Germany: Unsung heroes

Europe has been ravaged by the debt crisis and Germany has been far from immune, but the resilience of one segment of the economy is a boon to domestic law firms. Meet the Mittelstand

Germany’s hidden champions are keeping its law firms in the pink. While European law firms continue to feel the effects of the prolonged hangover caused by the eurozone crisis and general economic malaise, a number of German domestic law firms are seeing work pour in from German family-owned, small-to-medium sized businesses, the so-called Mittelstand.

What sets these clients apart is that they are less affected by the eurozone crisis than publicly listed companies. Many are internationally oriented, which allows them to identify growth potential in markets that are untouched by the debt crisis.

Many are non-listed, family-owned businesses, so the disrupted capital and debt markets haven’t hit them as hard. Their conservative approach in avoiding bank lending has protected their balance sheets from the heavy debt that many companies find themselves burdened with.

‘The Mittelstand is less dependent on banks,’ says Arno Maier-Bridou, partner at legal and accounting firm Grützmacher Gravert Viegener (GGV). ‘A typical company has more equity than a company listed on the stock exchange. They have a long-term business strategy as they are owned by individuals, and for the owner it is less important if they get a dividend tomorrow or a day later, whereas public companies have to keep their shareholders happy.’

Other managing partners from rival domestic firms hold similar views. GÖRG Partnerschaft von Rechtsanwälten partner Wolfgang König says many Mittelstand companies stick to using traditional business models primarily because the owner is also the shareholder.

‘The Mittelstand has always been active in Germany,’ he says. ‘They are led by their owners, so they focus very much on profitability. They are very flexible and make decisions fast. From a lawyer’s perspective, this is great. Mittelstand companies normally present a proposal and we, as a smaller firm, are able to present the decision very quickly.’

But Isabell Conrad, partner at IT boutique firm SSW Schneider Schiffer Weihermüller, says that while these clients may have weathered the economic downturn successfully, it is the business model of the small and mid-sized law firms themselves that has helped them to be more resilient than larger firms amid the debt crisis.

She says unlike the top firms in Germany, smaller firms don’t have the burden of dealing with bulky industrial clients that are heavily underfunded and experiencing a slowdown in transactions.

 

Export nation

The definition of Mittelstand is broad, covering a range of companies with up to 1,000 employees and a turnover of up to E500m. Export plays a very important role in Germany and a typical Mittelstand company may export 20-50% of its product. In addition, the debt crisis has reduced the real cost of these goods and services when they are paid for in foreign currencies like the US dollar and UK sterling.

‘The Mittelstand has always been active in Germany.
They are led by their owners, so they focus very much
on profitability.’
Wolfgang König, GÖRG

‘Some Mittelstand companies with 500 employees can easily have an export rate of over 50% to other European and Asian countries,’ says Maier-Bridou. ‘Law firms benefit from this as we advise them on their export transactions.’

He says Mittelstand companies with this export rate are typically found in the mechanical engineering industry, for example machine building. Germany is an export nation, encompassing not only its huge automotive, procurement and production industry but the Mittelstand as well. These domestic SMEs often produce for regional or national buyers, so are unaffected by foreign exchange rates.

Stefan Kridlo, partner at SKW Schwarz Rechtsanwälte, says: ‘German business strategy is innovative and focuses on good quality. Germany is all about production and delivery; it’s not service-based. The automotive and machinery sector is huge. The smaller companies here deliver to the larger companies abroad, so the market is always afloat.’

According to Maier-Bridou, the Mittelstand went through a slowdown around five to ten years ago, which caused many small companies to fold or lose some of their workforce. Back then, SMEs generally were influenced by the boom market to increase their borrowings. However, it was the Mittelstand’s resistance to such excessive lending practices that has shaped its strong position in the German market today.

 

The right fit

Small to mid-sized German law firms generally prefer the Mittelstand clients and vice versa. Ines Zenke, partner at Becker Büttner Held, says Mittelstand clients do not want to be treated as second class and fear that larger companies will get preferential treatment from larger law firms, especially because they have bigger accounts.

‘There is the problem of conflicts,’ she says. ‘The big law firm can’t advise both parties at once and with a dedicated smaller law firm there is never a problem should a legal dispute arise with a bigger player, for example.’

Becker Büttner Held is hardly small. Of its 500 employees, 28 are partners and 208 are associates, making it Berlin’s largest law firm. But the Mittelstand is extremely important as a source of work, bringing in the majority of high-value deals for the firm.

In addition, Mittelstand companies rarely employ in-house lawyers, so it is Germany’s small to mid-sized firms that become the outsourced legal department. This creates a unique lawyer-client relationship, adds Zenke.

Mittelstand management tends to be extremely loyal to its employees and it’s the same when it comes to relationships with law firms. Many domestic firms have held the same Mittelstand clients for over 30 years. This stable relationship allows the client to approach the firm in a more relaxed manner and the result is flexibility on both sides.

‘Clients are accustomed to dealing with only a few faces and don’t like the specialist focus of larger firms,’ says Kuhn Carl Norden Baum (KCNB) partner Marcus Baum. ‘All my clients are different and I advise them accordingly; where one client may be more cautious, another may be more of a risk taker.’

Kridlo at SKW has a similar view. He says a personal, close and unique relationship with each individual client is very important, because firms are not only advising the company, but also have to consider the owner, the shareholders and the successors. This means the dynamics are totally different when compared to dealing with major corporates.

The Mittelstand likes to work with lawyers that are not excessively specialised but have all-round experience. In fact, many of these owners prefer to seek out smaller boutique firms, as they tend to focus on niche areas but are able to offer all-round advice. With one prime contact per client case, work is seldom delegated, ensuring a faster and more efficient service.

Another huge selling point is lower billing rates. Many Mittelstand clients feel that because their annual turnover (and consequently their annual legal spend) is dwarfed by listed companies, they would not be treated as a priority at the larger firms.

‘A good medium-sized client for us is probably a small client to a very large law firm, and they get treated accordingly,’ says Maier-Bridou.

For Conrad at SSW, another common problem with larger companies is they fail to pay their fees on time whereas the Mittelstand is renowned for its punctuality.

‘In the international and industrial sector, there are regulations and huge compliance issues which they have to leave time for. The Mittelstand generally complies with the payment requests. This makes doing business much easier and more enjoyable,’ says Conrad.

 

Relying on the Mittelstand

There are numerous examples of German small and mid-sized firms that largely depend on the Mittelstand as a primary source of work. For example, almost all of GGV’s work flows in from the Mittelstand as the firm does not deal with any companies listed on the stock exchange. Maier-Bridou says he prefers to work directly with owners, which is possible in smaller enterprises but not in major corporates with large legal departments.

‘We advise individuals who have no legal training. We try to avoid legal jargon and legalese. A typical Mittelstand owner does not want to read 50 pages of legal jargon. Simplicity is our selling point,’ he says.

‘Clients are accustomed to dealing with only a few
faces and don’t like the specialist focus of larger firms.’
Marcus Baum, KCNB

Baum at KCNB says his firm is well suited for the Mittelstand. It is a small firm with seven lawyers and a turnover that hit almost E3.5m for the 2011/12 financial year. KCNB’s Mittelstand M&A practice is thriving: the firm’s domestic clients are currently acquiring businesses not only in other European countries – namely Italy, France, Sweden and the UK – but also hitting the upcoming ‘Chindia’ region.

On the other hand a firm like SKW has a larger headcount with a total of 60 lawyers, of which 26 are partners. Around 80% of SKW’s workload comes from the Mittelstand while a firm like GÖRG takes in around half of its workload from a similar client base.

Wolfgang König at GÖRG reports his firm’s mid-cap deals currently involve smaller-sized businesses being acquired by larger companies, especially within the automotive industry.

Maier-Bridou says one of the reasons M&A is more active within medium-sized companies is because Germany has a low birth rate and so many family-owned businesses, including those with up to 1,000 employees, don’t have heirs. Therefore owners will often try to release equity from the business by selling parts of it to competitors, many of which are foreign.

While small to medium-sized firms have the advantage of retaining the Mittelstand as clients, larger firms are also tapping into this market. However, the returns are less than spectacular. That said, while smaller law firms generally generate less profit per partner than the giant firms, they are less exposed to risks and can therefore generate more stable revenues.

‘Larger firms can achieve significant growth year-on-year but also have to be prepared for revenues to fall in much the same way. We don’t have that concern. Medium-sized firms are less exposed to risk than larger firms,’ says Maier-Bridou.

It seems the downturn is forcing larger firms to pay more attention to the more pedestrian revenues from mid-sized companies in Germany and the rivalry between them and the mid-market law firms is apparent.

Otto Haberstock, partner at P+P Pöllath + Partners, says business has slowed down in the large cap M&A and banking field so larger firms are looking towards the Mittelstand for work, but they need to adapt their business models. ‘Our business model serves the Mittelstand well and I think larger firms will have to adjust if they are serious about targeting this market,’ he says. ‘All of our partners here, including our most senior partners, are involved in daily business, so they remain available to the client all through a transaction.’

Conrad at SSW says competition has grown between IT boutiques and larger firms. Given the current economic situation, the industrial sector especially is seeking premium advice from the larger law firms. She doesn’t think smaller firms should be worried, but they may need to become more efficient.

‘The fees are a big selling point. This is our advantage but then we need to be careful when it comes to internal management and professionalism. In order to compete with larger firms, smaller firms need to build their networks with other boutiques as their resources and advice are limited,’ she says.

Wolfgang König is not unduly worried either about the competition, as Mittelstand companies and their respective law firms have long-term fixed arrangements. But with the financial downturn seriously affecting workload within the banking sector, international firms have spent more marketing efforts on the Mittelstand.

Zenke at Becker says larger firms are actively pursuing Mittelstand companies as clients and although they would not be interested in a local bakery, technically, a big bakery chain with a multinational focus might be considered as a Mittelstand company.

One example of direct competition comes from Hogan Lovells, which advises a Mittelstand company called First Sensor, a producer of hi-tech sensor solutions in Germany. The firm advised First Sensor last year when it acquired AUGUSTA Technologie’s entire Sensortechnics Group. The acquisition doubled the company’s turnover from E50m to E100m. Hogan Lovells also advises other Mittelstand companies on labour law, IP licensing, M&A, enterprise content management and financing.

Leading domestic firm Hengeler Mueller ranked second in mergermarket’s tables behind Freshfields Bruckhaus Deringer for M&A deals by value in Germany last year, with 42 transactions with a combined value of E31.6m. Recent key deals involving listed clients included the takeover of Porsche by Volkswagen, where Hengeler advised Porsche, and the complex acquisition of Open Grid by E.ON on which Hengeler advised E.ON. Nonetheless, co-managing partner Daniela Favoccia is clear to emphasise that work for the Mittelstand is vital to the firm.

‘More and more Mittelstand clients come to us with their complex work in the areas of transactions, financing or litigation,’ she says. ‘A lot of these deals are dealt with on an international level and our clients have realised how important it is to not only offer high-end technology solutions to their customers, but they themselves have to ensure they obtain high-end advice for their critical situations.’

Hengeler Mueller has recently advised a series of Mittelstand companies, predominantly in M&A transactions. The firm recently acted for Viessmann Heiztechnik in its acquisition of Viessmann Kältetechnik and ITT Corporation on its acquisition of Joh Heinr Bornemann (Bornemann Pumps) – Germany’s leading supplier of pumps for the oil and gas industry.

 

International relations

Heuking Kühn Lüer Wojtek is a primary Mittelstand adviser that has always had a large chunk of global work. With around 250 lawyers, the firm has seven offices, five in Germany and one each in Brussels and Zurich, with its main clients being mid to large-sized businesses.

Heuking is part of the World Services Group of law firms, a global network that helps facilitate deals abroad with like-minded firms. According to partner Pär Johansson, the growing rate of international deals will increase the demand for these types of network.

Other partners agree. Stephan König at Oppenhoff & Partner says using formal or informal networks allows a firm to deliver quality advice for its clients in other jurisdictions. This way, he says, the firm can choose the lawyers best suited for the relevant piece of work and have practically no conflicts.

KCNB is also working on a partner network basis as China becomes increasingly popular for deals. In a recent example, the firm has been working with Taylor Wessing to advise manufacturing company Eisenmann in its acquisition of Hightec Kunshan and Hightec Shanghai.

However, according to Markus Hartung, a former Linklaters partner in Germany and now director at the Bucerius Center on the Legal Profession – Germany’s first private institution for legal education – whether these global networks of independent firms can advise a client that has a cross-border transaction efficiently remains to be seen. Especially when they are up against firms like Baker & McKenzie and White & Case. He says global firms are at a competitive advantage as they can offer a seamless service, which network-based firms cannot, as they depend on their best friend relationships.

However, managing partner at Luther, Markus Sengpiel, says global networks allow firms to have an international presence without them having to raise the capital to expand overseas. In spite of this, Luther has tried a different approach. The firm chose to focus on countries where it could set up shop and used the ‘best friends’ strategy in jurisdictions where it was too expensive to invest.

‘Our business model serves the Mittelstand well
and larger firms will have to adjust if they are serious
about targeting this market.’
Otto Haberstock, P+P

Luther set up a representative office offering only German law advice in London at the beginning of 2012. The move aimed to align the firm with its London clients as well as UK law firms that are interested in the German market.

According to Sengpiel, since the London office launched Luther’s revenues have grown as deals from Luxembourg, Shanghai, Singapore and Brussels have increased. The firm’s German turnover has climbed 8% over the last year with the same headcount. Its prime clients are based in Europe and include private equity houses and multinational companies headquartered in the UK. The firm is planning to open offices in other jurisdictions with a strong focus in Asia, as most of the Mittelstand is active there. Sengpiel says IP, corporate and labour law are particularly buoyant.

‘Asia is becoming increasingly important as a global destination,’ he says. ‘I see the advantage of having our own offices in certain jurisdictions but it’s questionable whether this approach will fit smaller-sized law firms.’

Hartung says if smaller firms want to extend their client reach, they have to start by understanding what the expectations of bigger companies are. Around seven or eight years ago, Mittelstand companies traditionally sought advice from the ‘Deutscher Club’ (German Club), where a range of domestic and international firms participated in roundtables to exchange their views and experience for clients such as the Mittelstand. It was formed in the mid-1990s and comprised firms such as Schönherr (Austria), Pestalozzi (Switzerland), Clifford Chance, Linklaters, Freshfields, CMS Hasche Sigle, and other smaller German firms.

However, when the Mittelstand experienced severe cost pressures a few years ago, Hartung says they slashed their external legal spend and started to professionalise the way they bought legal services.

‘Mittelstand companies are now considering legal outsourcing providers and this new approach – which is something you already see in the US and the UK – is now becoming a trend in Germany,’ he says.

An example of this is legal process outsourcing (LPO) company CORNUUM. A spokesperson at the company says that it is receiving mandates directly from Mittelstand firms, while a growing number of top law firms are also using their offering in servicing Mittelstand clients.

‘This is definitely a trend in Germany that is picking up,’ said the spokesperson, who confirmed firms currently on its roster include Field Fisher Waterhouse Deutschland, Hogan Lovells, Shearman & Sterling, SJ Berwin and White & Case.

But with a series of mid-sized UK firms entering or strengthening their presence in the German market, the question whether small and mid-sized domestic firms in Germany need a stronger global presence to keep in line with the modernising market is relevant.

Osborne Clarke recently opened its third office in Germany. Managing partner Stefan Rizor said the new Hamburg practice forms the gateway to targeted areas such as Scandinavia, Russia and the Baltic region. Other firms that have also expanded significantly in Germany recently include Pinsent Masons, Olswang, Berwin Leighton Paisner and Norton Rose.

Nevertheless, most German small to mid-sized firms seem pretty relaxed with the potential influx of competition and the current market status.

Henning Hartwig, partner at IP boutique BARDEHLE PAGENBERG, says: ‘In the general environment, BARDEHLE PAGENBERG is a mid-sized firm, but as IP specialists with offices in Munich, Düsseldorf, Paris and Barcelona we count among the largest IP firms in Europe. From our point of view it makes more sense to expand by opening offices in other European countries than merging with a firm from the UK where we have long-time, excellent working relations with top experts in the IP field.’

Wolfgang König says: ‘We have numerous discussions with independent law firms in many countries. We have good connections so we are well placed to serve our clients from a global perspective. If a client requests for legal work to be done in another country, in Turkey for example, we have arrangements with other law firms who give us work and vice versa.

‘We don’t think it’s absolutely necessary to expand into London, but of course realise our competitors, such as Luther, are doing this. We are working fine without a London office.’

KCNB is also sceptical about the need to expand globally. Baum says: ‘I’m not so sure about international expansion. I know it’s good to select the right partners to find the right fit and find out whether they are comparable to you as a firm. I think opening up an office in the UK is a big step for a small or medium-sized firm. It has to be a strategic step that takes the time to build up the quality that you wish to serve.’

 

Consolidation fever

The UK market has experienced a well-documented spate of national and cross-border mergers, initiated by struggling firms trying to move up the ranks and seeking the nebulous ‘critical mass’ to guarantee their survival. However, the same pressure to consolidate is not being felt by the mid-market German law firms. Haberstock says the German market is mature enough to be unaffected by recent arrivals from other markets. He said: ‘I don’t think that one, two or three firms expanding here will really alter the market or start a major wave of mergers. The smart international firms have always approached the market by hiring from local teams so this probably will happen, but I don’t foresee a wave of mergers or market consolidation. We have seen most of that already.’

‘Even if hourly rates reach the level of international
firms, the overall amount of fees is still lower.’
Markus Hartung, Bucerius Center on the Legal Profession

The general consensus is that these firms do not need to raise their game and compete with the German legal elite. While firms are expected to open new offices to accommodate lateral hires of partners and teams, it seems mergers are not on the German cards.

‘There are always changes taking place in law firms, especially smaller firms merging and groups of lawyers leaving firms, but I think the time for big mergers is over,’ says Kridlo at SKW. ‘In the 1990s it was a big issue, especially for British and American firms entering the German market and merging with giant German firms. This led to smaller firms located in one town merging with firms in other towns to leverage their business and become more visible. But at the moment, I think the market is already consolidated. There are spin-offs and the market is always moving but not in terms of mergers.’

Maier-Bridou at GGV thinks German lawyers are more independently minded than UK lawyers, but despite this, the market needs will change and firms will consolidate.

‘We don’t have many large firms, but the tendency is to merge and grow. I think in ten years’ time, the average German law firm will be larger in size,’ he says.

GÖRG itself has confirmed it will do a ‘mini-merger’ in January 2013. The firm has hired seven partners and 15 lawyers from rival firms Brinkmann & Partner and Beck & Hölzle to create an insolvency practice. The firm will also be adding six new insolvency sites in Berlin, northern and eastern Germany and the lower Rhine region.

It seems mergers are taking place in Germany but won’t necessarily hit the headlines, especially if headcount is low. Instead of mergers, German law firms are more interested in opening new offices in other jurisdictions or creating spin-offs. For example, German firm Wendelstein Rechtsanwälte was created in February last year when five Hengeler lawyers broke away to create a boutique specialising in business law.

Another boutique that set up last year was Munich-based Gütt Olk Feldhaus, which was created by two lawyers from Freshfields and one from US firm Milbank, Tweed, Hadley & McCloy, who wanted to establish an entrepreneurial venture themselves after working at a large law firm.

Many partners think this trend will continue. Kridlo says: ‘I think it is more likely that lawyers will team up and open smaller firms such as boutique M&A or IP firms. This model is quite successful in Germany.’

With boutique firms, it is not that the individual fees are necessarily lower, but that the overall cost of legal advice is cheaper, as only one partner will work on each case without a legion of associates, which results in a lower number of hours being billed.

Hartung says: ‘Even if hourly rates reach the level of international firms, the overall amount of fees is still lower, which is very attractive for international companies.’

‘I see the advantage of having our own offices
in certain jurisdictions but it’s questionable whether
this approach will fit smaller law firms.’
Markus Sengpiel, Luther

He says there are lots of spin-off firms where senior associates have left big firms, realising their partner prospects are poor, to form their own highly focused firms. The competitive advantage here is these individuals come from big-name firms and bring with them experience and contacts.

One successful example is Taylor Wessing spin-off firm Glade Michel Wirtz, based in Düsseldorf. The firm hired two partners from Shearman & Sterling’s Düsseldorf and Munich offices in April. Three Taylor Wessing partners founded the corporate and competition boutique in 2007.

Hartung says that general counsel in Germany are seeking these types of outfits for specialist work. For complex high-end work, most German in-house teams still prefer to use large firms where the brand name is important. But because of the difficult market conditions, this type of work is shrinking for international firms. Therefore smaller firms that have understood this dynamic are better off.

Hartung believes it is the traditional Mittelstand firms that face tougher challenges than the smaller boutique firms because their internal organisation is not as modern as it should be.

‘These bigger Mittelstand law firms still have a very traditional mindset and what they have to understand is that entry to other segments of the market requires a better alignment of partners and a more focused strategic thinking, and that does not seem to be their strength,’ says Hartung.

Conrad says there are smaller boutiques in Munich that specialise in IP/IT law but there can be a lack of internal management in these types of firms and the individuality of partners can also lead to conflict. Meanwhile, Sengpiel at Luther thinks boutique firms will struggle in the long term because clients want more from a law firm than just a ‘one-stop shop’.

‘A significant portion of clients are reducing their legal panels so I think it’s more of the case that if firms want to work at a higher level, they will struggle being a boutique firm that offers only a limited portion of services,’ he says. ‘In most cases, these boutiques are formed by senior associates or junior partners from Magic Circle firms, who believe they are better off doing it on their own. I believe this works for the first three to five years but I’m not convinced this would be successful in the long term.’

Sengpiel also believes Germany will see more law firm merger activity in the near future because there are so many firms bringing in turnover of around E20m-30m each. Small domestic law firms in particular will need to consolidate to increase market share, improve their financials and invest in technology.

But with the Mittelstand going from strength to strength, many small and medium-sized German law firms seem content with both their workload and with Germany’s economic health.

While the UK and the US firms continue on the consolidation trail, it may be a long while until Germany will need to follow suit. However, with the likes of UK mid-market firms moving into Germany recently, domestic firms could be challenged sooner than they think. LB

jaishree.kalia@legalease.co.uk