In recent weeks, Post & Schell added all four attorneys of Montgomery County firm Galli and Reilly, Schnader Harrison Segal & Lewis added all six attorneys from Trujillo Rodriguez & Richards and Blank Rome added all eight attorneys at Houston-based Bell, Ryniker & Letourneau. But what those firms didn’t do is merge.
Growing through boutique firm acquisitions is often a good way to add depth to a practice area or geographic location. And as the market for laterals has thawed since the height of the recession, large firms are increasingly looking to gobble up boutiques. But their appetite for taking on the liabilities of those firms is still suppressed, causing many to structure asset deals as opposed to full-on mergers.
While the structure of these deals can be as varied as the imaginations of the attorneys, they typically entail the smaller firm keeping their work in progress and accounts receivable for a set period of time to help pay off the liabilities of their former firm. Those liabilities, and the assets, then don’t attach to the larger firm the attorneys have joined.
“It’s going to happen in situations where there are substantial obligations that come along with the [smaller] firm,” said Altman Weil principal Ward Bower. “What this really amounts to is an addition of a lateral group essentially. The upside of it is you don’t end up with the obligations or the liabilities of the existing firm or the acquirees.”
But there are trade-offs, Bower warned. By not merging the smaller firm into the larger firm, the larger firm doesn’t get the accounts receivable and work in progress of those attorneys for a certain period of time. That means the attorneys are getting paid and aren’t bringing in revenue for several months.
“Then they have to support these people from day one and that takes some working capital,” Bower said.
Any lateral requires some investment from the firm while it waits an average of three months for that attorney’s work to start generating revenue from clients. But Frank D’Amore of Attorney Career Catalysts said the situation becomes all the more magnified when taking on an entire firm of people and their staff.
Bower said that could factor into the compensation the new attorneys are given in the early going, though both he and D’Amore said there are so many ways to structure these deals that compensation doesn’t necessarily have to be affected.
The driving force behind the decision to merge or simply acquire the assets — the attorneys — of a firm often has to do with real estate. The larger firms are often loathe to take on the lease obligations of the boutique firm if it is in a market where the larger firm already has an office. Bower said deals are more likely to be structured as a full-scale merger if the larger firm is entering a new market and would need to assume the boutique firm’s space anyway.
The mergers firms like Altman Weil track are typically multi-city deals in which case some offices may overlap and some may be new markets for the acquirer, Bower said. In those instances, firms will take the good with the bad, or the assets with the liabilities, he said. Purely same-city mergers make the deal process that much more difficult, Bower said.
He said Altman Weil is involved in a number of potential deals right now in which the favored route on the part of the smaller firm is to merge with firms from out of town so the lease obligation is more likely to be picked up.
While leases are a big driver, D’Amore said other liabilities can factor into the structure of these acquisitions as well, such as unfunded pension liabilities, bank debt, malpractice liabilities or other obligations to former partners. The larger firms have to weigh these things very carefully, he said.
“If they don’t like it, then they just do an asset deal,” D’Amore said.
A smaller firm may simply have to pass on the acquisition altogether, however, if the larger firm is insisting on an asset deal and the boutique doesn’t think its work in progress and accounts receivable will be able to cover their liabilities in short order. There is incentive for smaller firms in asset deals to pay off their liabilities in short order because anything they net in the agreed-upon time goes back to the partners of the smaller firm, D’Amore said.
The boutiques can have negotiating power in these deals if they have a practice or a geographic reach the larger firm really wants. The same is true if the boutique is more profitable than the larger firm, D’Amore said. But typically, it is the larger firm that is more interested in entering asset deals over full-scale mergers.
D’Amore said firms are very careful about what they call asset deals and how they describe them. The larger firms don’t want outsiders thinking it’s a merger if it isn’t because creditors may come a-calling, he said. And how the deals are described could be construed to create a de facto merger, D’Amore said.
Asset deals aren’t always done based on weighing a firm’s balance sheet, but tax consequences often come into play as well.
If an LLP and a PC are merging, for example, the tax consequences might be such that firms enter an asset deal with the goal of winding down one or both firms over a period of about a year or two, creating a new, unified entity in their place at the end of that period, D’Amore said.
That is similar to what happened when Ballard Spahr entered New York earlier this year with its acquisition of Stillman & Friedman. The firms were careful not to call the deal a merger and said they created a new legal entity, Ballard Spahr Stillman & Friedman, that would exist only in New York. The Stillman & Friedman name will drop off in about two years, the firms said. They said their advisers recommended such a structure given the implications of merging an LLP with a PC.