firms to their highest point since 2007 (238 mergers), and represent a 51% increase on 2009’s 146 mergers (see graph below).
Wilkins Kennedy explains that in the main mergers are happening for ‘defensive’ reasons, as opposed to firms pursuing expansionary strategies.
Larger firms are looking to cut costs and reduce risks to protect profits, while smaller firms are pre-emptively consolidating as a result of regulatory changes such as the introduction of Alternative Business Structures and the Legal Services Act (‘Tesco Law’), and the decline in Legal Aid work.
Tommy White, a partner at Wilkins Kennedy, says: “Larger law firms are increasingly looking to cut costs and reduce under-utilised staff and property. Mergers are an opportunity for significant economies of scale, so can be an attractive option for firms looking to explore every extra avenue of revenue or squeeze as much value from their business as they can.”
“Declining profits increase the risk of partner defections. Merging with another firm can boost profitability for the merging parties, reducing this defection risk. As the collapse of Dewey & LeBoeuf showed, failing to meet partner expectations can potentially lead to a downward spiral.”
Tommy White adds: “Keeping costs down, whether it’s property or personnel costs, or increasing indemnity insurance premiums, is one way of protecting profits. Mergers, with their economies of scale, can help tackle these costs.”
“High commercial property costs have been a thorn in the side of law firms recently; mergers can help alleviate this pressure. Many leases were signed on expensive office space during the boom times, but now those rents are unsustainable. A lot of firms are being pragmatic and using the break clauses in their leases to merge with other firms and shed their under-used property.”
“Other firms will be merging and then sub-letting their old office space as they look for new sources of revenue.”
Notable UK law firm mergers in 2011 include the Davies Arnold Cooper – Beachcroft tie-up and the Clyde & Co – Barlow Lyde & Gilbert merger.
‘Tesco Law’ looms large for small firms
Wilkins Kennedy says that mergers amongst smaller law firms are being driven in part by changes to the regulatory environment, such as the Legal Services Act – better known as the ‘Tesco Law’.
Tommy White says: “The advent of Alternative Business Structures will introduce new players to the legal market and new ways of offering legal services. It’s not yet clear what impact they will have, but smaller law firms might consider mergers a way of future-proofing their business.”
“Smaller law firms are under pressure from changes to their business environment. On top of the arrival of the ‘Tesco Law’, they’re facing cuts in Legal Aid work and proposed changes to no-win, no-fee rules. Smaller firms are using mergers to make sure they can compete effectively in future.”
The Legal Services Act allows non-law firms to offer some legal services. This could lead to a number of new entrants to the legal market, including supermarkets.
Is the time right for a merger?
Tommy White comments: “We’re seeing mergers at every level, from City firms with international networks to small High Street outfits. These mergers are almost always defensive – the strategy behind them is very rarely one of aggressive expansion. Generally, firms aren’t looking to move into new sectors or markets: they’re looking to protect what they already have.”
“The firms that are looking to move into new sectors are doing so mostly because they’re looking to diversify their risks. The financial crisis and its fallout exposed the risk for law firms of relying too heavily on a particularly profitable sector which then turned sour. We saw this with the decline in conveyancing work, for example.”
“If the two firms are a good fit, mergers can help cut risk by broadening out the merged firms’ profit base.”
Tommy White adds: “This trend is set to continue as the marketplace is not likely to improve any time soon. Litigation and personal injury work remain healthy, but M&A work and commercial property work are still recovering.”
“The law firm landscape has always been rather fragmented. With the number of challenges facing a modern firm always rising, the time is right for firms to look at whether a merger, acquisition, or even a sale, is now the right solution.”
*Year ending 31 December; latest available data from the Solicitors’ Regulatory Authority.
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