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May162022

Growth Through Laterals — Supersize It  

John Fitzgerald, CPA

5.16.22 | Practice Made Perfect

Law firms might bring in a single lateral or a few top performers to start or enhance a practice area and fill talent gaps. However, today firms seeking growth and possessing available cash on the sidelines are looking at bringing in whole practice areas – 10, 20, 30, or more people at a time – as laterals. Such a bold step can make a statement about how the firm is positioning itself among its peers. The potential for almost immediate growth can be enticing.

As in the past, any firm considering a lateral should go through a due diligence process. Now with so much more at stake, that process takes on greater significance. Grand scale laterals can produce grand scale success … or failure. Let’s examine the path to a successful lateral.

Identify the Need(s) of Your Firm

What is your objective? Expanding an existing practice area? Revenue expansion? Entering new markets? Embarking on a new practice area? Filling a talent gap? Replacing aging-out top performers? Is your purpose to reposition your firm in the market or perhaps become more attractive as a merger candidate? A potential failed lateral starts at the beginning if both sides are not in complete agreement on the purpose of this union and the cultural alignment. Answering these fundamental questions will help you identify the ideal candidates that you will want to approach.

Dig Into the Financials of the Targeted Lateral

This “digging” is the check-under-the hood phase where you seek to determine whether the candidate is in good financial order or if there are issues — debt, poor accounting, and revenue issues, among other possible practice concerns. Have your financial professionals review the following:

  • External and internal financial statements (accrual and cash) for the previous three years and most interim period
  • Tax returns for the past three years
  • General ledger
  • Accounts receivable statistics for the previous three years
  • Recent accounts receivable and work-in-process status reports for the last three years
  • Realization rates for the previous three years
  • Projected revenue by attorney over a three-year period
  • Origination by partners
  • Potential synergies of the combined firms
  • Compensation
  • Overhead costs that will be allocated to the new group
  • Verification of the client list and fees generated
  • Conflict searches
  • Billing and collection realization history, including uncollectable accounts
  • Billable hours by timekeeper for the last two years and billable hourly rates
  • Any client alternative fee arrangements
  • List of major clients and revenue generated
  • Expenses
  • Business plans (including budgets and cash flow forecasts)
  • Litigations (Pending and any recent ones that were settled)
  • Conflicts

Know Who You May Be Hiring

It is essential to know the people who comprise this potential lateral – their backgrounds, achievements, responsibilities, and career trajectories. Learn all you can about the following areas:

  • Your lateral message – why you are bringing in this lateral
  • Members/Partners – biographies, compensation, year admitted to the partnership
  • Employees – title, job function, salary
  • Employment and consulting agreements
  • Bar association memberships
  • Benefits — pensions and healthcare plans
  • CLE compliance
  • Common culture
  • Common business practices
  • Lateral partner questionnaire including personal, professional, and business data
  • Background checks

What Are Their Contractual Obligations?

There will undoubtedly be some contractual obligations. Some may be simple to assume, while others may have terms and conditions that you find unfavorable and may need to renegotiate. The following should be weighed as part of your considerations:

  • Partnership agreement or operating agreement
  • Capital structure
  • 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

Consider the Cost of Technology and Systems

A major cost factor may be integrating the lateral’s technology and systems with yours. As you look into the potential transition, here are some of the areas to be analyzed:

  • Accounting software
  • Web hosting and cloud service providers
  • Content management systems
  • Cybersecurity policies and procedures
  • Client portals
  • Insourcing and outsourcing of services
  • Disaster recovery and backup

Can the Lateral Integrate Into Your Culture?

To assimilate into your firm, the lateral must be able to adapt as much as possible to your firm culture. This process might have been a smaller issue when the lateral was an individual or a  small group. When that lateral might mean as many as 30 new people or more, cultural adaptability takes on greater significance. Among the cultural issues to address:

  • Dress code
  • Communication – internal and external
  • Office attendance – hybrid schedules
  • Open/closed compensation systems
  • Participation in professional society and other external events
  • Diversity and inclusion initiatives
  • Performance review
  • Partner track
  • Compensation expectations
  • Disciplinary procedures
  • Retirement expectations
  • Hours expectations

Lay it All Out With a Memorandum of Understanding

Here is your opportunity to present a detailed document to the lateral group that addresses the numerous issues you have uncovered and spells out what is being offered. Your memorandum can address a compensation guaranty, retirement provisions, representations and warranties, individual roles in the combined new firm, contractual obligations, pending litigations (if any), tax issues and audits, and technology. The goal is that there will be no surprises down the road.

The lateral due diligence process may seem daunting, but it must be weighed against the consequences of missing a dealbreaker or debilitating risk by taking a short-cut here and there. With proper planning and a methodical approach, you will be able to start this new relationship with confidence and look forward to the rewards of time well spent.

The process does not end here. Integration of the lateral into your firm is the final decisive step that will help determine success or failure. In our next Practice Made Perfect, we will examine: Integrating Your Lateral – Leveraging Skills, Culture, and Growth Potential.

Questions? Contact John Fitzgerald at 212.331.7411 | jfitzgerald@berdonllp.com or your Berdon advisor.

Berdon LLP New York Accountants

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