Having delivered many mergers and acquisitions, my experience is there are always two variables that both have to work for any deal to be a success: finance and culture. They might seem quite obvious but failing on one or both usually means not enough synergy is created to deliver the anticipated benefit of a deal. Both factors need to be critically examined before any deal is contemplated.
When you are acquiring a practice it is likely the partners of the firm being acquired will think their business is worth more than it really is so be prepared for a lot of deals that never get off the ground! There are often arguments about the value of ‘goodwill’ that is not represented on the balance sheet that might or might not be credible. An assessment of the business in terms of reputation, order book, key staff and other such factors can help assess this. Another factor to consider are the hidden liabilities not on the balance sheet (or not obviously so!) and the benefit to the potential sellers of shedding them. For example leases the firm is tied into, redundancy costs if the firm ceased to operate as well as insurance run-off cover in the same situation.
When undertaking financial due diligence an assessment of two potentially big numbers on the balance sheet is vital– work in progress (WIP) and debtors. There is frightening potential for a WIP balance sheet valuation to be far from what the value is in reality. A firm I heard of was being acquired but due diligence found that large volumes of WIP had not been processed or written down against bills raised and hence remained on the balance sheet. As a traditional partnership there was less emphasis required in terms of financial audit so the problem had accumulated over several years. The deal fell through as sadly did the firm as its bank pulled the plug straight away. When considering acquisition a number of tests can be done to calculate the accuracy of the WIP and these are essential before any deal is considered.
Debtors can be a real problem for many firms when money isn’t got on account from clients and on-going costs aren’t monitored and controlled. Legal services are often a ‘distress purchase’ and debts can be difficult to get settled once such a service is delivered on credit. . So again the balance sheet might be overvalued with the debtors figure having to be heavily written down since it is unrecoverable. Again using ratios such as debtor days and lock-up will help determine real values. Also looking at debts by individual fee-earners and work types will give important insight.
The other reason that mergers can fail is due to a clash of culture. Firms differ hugely in terms of approach, systems, technology, leadership and personality. Extreme differences in these factors between two potential bedfellows will usually lead to a bad merger. Forcing change on people can lead to problems if not managed properly. So finding firms who share common denominators is the most likely route to success. For example it is important to compare values to ensure synergies. Factors such as using the same case management system can help smooth the process. An audit of potential cultural issues should be identified by a delivery team (consisting of people from both firms) and then integrated into the overall merger delivery plan. And managing the whole process is critical – being able to maintain the staff morale when there is uncertainty is an important attribute. Keeping people involved and maintaining and building relationships between the two firms before and especially after merger is essential.