Partnership – should I or shouldn’t I?
Due diligence is something lawyers do for their clients. But how many undertake the due diligence process on behalf of themselves when offered partnership? Darise Ogden investigates
It’s finally happened. The thing you’ve been dreaming about since those first heady days of law school. You’ve been offered partnership. As the managing partner stands there giving you the news, you gallantly fight back tears of joy and the inappropriate desire to fan yourself like a beauty queen who’s just been named Miss World. Does it even cross your mind to ask whether or not you should accept?
Being offered partnership is not a promotion. It is an opportunity to buy into a business – a business you may know very little about, despite the fact that you’ve spent the last five to 10 years working for the firm. Apparently, too few of you will actually embark on an extensive due diligence of the firm that you have been invited to join – especially if you’re being made up internally. Is it because you feel that it will seem a little ungrateful to say, “Hey, thanks! Now, before I say yes, show me the books”?
Informing yourself
Many firms offering partnership opportunities may not be altogether transparent about their respective financial positions. This does not necessarily mean there is anything amiss with the firm’s finances. But in today’s less than fantastic economic conditions, how can you be sure that the business you’re about to join – a business for which you will become jointly and severally liable if it should fail – is in a stable financial position? Aren’t you doing yourself a disservice if you do not analyse the business?
Would you let your clients buy into a business they knew nothing about? Of course not. Who knows what you might find. One lawyer, who was very flattered to be invited to join the partnership where he had been working for some time, soon changed his tune when his accountant recommended rather vigorously that he turn the offer down – “over my dead body” were the words the accountant apparently used when advising whether or not the lawyer should sign the partnership agreement.
PricewaterhouseCoopers partner Colum Rice advises people considering partnership offers to look at the allocations of risk, do a due diligence on the documentation available, obtain a good understanding of the risks, rewards, and liabilities implicit in the documents, and then step back and ask, “What do I know about the financial rewards associated with this, and how certain are they?”
Stephen Leavy of executive search firm Hobson Leavy says there are a number of people who take partnership knowing virtually nothing about the firm’s business. While they might know about their own liability, what they’re going to receive, their budget, and their team’s budget, they might not know what the firm’s revenues or profits are, they might not have seen the books, and they might not know about any “skeletons in the closet”, he says.
Not all firms are reluctant to provide you with the information you seek. Some firms are open to questions about the business they are asking you to buy into – they come prepared with a pack of financial information. One partner, who has been through the process more than once, says that one of the firms he met with was very well prepared. “I was basically given a package which had everything in it,” he said. They expected that he would ask certain questions, and so provided him with the information. Included in the package were the partnership agreement, the financial accounts, the lease, the bank documents, and the recent PI claims.
Of course, having been provided with the information is one thing. Understanding what it means is quite another.
Understanding the numbers
Jackie Russell-Green, a manager with WHK Corporate Finance, points to a number of things that you need to be absolutely certain you understand before committing your own capital to the business. These include:
• The debt position of the firm.
• The diversity of the firm’s clients. Generally speaking, says Russell-Green, if you’ve got a small number of clients, and they all fit into a tightly defined profile, you’re less likely to survive the loss of some clients in a recession than a firm that’s got a well-diversified client base and a large number of clients.
• The clients’ ability to pay. What is their payment history? Do they tend to pay quickly or slowly? Russell-Green says that, generally speaking, the slower a client pays, the less likely they are to ever actually pay.
• Whether the firm has a lot of bad debts.
• How well the firm manages its cash. Does it tend to have a reasonable availability of cash so that it can meet its immediate needs, or is it always moving from overdraft to overdraft, constantly juggling its cash so that it can actually stay liquid for the next week?
You also need to assess the firm’s profitability to determine whether it’s actually going to provide reward that’s commensurate with the type of risk you’re taking, says Russell-Green. If the firm you’re buying into has a high debt position, or has debtors that pay more slowly than in the past, then your investment risk will increase.
But even looking at the numbers will not be sufficient. Says Rice, “If you look at the basic bold numbers in isolation from understanding the business, the probability is that you’re going to misinterpret them.” You also need to know the key drivers of the business, and how sustainable its performance has been.
Sustainability is a key issue. “Financially speaking,” says Russell-Green, “does this business stack up? Does it look like it’s going to continue? Is it actually a solid investment? Does it look like it’s going to be good into the future?”
If this all sounds like numbers to you, and you’re shuddering at the thought of it, then it may be time to reassess whether you really do want partnership. Being able to project the growth and performance of the firm into the future is a necessary evil – because that is exactly what you’re buying into: the firm’s future.
But it’s not just about the money, either. The people and the practice itself are also important. As one partner confessed, with the first firm he joined, the numbers were great. Financially, everything was on the right track. However, a few years in, he discovered that the people were not quite right – for him.
Studying your partners
Let’s assume that many of you will at least look at the senior partners in the firm before making your decision. Do you respect them? Do you want to be part of the firm they have built up over the years? Is it their reputation that you seek to align with yours? If so, then you need to consider the impact on the firm of their upcoming retirement. Do they bring in the bulk of the fees? Will their clients stay with the firm once they’re gone? “Unless there has been a real transition plan to make sure those clients are going to stay with that business, with that partnership, and that work is going to perpetuate, then you’re buying into more risk than reward,” warns Rice.
Leavy has noticed that the junior partners being made up often look at the senior partners when making their decision. However, he suggests that the partners to whom they should be looking are those in their own peer group. People should be looking at the make-up of the firm in 10 years’ time, he says.
If you were starting your own firm, you would be picking the people you wanted to join you in partnership. However, if you’re being made up in a long-established firm, it is the senior partners who will be deciding your future business partners. Firms have imploded in the past (and will do so again in the future) as a result of irreparable personality clashes within the partnership itself. A long history will not save a firm being torn apart by partners who simply cannot work together.
Financial concerns can also arise in a partnership. As Clifford Chance’s partners have discovered recently, when times are tough, and a cash injection is required, it is the partners who have to reach into their pockets to cover any shortfall in the firm’s revenue. According to reports, the partners at Clifford Chance were asked to put in up to ₤150,000 each. Can you afford to provide something akin to that if your firm needed it? Are you confident your fellow partners could do the same?
And it’s not just in times of trouble that a cash injection may be needed. What about the most senior of the senior partners? No doubt there will be a considerable capital payment coming due to them upon their retirement. “The capital in most cases is an imaginary number on a balance sheet,” explains a partner. “It’s not sitting in an account.” But if someone is leaving the partnership, that person needs to be paid out. And where is that money going to come from? “It’s going to come from you, it doesn’t matter whether you’ve been there 10 years or 10 minutes,” he says.
Should your due diligence on the firm include a consideration of the personal situation of the partners? Leavy says yes. You need to know if you’re comfortable with them in terms of their capabilities and skills, he says. You also need to be comfortable that they’re not going to do anything that could bring down the firm. “Are you comfortable that they’re financially sound enough? Again, if the business ran into trouble, are they all over-leveraged, or are they all going to be able to do something?”
Some of you may feel uncomfortable asking questions about your fellow partners’ personal circumstances. Why should you know about a partner’s ugly divorce? Is it any of your business, really? Actually, it could be – especially if the Court awards his or her spouse a share in the partnership’s future income.
It’s about your money
Congratulations to all of you who have been invited into partnership recently. You deserve it – you’ve worked hard to get there. But before you say yes, don’t forget to ask yourself a few questions first. For instance, do you know how long your debtors’ days are? What about the firm’s client mix? Is it robust? Or, most importantly in the current hard times we are facing, do you know what the firm’s debt position is? Does it have cash flow issues?
It’s unlikely that you’ll be able to find everything out about the business before you buy in. Says the partner who discovered the financials were fine, but the partnership wasn’t, “You’re still taking a punt at the end of the day, but you should be a lot better prepared for what you find as a result of having done the work.”
And if you’ve already said yes, then now’s the time to make sure you really do understand this business you have bought into, and the partners who will be your family for the next 20 to 30 years.
NZLawyer, issue 105, 5 February 2009