Let’s connect!

Industry Insights

Greenlighting a Lateral or Merger? Financial Due Diligence Leads the Way

John Fitzgerald, CPA and Michelle Chan, CPA
01.28.2016 | Practice Made Perfect
Pushing the button on a lateral or merger can be one of the most difficult decisions a firm can make. We’ve all heard “bad marriage” horror stories and no one wants to be the next one. On the other hand, a lateral or merger could be the best thing possible for the future of the firm. Nothing is more effective in helping a firm make that decision with confidence, either way, than a comprehensive and probing financial due diligence.

The following explores the due diligence activities a financial professional will perform in order to arm a firm with data that is crucial to making this pivotal decision.

Financial Results of the Target Firm

There are many reasons why a firm may be interested in joining you. Some are good: retiring leadership, blending of like practices, adding strength to strength, geographic expansion. Other reasons may be less attractive: financial disorder, debt, dipping revenue. To get a comprehensive grasps of the candidate’s financial condition, your financial professional will review the following:

  • Financial statements (accrual and cash) for the past three years and most interim period
  • General ledger
  • Accounts receivable statistics
  • Recent accounts receivable and work-in-process status reports
  • Billing and collection realization history including uncollectable accounts
  • Billable hours by timekeeper for the last two years and billable hourly rates
  • Client alternative fee arrangements
  • List of major clients and revenue generated
  • Expenses
  • Business plans (including budgets and cash flow forecasts)

The People of the Firm

Firms don’t exist just on paper. They are comprised of living, breathing people. Who are they? Are you looking at go-getters, superior technicians, or young people on the rise? Or, do they have salaries out of step with the times, partners ready for retirement, or considerable redundancies with your current office personnel? Your due diligence should delve into the following areas as well:

  • Members/Partners
  • Biographies
  • Compensation history
  • Year admitted to the partnership
  • Employees
  • Title
  • Job function
  • Salary history
  • Employment and consulting agreements
  • Bar association memberships
  • Benefits such as pensions and healthcare plans
  • CLE compliance

Contractual Obligations

The target firm will undoubtedly have some contractual obligations, some of which will be no problem to assume. Others may have terms and conditions that you find unfavorable. These should be brought to light and weighed as part of your considerations. Your due diligence should work to see that there are no surprises in looking at:

  • Partnership agreement or operating agreement
  • Capital structure
  • Any unfunded obligations to retired partners
  • Major leases (e.g. real estate, equipment, technology)
  • Loans and credit lines
  • Settlement agreements
  • Unrecorded liabilities
  • Client conflict review
  • Controls over escrow accounts


Malpractice litigations and any legal actions against the target firm can be deal breakers. If you are going to be taking on these responsibilities, it is vital that you are aware of them and understand if they have merit. If the legal action might be lost, are you prepared to absorb the financial consequences and any damage to your reputation that may ensue?

Tax Matters

Ideally, your target firm has a clean slate when it comes to federal and state taxation. If not, you had better know the issues before they become your problems. If that firm operates in states where you currently have no presence, your due diligence should also factor in any tax laws that may have an impact. Here are some key tax areas to be considered:

  • Tax returns for the past three years
  • Pending or current tax audits
  • Results of any recent government audits
  • Status of any current government audits


You will want to know what types of coverage the candidate has and when the policies are up for renewal. Is the candidate over-insured or underinsured? What will it take to blend your policies? Your due diligence professional will look at the following:

  • Error and omissions insurance
  • Umbrella policies
  • Life insurance policies
  • Claims

Technology and Systems

More than ever, law firm technology and systems are a major expense. More than likely, you will have to deal with integration issues when you attempt to blend the two systems. As you look into the transition of the candidate’s website, consider if any of the technology being used may be valuable on your website. Look into the disaster recovery and backup plans to see if they are sufficient and have aspects you can apply to your own plans. Here are some of the areas to be analyzed:

  • Accounting software
  • Web hosting and cloud service providers
  • Content management systems
  • Client portals
  • Insourcing and outsourcing of services

While the scope of a financial due diligence may seem overwhelming, it can be accomplished with proper planning and a methodical approach. The value of the results is too high to risk short-cuts and what you learn can spell the difference between a profitable success and a costly failure.

Questions? Contact John Fitzgerald at 212.331.7411 | jfitzgerald@berdonllp.com