Purging the urge to merge

The state’s changing economic climate could cool off
the coupling of homegrown and out-of-state law firms.
By Suzanne Northington

In the 2000s, the urge to merge seemed to surge. If Tar Heel law firms weren’t pairing up, they often were playing the field, flirting with potential suitors looking for that special someone. As the state’s reputation grew, especially for banking and securities law, so did the parade of out-of-state swains, who weren’t discouraged if the perfect partner eluded them. They would open an office in Charlotte or affiliate with local firms, which often portended a merger.

The cooling economy has been like a cold shower. Structured finance, where much of the growth was centered, has withered and might never return to its glory days. “Manufacturing and banking are now totally in the tank,” says John Martin Conley, a law professor at UNC Chapel Hill, “and who knows what will happen going forward.” Even well-positioned firms are cautious. “We are watching things closely and are concerned like any business about what the impact of the global recession will be,” says Keith Kapp, a board member of Richmond, Va.-based Williams Mullen, which has offices in Raleigh, Durham and Wilmington.

Yet any weakness in North Carolina’s legal market manifests itself more through layoffs and branch-office closings than by a change in merger patterns. Though none will confirm published reports, firms that laid off lawyers in North Carolina in 2008 included New York-based Cadwalader, Wickersham & Taft, the former Charlotte-based Kennedy Covington Lobdell & Hickman, Winston-Salem-based Womble Carlyle Sandridge & Rice and Charlotte-based Moore & Van Allen. New York-based Dewey & LeBoeuf announced its Charlotte office was closing at the end of the year. But while firms struggled with slowdowns in practice groups such as structured finance, others such as health care should weather the storm and might even grow. No one should assume the passion for mergers is extinguished.

Not that the numbers ever looked startling on their face. According to Somerset, N.J.-based Hildebrandt International, the state has had just 15 major mergers since 2000. It’s only when you look at the genealogical history of any one firm that it becomes obvious how few adhere to the “grow from within” strategy of old. Traditional management notions of identity, control and cohesion no longer apply.

Here’s proof that law firms have nine lives: The former Kennedy Covington has merged three times; its latest partner, Pittsburgh-based K&L Gates, eight times; the former Raleigh-based Maupin Taylor & Ellis, five; Richmond, Va.-based McGuireWoods, 12 (including with two North Carolina firms); Williams Mullen, five; and Womble Carlyle, five. And those numbers don’t include the mergers of the firms’ new partners, nor do they include what might be called “demi-mergers,” whereby a firm poaches a passel of lawyers from competitors or when a practice group defects en masse for another firm. And don’t attempt to follow the thread of name changes among these firms — it will quickly lead to vertigo.

Allan Head, executive director of the North Carolina Bar Association, admits he is amazed by the way the profession has changed since he came to the group in 1973. “Firms grew from within. You hired who you needed, and the folks you hired stayed with you for life. Now lawyers come and go, operating as free agents and taking care of themselves.”

Until recently, most North Carolina mergers involved either two Tar Heel firms joining forces or a combination with other Southeast firms. With a client base largely of local businesses, few homegrown firms seemed interested in merging with firms in New York or Los Angeles, much less from foreign locales. But in July, K&L Gates — one of the world’s 10 largest firms, with 28 offices and about 1,700 lawyers in North America, Europe and Asia — merged with Kennedy Covington Lobdell & Hickman. “This was the first time a truly international law firm with offices around the world had come to Charlotte,” Head says. “Although we’ve had firms from Virginia, South Carolina, New York and Georgia merge with North Carolina firms and some even with international offices, the K&L Gates merger took it to a new level.”

“For the longest time, the state was fairly immune to firms coming from out of state because the billing rates didn’t measure up to rates in Atlanta, Richmond or Washington,” says Tom Clay, a principal at Newtown Square, Pa.-based Altman Weil, a management consultant for legal firms. Hourly billing rates here have risen the last eight years, though they don’t match those in bigger cities. “In New York, lawyers bill $400 to $800 per hour. You won’t find lawyers in North Carolina billing that kind of money. It’s more like $250 to $450.”

Other noteworthy mergers in recent years include Charlotte-based Helms Mulliss & Wicker with McGuireWoods, Maupin Taylor with Williams Mullen and Greensboro-based Adams Kleemeier with Columbia, S.C.-based Nexsen Pruet. Then there were New Bern-based Ward and Smith with Durham-based Daniels Daniels & Verdonik; Lexington-based Brinkley Walser with the Smith Law Firm of the same city; Essex Richards with Lesesne & Connette, both of Charlotte; Raleigh-based Poyner Spruill with Southern Pines-based Broughton & Broughton; and Womble Carlyle with Washington, D.C.-based Pepper & Corazzini and The Jefferson Law Firm of McLean, Va.

One firm has been walking to the altar — and to divorce court — more than most. Greensboro-based Smith Moore has often resembled a nervous bride in its penchant for tying and untying the knot. In the past three years, it has merged three times, with Raleigh-based Holt, York, McDarris & High, with Atlanta-based Carter & Ansley and with Greenville, S.C.-based Leatherwood Walker Todd & Mann. But in 2002, it undid a previous union to cut loose what became Helms Mulliss & Wicker. Such demergers are rare anywhere, Clay says. Smith Moore Chairman Stephen Earp did not respond to requests for an interview, but Scott Vaughn, managing partner of the former Helms Mulliss & Wicker — which itself saw something of a demerger when former Lt. Gov. Dennis Wicker and 11 lawyers opened a Raleigh office for Columbus, Ohio-based Schottenstein Zox & Dunn rather than join McGuireWoods — says the divorce from Smith Moore was done “amicably.”

Just because some law firms have been merging like rapacious rabbits doesn’t mean the combinations have been successful or are in the best long-term interests of clients. A common rationale is that clients prefer “full-service” firms with regional or practice diversity. That’s not always borne out by clients. A spokesman for Winston-Salem-based BB&T Corp., for example, says mergers involving outside counsel haven’t affected the quality of legal services it receives. Don’t tell that to firms that have merged. Kapp says his wanted “to create a Southeastern regional firm, not just a North Carolina firm … and to be able to provide better service to our client base.” Vaughn sees Helms Mulliss Wicker’s merger with McGuireWoods as client-driven. “We thought we were growing at an adequate pace but were being outstripped by the needs of a lot of our clients.”

“There are a lot of reasons why a law firm will decide to merge. Sometimes they are doing well but think they might do better with some kind of change,” says Robert Griffin, a specialist in mergers and acquisitions who is managing partner of Charlotte-based Robinson, Bradshaw & Hinson. “Or they feel themselves vulnerable and feel they need some kind of enhancement. Other times there are internal conflicts that firms find difficult to resolve, such as the firm’s direction, how you compensate people or what the profit centers should be. The result is to combine with a larger firm in the belief that you will be able to work through those issues better in that environment.”

But Bill Brown, visiting professor of law at Duke University, warns that mergers often don’t solve internal problems. He believes some of the turmoil can be explained by which generation is in charge. “The first, second and third generations of a law firm are very different animals. The first generation has the original founders in place to provide the leadership necessary for growth. The third generation has successfully transitioned away from the founders and has survived.”

Members of the second generation, he says, usually are the most vulnerable and the most prone to merge. “They are moving from a founder-led law firm to new leadership, and until they have the succession routine down, they will have a gap in leadership and will struggle to define themselves organically.” Brown believes that the reason for a merger often will predict its eventual success or failure. “If a law firm is merging for diversification, that’s a legitimate goal. But if it’s merging because it believes a merger will fill some kind of power void, then the merger may actually [intensify frictions].”

A precipitating event often is the defection of key partners, which leaves the firm with a talent vacuum. For example, seven lawyers left Helms Mulliss in the year before its merger. Kennedy Covington, according to published reports, lost six partners and 12 other lawyers to Chicago-based Winston & Strawn, 13 to Atlanta-based Alston & Bird and five to Atlanta-based King & Spalding before its merger. Kennedy Covington administrative partner Eugene Pridgen didn’t respond to requests for information about the defections, but he earlier said the firm merged with K&L Gates to increase revenue and offer more services. Clients have been enthusiastic, he says. “All of a sudden, we’re able to offer them the opportunity to be served by our firm in China, and that’s a huge advantage.”

Others wonder. “The merger thing in North Carolina has always been something of a puzzle to me,” Conley, the UNC law professor, says. “Why a big global firm wants to be in Raleigh — that makes no economic sense. I don’t see regional corporations going preferentially to a law firm with a mother ship in New York or London.”

In the final analysis, the decision to merge or not to merge comes down to a simple question: Will a merger improve the bottom line? In fact, a prime motivation for seeking a partner is an eroding profit margin or at least the perception that the margin is not as good as it should be. Pridgen says mergers benefit the bottom line because they increase revenue. But Conley, himself a former lawyer, is perplexed by that argument. “As far as I know, lawyers only care about one thing, and that’s profits per partner. That’s the magic number.”

When a firm is weighing a decision to merge, it may believe that the combination will lead to efficiencies that will save money and bolster margins. Conley says this is a misconception. “There aren’t any economies of scale in law firms. Back in the days of mainframe computing, there might have been. But with computers all distributed, any economies of scale in a law firm are nickels and dimes.” Kapp concurs. “A law-firm merger,” he says, “is not like a merger in a standard industry, where you can get synergies by eliminating duplication. Each attorney must serve his own client base.”

That client base can grow without merging. Firms can open satellite offices, launch affiliations with foreign practices or simply hire more talent. Going it alone can work best in many instances, Brown says. “Your cultural compass is much truer, and you do not waste time in fighting the internal political battles that will inevitably result from a merger and can instead focus on a very well-defined inward direction.” But given the competitive pressures that law firms feel these days and the easy-fix reputation of merging, it’s unlikely that many firms will take his advice.

Freelance writer Suzanne Northington lives in Sandy Springs, Ga.