The financial health of any law firm ultimately depends on cash management. Too many firms operate like small businesses on a cash-in-hand basis, with insufficient reserves to weather a crisis or take advantage of an opportunity. Such thinking is no longer feasible (if it ever was) in today’s tight credit markets.
So this raises the question that often confronts management committees and administrators: What are the best strategies to raise cash?
There are four traditional answers, each with pluses and minuses.
1. Capital call
The traditional method of capital infusion for firms is a capital call from their partners. This is not so good a strategy as it used to be.
Partners who are themselves financially thin may have to ask the bank for help in order to satisfy the capital call, and in return may need to get a second mortgage, pledge other assets as additional collateral or even get guarantors.
Seen in this light, a partnership requirement to contribute more to the firm can be a call to action, for partners to make the firm better at its use of capital.
2. Credit line
Law firms can have credit lines against which the firm borrows and repays at will up to the limit. Banks are much more reluctant today than they were before the Great Recession to give credit to any commercial customer.
Moreover, credit line terms and limits can fluctuate substantially. Banks often set formal credit line limits such as three times monthly expenses. The bank also usually prefers that the law firm borrower be out of debt for at least 30 to 90 days each year.
The firm may be able to borrow and repay at will up to the amount of the credit line maximum limit. The line of credit is reviewed regularly by the bank and extended, cut or terminated as circumstances warrant.
In short, a line of credit may not be the best alternative.
3. Bank loan
Most typical is a term loan, which can be as long as seven to 10 years for a large law firm, or three to five for a smaller one.
In a revolving line of credit, the firm obtains a designated sum that is converted to a term loan, repayable over a period of two to five years. And there are specialized loan transactions such as an equipment term loan, in which the amount provided to purchase new equipment will normally be no longer than the depreciable life of a law firm’s equipment, usually three to five years.
To get any kind of loan, firms must demonstrate the strength of their financial controls and business model, and have a high credit score in hand.
It cannot be emphasized too strongly that the best way for law firms to raise capital is to promptly collect the billings due to them. That means firms should be diligent in collection policies and should not offer discounts on fees that have been agreed upon.
Uncollected receivables are in essence an interest-free loan to the client that can stay on the books while eating up considerable cash flow – not to mention partner compensation.
Stipulating payment rates and terms in the engagement agreement and enforcing them, along with wise management policies, will assure adequate capital.
Ed Poll is the principal of LawBiz Management, a national law firm practice management consultancy based in Venice, Calif.