Case Study: An Upstream Merger

On July 31, Jonathan Moore was a panelist at our M&A Symposium, discussing his firm’s upstream merger into the firm of PKF O’Connor Davies (PKFOD) on January 1, 2016. Moore’s Ridgewood, New Jersey firm had revenues of $6 million with seven partners — six equity partners and one income partner. All seven transitioned into the acquiring firm.

Moore is now partner in charge  of transaction advisory services, providing merger and acquisition assistance to private equity firms and business owners.

Merger Strategy

A significant factor in the firm’s decision to merge up was the prospect of adding complementary services to its client base — services it could not effectively provide on its own.

The firm had 30 people with good audit, tax, and advisory services practices, as well as a successful niche serving private equity firms. But to best grow that practice it opted to merge with a firm that had the resources to support complementary services needed by more sophisticated clients, including complex tax, valuation, and international audit services. This also afforded Moore’s firm the opportunity to attract regional and international clients.

PKFOD was interested in the private equity firm niche. It had financial services, hedge fund, and family office practices, but it didn’t offer transaction advisory services, which was Moore’s area of expertise. There was a clear opportunity to cross-sell to each other’s client base.

The Merger Process

Moore’s firm met with three firms before beginning the merger process with PKFOD. The initial meeting included the managing partner plus one other partner from each firm. Later, all the partners from Moore’s firm met with key partners from PKFOD.

There were no major disagreements among the selling partners. Once they decided on the merger route they made sure their objectives were in alignment. 

Communicating with staff was a very delicate process. They kept a lid on the negotiation until there was a deal in place, then told the staff about the transaction and the reasons behind it. Representatives from PKFOD, including the managing partner, came out and spent time with the staff. There were get-togethers over cocktails so the firms could get to know each other.

The selling-firm partners transitioned to the PKFOD partner compensation and retirement models. With respect to the payout, no one was exiting immediately. All the partners became partners in PKFOD. The working capital, equipment, and fixed assets were rolled into the firm. Four partners were five years from retirement and are still active. One has begun transitioning into retirement.

The selling firm kept its office for the one year left on its lease. Because the merger happened at the beginning of tax season, moving immediately would have been quite a burden. PKFOD had a 20-person office in Paramus, New Jersey. Another firm, in a nearby city, also merged in a year later. The three offices were combined into one, in Woodcliff Lake, New Jersey.

Because of the delay in moving, it took longer to get the staff integrated, which can cause the firm to be locked in to the staff in its office. But access to staff was an important objective of the merger. When they moved together, access to staff became easier. 

Merger Challenges and Benefits

Although not moving for one year was a problem, it also offered an opportunity. The delay may have helped staff members because they didn’t have to deal with change for a while.

A problem requiring adjustment by the selling-firm partners was adapting to the new partner compensation system. Fortunately, although the combined firm’s compensation committee operates in a closed system, the six selling equity partners had the ability to reallocate compensation among themselves during the first two years post-merger. 

A key challenge in the merger was integrating the two firms’ cultures. The selling firm, which was founded in the early 1900s, had a long history with a great culture, which was very important to them. Significant issues included treatment of employees, alignment of benefits and perks, and work lifestyle. These subjects generated many discussions and were addressed in several meet-and-greet sessions with both the partner groups and the staff. Ultimately, PKFOD adopted some of the selling firm’s perks, including fresh fruit, chair massages, super bowl parties, summer hours, and early Fridays. All of this became part of the firm manual.

The selling firm had to provide its own tail insurance policy, which covered claims based on work done before the merger. Premiums are based on the firm’s annual practice liability insurance premiums. Fortunately, there have been no claims.

No one lost anything in the merger. The cultures were similar, so the new merged firm was able to accommodate everyone. Only two people were lost, a senior staff member who didn’t want to work for a large firm and an administrative person who wanted to seek other opportunities in a small firm. The partners lost a little control, but when it’s a good cultural fit control is somewhat less important. Software integration caused some short-term pain — merging IT takes time. One interesting problem is where to go for help in solving various problems. In a bigger organization it takes time to learn.

Benefits of the merger included:

• • Some of the more senior staff were promoted to partner sooner in the larger firm than they would have been had the firms remained independent.
• • Revenue growth in the private equity niche grew exponentially.
• • Marketing and branding are much easier when you can tap into and leverage the strength of the larger firm.  

Lessons Learned

Advice to sellers on how to choose a buyer: Culture comes first. For millennials in particular, workplace environment and the type of work they do is extremely important, so it’s critical to ensure that a potential merger partner has the right environment and work style. It’s also important to understand the strategic rationale for merging from the perspective of both sides.

When you become part of a large firm, you need to be willing to evolve your practice. For example, if  you have clients with only a $500 tax return each year, you’ll want to  bring the combined firm’s additional resources to those relationships. 

Institutionalizing the combined firm was a challenge, particularly in terms of onboarding. The onboarding process was fragmented, in part because certain departments — e.g., human resources, IT, finance — operated in organizational silos. This has improved tremendously with time and additional mergers. 

The Bottom Line

Here’s how the merger turned out in terms of original goals: Revenue for Moore’s firm grew from $6 million to $10 million in just three years. And with an influx of new, larger private equity clients, transaction advisory services have more than doubled.