Why Most Lenders Don’t Understand Law Firms

  • 11/24/2020
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When it comes to achieving justice for their clients, plaintiff law firms face any number of obstacles over the course of their cases. Too often, outlaying the capital to pay for necessary case costs is one of their biggest hurdles. It is widely accepted that lawyers who invest more money in hiring better experts on behalf of their clients achieve better results. As such, many contingency fee law firms turn to some form of financing to help pay for their litigation expenses. However, there is a fundamental misunderstanding on the part of many of the lenders providing these loans.

For contingency fee law firms, litigation is a capital-intensive business and it often takes years before there is an outcome. Litigation expenses for any one case can include everything from medical expert witnesses, to an accident reconstructionist, economists, life care planners and document processing, to a whole host of other related expenditures that quickly add up. This places an enormous financial burden on plaintiff law firms and their already irregular cash flow.  This becomes exponentially more expensive as the law firm’s case inventory continues to grow and diversify.

Unfortunately, those same law firms are often faced with a dilemma when it comes to securing financing. Traditional lenders, such as banks, typically lend to contingency fee law firms based on their financial history rather than their projected fees. They do this because they do not understand the business of being a contingency fee law firm.  They don’t view a firm’s case inventory as an asset, nor do they appreciate the timing for settlements or comprehend the variability in settlement amounts.  For law firms that are in a growth mode, this is especially problematic because traditional banks generally do not offer these firms the amount of capital they need, unless they offer-up additional, personal collateral.

Generally speaking, traditional lenders do not like lending money to businesses with irregular cash flow. They believe such a business model creates additional credit risk. But in reality, quality lawyers who work on quality cases are successful well over 90% of the time. Therefore, the real risk associated with irregular cash flow is not an actual credit risk, but a perceived credit risk – we call it duration risk – the time it takes to settle a case. These same lenders generally do not like lending money against receivables to go out longer than 90 days, 120 days or for a progressive lender, 180 days. Typically, plaintiffs’ lawyers prosecute cases for a minimum of 6 months and often cases take 2-3 years or more to resolve.

Traditional lenders don’t have the experience or expertise, to understand the business of being a contingency fee law firm, nor do they know how to view the value of a firm’s case inventory as assets. These lenders do not appreciate that case costs do not impact a law firm’s revenue as they are repaid out of their clients’ share of the settlements.  This may seem like a minor point, but it significantly affects a lender’s underwriting analysis and how much they are willing to lend.

Fortunately for these law firms that are all too often misunderstood and underserviced, some lenders do have the relevant background and necessary expertise to afford them the financing they are seeking.  Various specialty lenders exist to create tailored financial solutions that have a deep appreciation for the business of being a contingency fee law firm.  They understand that irregular cash flow does not equate to credit risk and appreciate the challenges of funding case costs.  As such, these lenders can meet the unique, specific financial needs of  contingency fee law firms. So, while most lenders don’t understand plaintiff law firms, it’s important to keep in mind that some do.