The final part of a 3-part series around contingency fee law firms and being financially prepared throughout and beyond the pandemic.
In our previous articles, we touched on the importance of financial preparation, forecasting, and why these topics should be “top of mind” to ensure that your law firm’s liquidity and expansion plans continue to move in the right direction.
In this article, we’ll talk about what contingency fee law firms are doing to ensure that they come out of the recession on top (the “unicorns”).
First and foremost, let’s talk about a key factor that seems to make these unicorns stand out – these law firms have an accounting or finance department. This could be as simple as a lawyer with a finance background and thinks actively about the firm’s finances, or a CFO or finance manager dedicated to the accounting and finance function.
Lawyers all too often are laser-focused on their clients’ needs and successfully litigating cases while limiting their capacity to managing the financial aspects of running a complex business with irregular cash flows. Managing a typical business with short-term receivables or inventory is hard enough, but managing a contingency fee law firm’s peaks and troughs in cash flow is a monumental task that requires focus and expertise. Often lawyers will have a non-employee accountant managing their books, but what they really need is a full-time business manager with a core competency in accounting or finance.
A part-time accountant will react to your needs (i.e.-proper books and records, taxes), but a full-time business manager will be proactive. They will not only maintain your current books and records, but they will pro-actively manage your business including, but not limited to: continuously managing and updating your case inventory and associated case values; tracking and monitoring your case costs at the case level; ensuring that each partner’s portfolio of cases is updated timely; preparing strategic financial forecasts based on quality case-level data; managing and measuring current and projected costs as well as their effective and efficient utilization; and prepare a strategic forecast and dynamic budget for the firm. From this critical information, they can assist in advising the firm on strategies to grow the business, invest in resources, and ensure that the firm has proper financing to augment and accomplish those goals. Typically, this concretely comes down to managing your future cash flow, investing in people, investing in IT, and investing in new cases via your marketing strategy. Whether your law firm needs access to capital or not, having the right financing options for your future needs or unknown contingencies is the only way to properly run a business.
In order to maximize your time with current and prospective clients, the law firm accounting/finance department should be “leading the charge” for financing alternatives – they understand the financials, the forecasting models, the financing terms, and the questions to ask based on the terms from various financing alternatives.
This can be a difficult process since you not only need to know your business model, but it requires you to understand the bank’s or non-bank’s requests and questions to achieve the right results and make the proper decision. As an example, lenders will often employ tactics that stunt your ability to compare ‘apples to apples’ including various types of fees including, but not limited to: origination fees, non-usage fees, drawdown fees, prepayment fees, and renewal fees to name a few. This could impede your ability to make the “right” financing decision based on the amount of funds you may need while balancing the “all-in” costs of that financing.
Here are the top five tactics we have found lenders employ when it comes to lending to law firms that disguise the real cost of lending and what you should look out for when revising your law firm’s lending position:
- Rate – when requesting financing alternatives, you should always get an Annual Percentage Rate (APR) for the facility (i.e.-credit cards and home mortgages all have APR disclosures in order to compare “apples to apples”).
- Draw Down Fees – When you utilize your lending facility, you should not be charged for using it. If you’re getting charged for using your facility, that’s simply a tactic that lenders use to disguise the real APR. Do you get charged every time you use your credit card? You shouldn’t when you use your lending facility.
- Non-Usage Fees – if you don’t use your facility, you shouldn’t be charged. You may want a lending facility if and when you have an unanticipated delay in cash flow. You don’t need to be charged for not using your loan facility.
- Collateral – Often, traditional banks do not understand that a law firm’s case inventory and case costs are assets., Therefore they request traditional partner type assets or hard assets as collateral (i.e.-brokerage accounts, real estate investments, mortgages) Often, this means a managing partner’s personal assets are tied into the law firm’s loan
- Clean-up Provisions – Often, traditional banks have a 30 day clean-up provisions where your line-of-credit must be paid to $0.00 for 30 days. If you are using your credit facility that way it was designed, your normal cash flow cycle should allow you to pay down the line during cash inflows and draw down on the line when cash flow is needed. The clean-up provisions should only be mandated when you fully draw down on your credit facility for a duration of 12+ plus months with no pay downs. And even then, the clean-up provision should not be as onerous as a 100% pay down for 30 days.
These are just a few tactics that banks and non-banks utilize when lending to law firms. Often, partners will focus on the interest rate as the focal point for negotiations – but the devil is in the details. At Esquire Bank, we believe we not only offer one of the most compelling interest rates in the market for law firms, but we also believe we offer the best terms for our financing. During our business discussions with prospective law firms, they typically are surprised and unaware of the aforementioned tactics.
During this pandemic and economic recessions, we suggest that all law firms “shop” their financial options with banks and non-bank financing alternatives, whether you need it, want it or don’t think you need it at all. But for the sake of your law firm and your clients – understand the five tactics above employed by lenders in the market and ask the right questions at the right time.