News focus: What explains a spate of law firm mergers?

The nights are drawing in and the heating is going on. And in the legal sector, we are firmly in the middle of acquisition season. 

Press releases announcing such tie-ups usually proclaim that the parties have found themselves indelibly drawn together through a common ethos and ‘synergies’. In reality, many are the product of one firm needing a quick exit after the insurance renewal bill tipped them over the edge.

This year the driving forces may be different, however. While PII premiums are certainly rising, many firms are seeking mergers for positive reasons. Lockdown has focused minds, refined business plans and perhaps most importantly, left firms leaner than before. There may be no better time to attract a new bedfellow. Market experts reckon merger activity is higher than for many years, but this time it is not as a last resort.

‘I am only dealing with one forced closure where a firm has been offered insurance terms but cannot afford it,’ said Andrew Roberts, director of law firm merger specialist Ampersand Legal. ‘People have used Covid to get rid of staff that were not performing, and married with people working from home all of a sudden, you don’t need all these support staff and offices.’

While turnover is generally down by 10%, costs have been cut by 15-25%, Roberts said. ‘Firms with strong balance sheets are thinking “let’s get into another profit centre or another team that we want”. Far from being negative [Covid] has been enormously positive from a merger perspective.’

Paul Bennett, a partner with Bennett Briegal and adviser to lawyers and their clients, said merger activity is likely to be high for the next three years.

‘There will be two trends,’ he explained. ‘A strong firm financially acquiring an uplift in profitability by merging with a profitable small firm; and junior partners seeking control of the partnership through acquisition to do things differently, using more technology, working flexibly and building the firms they want to work in.

‘For some senior partners the only way to secure some capital on retirement is to do a discounted deal.’

Merger talk is always higher at this time of year. According to the Solicitors Regulation Authority, 174 firms closed in September and October last year, with 198 closing in the same period in 2018. These numbers are far higher than in the rest of year. For the 12 months from June 2019 to May 2020, around 23% of all closures were as a result of firms merging.

The biggest driver for this annual autumnal flurry is traditionally the 1 October renewal date for professional indemnity insurance. Around two-thirds of firms still renew their cover on this date, and such a big cost often steers managing partners towards an exit. This year the pressure will be no different, with Roberts saying that insurance costs are up between 10% and 20%.

In addition, firms will also be seeking financial respite this year because of the closure of the furlough scheme, which contributes to staff salaries, at the end of this month. The chancellor’s offer to pay up to a third of salaries for ‘viable’ jobs, on the basis that these staff work up to a third of their hours, is little use for firms where staff have no immediate purpose while the office is closed.

Bennett said that PII renewal has crystallised for some firms the fact that they have a long-term issue with finances, which, combined with the increase in salary costs, has made their decision for them. The aging demographic of partners, an underlying trend since the 2008 financial crisis, has also led to plans being brought forward to retire, merge or sell to junior partners.

The Covid pandemic might have made some firms less profitable but no less attractive to potential buyers. Those potential buyers are now fortified by reduced costs and overheads. The combination of the two means we will surely see many more firms declaring their ‘synergies’ in the coming weeks and months.