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Financing the Life Cycle of the Law Firm

by Dwight Hill on Categories: law firm financing

Financing the Life Cycle of the Law Firm

Financing the Life Cycle of the Law Firm

Since 1978, when our South Florida bank was founded by a group of lawyers, our team has provided advice and assistance to law firms and attorneys from solo practitioners and boutique practices to national and multinational organizations. While each firm has its own distinctive personality, strategy, market and client base, there is a pattern of issues that need to be considered at every stage of the financial life cycle.

Launching a New Firm

For lawyers, starting a new firm is a venture that typically occurs once or twice in a lifetime. Like buying a home or undertaking a complex surgical procedure, this can be a life-changing decision that requires careful consideration. In thinking through the issues, advice from trusted professionals can help get them off to the right start.

For example, attorneys should consult with an experienced business lawyer about structuring a partnership agreement that spells out roles and responsibilities, as well as how to handle a potential dissolution of the firm in the future. It’s like a prenuptial agreement designed to resolve conflicts in advance.

Many times, I have talked with attorneys who have left their old firms and started new ones with their colleagues. They tell me, “I don’t need an agreement because we are good friends who get along well.” However, circumstances change through the years and the result could be a battle that ruins those friendships.

Another good step in creating a new law firm is to engage the right full-service accounting professional – especially with the pending changes in tax laws. For example, an accountant might suggest creating two levels of business structures: one that owns the assets and leases the law firm’s space, and professional associations (PAs) that pass-through income for individual attorneys.

As banking professionals, we don’t provide that type of legal or accounting advice. Instead, we draw on our wide network of professional contacts to make referrals and to act as quarterbacks during the start-up process.

Financing the Start-up Firm

On the financial side, a new firm can usually benefit from a term loan to pay for equipment and the build-out of the office space. These are capital expenses that can be depreciated over the years.
New firms also require adequate working capital to pay staff and cover other expenses until revenue begins to arrive. Drawing on our decades of experience serving the legal sector, we can help the partners walk through key financial issues:

• What are your weekly and monthly expenses?
• What is your revenue recognition cycle?
• When do you actually collect money?
• What large a cash flow do you expect?
• How large a line of credit will you need to keep the firm operating?
    
Remember that even if you are winning your first cases and generating receivables, you may still be waiting for payments from your clients. Billings are not cash; only cash is cash.

For many firms, the length of the revenue cycle depends on the nature of the practice. If you firm is doing defense work or business litigation, for instance, you should be generating revenue after 90 to 120 days.

On the other hand, if your firm is doing contingency work or handling bankruptcies or class actions, it may be many months before you see any significant revenue. If you are funding client costs or engaging expert witnesses for cases with a big potential payoff, you need to factor those expenses into your credit needs.

A smaller firm might only need one loan package, but a larger firm can benefit from having two or three distinct lines of credit for capital purchases, working capital, and client expenses. This provides greater transparency and financial insights for the partners, helping them make better business decisions.
 
Growing the Firm

Many successful law firms find that their financial requirements change over time. Transactional banking services, such as checking, money market, debit and credit card accounts, can easily be scaled up to accommodate growth.

However, bringing in a new attorney or group will increase the operational costs to the firm prior to the arrival of the additional projected revenue. The firm is likely to need money to cover salaries, purchase additional equipment and reconfigure the existing office or lease additional space.

Through the years, our bank has provided hundreds of terms loans to law firms, helping them stay focused on moving that larger volume of cases forward, rather than worrying about paying the bills.

On the other hand, some firms take a conservative approach to finances and don’t want to take on new debt. That’s an understandable position that avoids the risks associated with over-expansion or too-rapid growth. However, it may also mean forgoing new revenue that could add to the firm’s profitability by more than covering those loan payments. If your firm has turned down new business because of a lack of financial resources to carry the case, you may want to consider creating a certain level of debt in order to gain that revenue.

Having an experienced banking partner is also important in managing client trust accounts and escrow accounts. A failure to comply with fiduciary, legal and ethical requirements could result in disbarment, loss of license and other penalties. We strive to preserve those funds in their entirety, and any service charges or fees should be covered by the firm to avoid any concerns from
the client.

We have also participated in The Florida Bar’s Interest on Trust Accounts (IOTA) program since it was implemented in 1981. Although rates are currently low, we believe clients are entitled to interest on their trust and escrow accounts. If market rates rise in the coming year, earning interest will be an increasingly important issue for law firms handling these client accounts.

Handling the Transition

It takes careful planning for mature law firms to manage business transitions, such as a sale or merger with another firm or the transition of leadership to a new generation of partners. It’s also essential to consider the financial ramifications of a senior partner’s retirement – particularly if he is the “rainmaker” for the firm.

If the firm’s leadership believes that seeking a merger or sale is the right strategic direction, then an accountant or transaction specialist can provide advice on enhancing the firm’s value in the marketplace. That might mean downsizing the firm to reduce expenses or accelerating revenue collection before putting the firm on the market.

Effective succession planning is needed for firms seeking to pass on the mantle of leadership. This is a process best done over a period of several years, so that younger attorneys are well prepared to keep the firm moving ahead after one or more of the senior partners leaves the firm for retirement. Otherwise, it might be too late for a small firm or a solo practitioner to find a junior partner who can help the exiting partner realize the true value of his or her investment.

Hopefully, a partnership agreement will specify the terms of a partner’s exit, but there are likely to be other considerations to discuss, such as the timing and nature of the payout, any ongoing involvement with the firm, as well as benefits like health insurance and vehicle leases. Our bank offers a loan program that allows senior associates to buy into a firm or provides funding to a group of partners who want to buy out the share of a senior partner making the transition to the next chapter of life.

Assisting Attorneys in Their Careers

Just as law firms grow and mature, individual attorneys also need certain types of financial advice and banking services at different points in their careers. For instance, many young associates are carrying a high level of student debt. We often counsel these newcomers to the profession about making appropriate financial decisions, such as minimizing expensive credit card debt until they can pay down their older loans.

We also assist attorneys by financing their lifestyle decisions, such as the purchase of a home or condominium – including jumbo mortgages for expensive properties – as well as loans for vacation homes, boats and planes.

As attorneys move forward in their careers, we can assist with financial planning, building investment portfolios and managing wealth. Later in life, we work with legal, insurance and accounting professionals who can prepare trust and estate documents in accordance with a senior attorney’s wishes. We then can act as a fiduciary and administer the estate.

With our deep pool of knowledge and experience in serving the legal community, our bank is committed to providing attorneys, law firms and their clients with the right financial products and services, building lasting relationships as a trusted advisor.

Dwight Hill is Market President for IBERIABANK. He can be reached at dwight.hill@iberiabank.com or 305-808-2223

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