Business of Law Firms
Shearman and Hogan talks fall through​

By Jake Rickman​

What do you need to know this week?

Welcome to TCLA’s Business of Law Firm series.

We previously looked at the fanfare surrounding the merger discussions between Shearman & Sterling and Hogan Lovells on two separate occasions. Sadly, it seems that these talks have ended without a deal.

On 3 March, the firms conceded that pursuing a deal was not in their best interests. As to be expected, neither firm divulged what the deal breakers were. Instead, as reported by The Lawyer, they released a joint statement:

"As has been widely reported, our firms have been in preliminary and exploratory conversations regarding a possible combination.

After careful consideration, we have mutually agreed that a combination at this time is not in the best interest of either firm. We have been deeply impressed with each other’s business, practices and people and wish each other continued success."

Shortly following the announcement, Shearman has taken a series of beatings in the form of several high-profile partner exits worldwide. These include:
  • The exit of two finance partners to Cravath, Swaine & Moore as part of the elite NYC firm’s recent recommitment to the London market;
  • The loss of Shearman’s entire Munich team, which Morgan Lewis & Bockius has lifted and consists of three partners, 20 associates, and 13 business services professionals working across corporate, tax and leveraged finance, according to The Lawyer; and
  • Paul Hastings poaching of a litigation advocate-partner in London.
Shearman’s Senior Partner, David Beveridge, has since announced he will step down from the firm’s executive post ahead of the expiry of his three-year term in what The Lawyer has painted as Mr Beveridge “falling on his sword”. Head of litigation, Adam Hakki, will take Mr Beveridge’s place.

Why is this important for your interviews?

In the previous two articles covering the potential merger, we speculated as to what the key drivers of the deal were. Now that the talks have collapsed, we can further evaluate what the likely issues may have been. Doing so will help us better understand the objectives and priorities that dictate management decisions in large law firms more generally.

Law firm mergers are notoriously hard to pull off for several reasons, but the most vexing issue relates to equity partner remuneration and business valuation.

Unlike limited companies, where ownership and management are more strictly distinguished between shareholders on the one hand and the board of directors and executive leadership on the other, the situation for limited liability partnerships (LLPs) is more fluid. While all partnerships have in common the fact that its equity partners — also called “members”, akin to shareholders while also having substantial management powers similar to senior executives in a company — participate in the firm’s profits, each LLP is free to structure the precise terms of profit sharing according to its own circumstances.

These profit-sharing terms, contained in a private limited partnership agreement, usually apportion partnership ‘shares' to each equity partner. The number of shares usually entitles each partner to a specific portion of the year end profits, in addition to other terms that may entitle certain partners to additional profit shares based on performance.

As these terms are often bespoke to each law firm, it becomes difficult to value for the purposes of a merger each partner’s share across two different law firms. Most mergers therefore involve the risk that equity partners from one law firm may obtain less valuable partnership shares in the post-merger firm than before.

In the case of Shearman and Hogan, average profitability per equity partner (PEP) was higher for Shearman than for Hogan at ~$3m vs $1.8m, respectively. Translating this differential may have been the frustrating factor, or one among several others such as concerns about the cultural compatibility between the two firms.