Law firms that partner with specialty finance companies likely enjoy some helpful benefits. As non-bank lenders, these companies are able to offer funding to law firms that may have difficulties obtaining financing through other traditional avenues. Additionally, they often offer specific industry expertise – a tremendous value for contingency-fee law firms that have complex structures and nuanced business models.
But while securing funding from a specialty finance company might be a step up from traditional banks when it comes to lending flexibility and industry knowledge, there are five key disadvantages for law firms. Namely, specialty finance companies:
- Are not financially regulated institutions like banks and thus, borrowing law firms cannot be protected by regulators
- Do not offer a full suite of business services and products as a bank can
- Must borrow high-cost capital to then lend to law firms because they lack low-cost deposits that can be used to finance the loans they provide, resulting in higher interest rates
- Have a number of fee covenants baked into their loan documents that make it difficult for borrowing law firms to pay back their debt; these covenants may include underwriting fees, upfront fees, pre-payment penalties, application fees, maintenance fees, and broker fees, among others
- Often must maintain a certain yield in order to answer to investors, pushing rates and fees up even higher for borrowing law firms
Let’s look at an example: a specialty finance company loans a law firm $10 million in financing and it is expected to be paid back in three years; in the agreement for the loan, it states that the law firm must pay back the loan only with money received from its case settlement, otherwise a 15% fee would be charged on top of the original principal balance for the loan; without regulation, the specialty finance company then add on new origination fees and pre-payment penalties. This can make it very difficult for a lawyer to try and refinance that loan through a traditional bank or pay it off with other forms of capital within the repayment period.
Law firms should not take this risk and should work with a lender that answers to regulators, not investors and other lenders. Partnering with a modern full-service commercial bank that is regulated and dedicated to serving the financial needs of the legal industry can offer the best of both worlds – they can protect the interests of borrowing law firms and provide access to a wide range of resources, products and services with competitive (mostly single-digit) interest rates and high-touch, industry-specific expertise.
