Whether you’re starting a new law firm or managing a long-established one, capital — how much you have and how much you need — is a constant consideration. A successful firm requires both working capital to fund daily operations and long-term capital to buy assets and make strategic investments. Unfortunately, determining your firm’s capital needs and meeting them are two of the most difficult tasks you’ll face as an administrator.
One size doesn’t fit all
Conventional wisdom says that law firms need capital to cover at least 12 months of operating expenses. That’s not a bad place to start, but it fails to take into account many factors. For example, as some firms have learned the hard way over the past few years, severe economic downturns can last much longer than anyone expects.
What’s more, every firm’s needs are different. If, for example, you pay substantial out-of-pocket expenses on behalf of clients, your capital requirements will be greater than those of a firm that covers expenses through the use of retainers. Your billing and collections practices also may necessitate a smaller or larger capital cushion, as will your strategic plans. Firms with aggressive growth objectives generally need greater capital resources than those pursuing slow and steady growth.
Crunching the numbers
Established firms can get a rough estimate of their capital needs fairly easily. Just add your one-year operating budget to the cost of any major asset purchases and strategic growth initiatives (for example, making acquisitions or hiring new associates) planned for the coming year. Then make adjustments for unique situations, such as the need to pay out a senior partner who will soon retire.
Capital needs calculations are a little trickier for startup firms; you first must estimate how long it will be before you see positive cash flows. This period could last several months or a couple of years, depending on such factors as:
Ensure you have the capital to cover all ordinary — and extraordinary — costs during the startup stage or your firm will fail before it ever has a shot at succeeding.
Funding sources
Once you have a ballpark figure of your capital requirements, if you’re short, you’ll need to decide where you’ll get the additional funds. Typically, capital comes from a combination of bank debt, capital leases, undistributed earnings and partner contributions.
Due to the credit crunch, bank debt has become difficult for business borrowers to obtain. However, law firms most commonly borrow in the form of working capital lines of credit secured by accounts receivable and term loans secured by assets being purchased — which can be easier to get than other types of loans. Here, your firm’s financial history, business plan and relationships with bankers will be critical.
Whether you can secure capital through bank borrowing — or through capital leases —will also depend on your firm’s financial philosophy and appetite for risk. For example, are your partners comfortable borrowing against future collections? Do they mind financing office furniture and IT equipment with capital leases?
If not, they’ll likely need to contribute more from their own pockets. Contributed capital includes cash paid in when partners join your firm, as well as additional cash they may be required to contribute periodically. Your partnership agreement may require equal contributions from each partner or allow contributions to be determined based on the amount of income each earned in the previous year. If the current contribution method isn’t covering your firm’s capital needs, you may need to revisit this agreement.
A moving target
Determining your capital needs and funding them is only the start. Firm growth, including adding new partners, practice groups and offices, and operational changes, such as adopting alternative billing arrangements, make it necessary to regularly review your capital target. So incorporate the task into your firm’s annual budgeting process to keep your target current.
Posted by Bauerle and Company 3 months, 2 weeks ago
