Acquisitions: Due diligence and integration are key
A Solicitors Regulation Authority (SRA) review of law firm acquisitions has highlighted failures and behaviours on the part of some target firms as a cause for concern.
It identified thorough due diligence and well-planned integration as key to the long-term success of deals.
The thematic review of growth strategies [1] focused on accumulator, acquisition and consultant models, and highlighted good and bad practice, as well as the requirements around issues such as confidentiality, live files and client money.
“Although many acquisitions go on to be successful, there are occasions where they do not,” the regulator said, explaining the reason for the review.
“Sometimes failures can result in consumer or other detriments. Where this occurs, understanding why this was the case can help us target our regulation and can help other firms address issues in advance of a proposed acquisition and take steps to prevent detriment…
“We are also concerned that some acquisitions involve behaviours on the part of the target firm that do not prioritise clients’ interests, so clients suffer significant detriment after an acquisition.
“This detriment may arise because the target firm does not take steps to investigate concerns about the acquiring firm’s competence, systems, staffing and capacity to act in its clients’ best interests going forward.”
The SRA spoke to five accumulator firms, five ‘acquisitive’ firms, four individuals involved in failed acquisitions and four firms using the fee-share consultant model.
In examining motivations, one acquiring firm said they found acquisitions were often cheaper than advertising in increasing their client base.
The absence of any or a sufficient plan or criteria for acquisitions was a key risk.
“Acquiring any firm regardless of its strategic fit can create significant issues in the longer term to the stability of the firm. One individual told us that the firm changed its strategy from focused regional acquisitions to firms in financial distress and that proved fatal to the business.”
For accumulator firms, “several acquisitions over a short period of time can put increased pressure on resources. Acquiring firms that are poorly organised, with no or ineffective plans or inadequate practical arrangements in place to manage or control rapid accumulation, are likely to struggle”.
There was a “clear message” that risks relating to due diligence and integration were key, with a link between the thoroughness of both processes and the deal’s eventual success.
“Individuals at target firms who did not undertake due diligence often relied upon pre-existing relationships with solicitors at the acquiring firm. However, good solicitors are not necessarily good business people.”
Target firms “tended to undertake less extensive due diligence” – especially if they were leaving the profession – “and sometimes perceived it as the responsibility of the acquiring firm”.
The SRA said: “As our warning notice [1] makes clear, sellers have a responsibility to investigate concerns about the acquiring firm’s competence, systems, staffing or capacity to act in their client’s best interests.”
Interventions it had carried out after failed acquisitions sometimes showed deliberate attempts to conceal serious issues, such as client account shortages.
Firms emphasised the importance of a change management plan and budget to support integration.
“One acquiring firm explained, ‘you cannot cut corners, and you have to be in control of these issues from day one. If you lose control of these issues, you will lose control of your business’.
“Firms reflected that it was easy to underestimate the resources required for integration. One individual attributed the failure of a firm to the mindset of growth as a means to increase turnover in order to sell the firm.
“As there was no long-term commitment to the future of the firm, there was no intention to integrate and acquisitions were in name only.”
There was again a link between poorly planned or managed integration and firm failure. “This was particularly the case where firms continued to operate independently, thereby increasing costs and making it difficult to maintain oversight.”
Fee-share firms that talked to the SRA “were at pains to make sure recruitment avoided those solicitors who simply wanted to ‘plug in’ to their platform and operate in a silo without embracing the firm’s processes, procedures, culture and values”.
They were “inundated with CVs from solicitors” but had “robust and selective” recruitment policies.
One of the risks to the model was the fee split between the firm and consultant being weighted too heavily in favour of the consultant.
“This may prevent money being reinvested into the business and in particular infrastructure. The fee split may be unsustainable for the business in the long term.” But with more law firms adopting this model, it was increasing competition.