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Financing a Law Practice

Vol. 28 No. 5

By Laura A. Calloway, David J. Bilinsky

Laura A. Calloway is director of the Alabama State Bar’s Practice Management Assistance Program.

David J. Bilinsky is the practice management advisor and staff lawyer for the Law Society of British Columbia. The views expressed herein are strictly those of the author and may not be shared by the Law Society of British Columbia

In the lobby of one of the oldest and most highly esteemed law firms in Montgomery, Alabama, sits a partner’s desk. Built to serve two users at once, it faces, Janus-like, in opposite directions, with a knee-hole opening and a row of drawers on each side, its splendid oak surface rubbed smooth by the passage of years and the movement across it of hundreds of files, pleadings, and law books. If only this desk could talk, what tales it would tell.

This desk was the first purchase made by the brothers who were the founding partners of the firm, and the story told is that they had it delivered to the small, single-room office that they originally shared when they first went into practice together in the early 1900s. When one would need to meet with a client, the other would excuse himself and go stand in the hallway until the meeting was over, or stroll across the street to see what was going on at the courthouse. And, from this modest first asset, they built their firm, over time, into what it is today: one of the largest and most respected law firms in the city.

At the beginning of the twentieth century, a small office with a desk and a few legal pads and pens was all you needed to open a practice. Later, at the dawning of legal technology, telephones and typewriters become necessities, and more prosperous lawyers abandoned the shared law library at the courthouse in favor of law books of their own. Now, as the stunning array of technology available to the modern lawyer continues to drive up the costs of being a competent practitioner, capital—the money needed to start, maintain, and expand a successful practice—and where to get it are things that every lawyer thinking about hanging a shingle, or hoping to keep one hanging, must seriously consider.

So where does the capital needed to start or continue a law practice come from in the early twenty-first century? Here’s our take on some options that sole practitioners and small firms may consider.

Many lawyers who hang a shingle don’t have much more than the shingle and a shiny new diploma (along with as-yet-unrepaid student loans) when they start out. The idea is to start with just the essentials and add what you can as you can, and this approach has worked for many lawyers in the past. If you’re going to try it, though, you should have a minimum amount of cash in the bank, available to get you started and keep you going for at least six months and, preferably, for a year. But how much is enough? And how much should you expect to spend, just to get the doors open?

Minimum monthly office expenses. We always recommend that lawyers seeking to start a new practice create a business plan or, failing that, at least a pro forma budget for the first year. Make a list of all of the regular, recurring monthly expenses you expect for your practice. Rent, utilities, and research services, if your bar doesn’t provide one of the free services as a member benefit, are the absolute, rock-bottom minimum you must prepare to meet. Many jurisdictions have gone to electronic filing and require monthly connection fees, as well as per-page fees, to access court dockets and copy or download materials from court files. Other necessities include a small monthly allowance for office supplies, a backup service for your electronic data, and funds for regular marketing activities. After all, you want your new firm to succeed, and it’s unlikely it will if you don’t take the time and spend the money to spread the word, even if your marketing activities consist solely of targeting other lawyers who are in a position to refer clients to you and taking them out for a burger or drinks once a month.

Another thing to think about is filing fees. Ideally, any client who comes to you with a good case will also have sufficient cash on hand to at least pay the court filing fee. Unfortunately, however, that’s not always the case. Add to your calculations a reasonable amount that can be used to provide advances for filing fees, copying of medical records, or whatever similar expenses the type of clients you represent can expect to incur. It would be a shame to have to refer a good case to another lawyer because you didn’t include advancing the occasional filing fee in your budget.

And don’t forget things like insurance. Some lawyers start out practicing “bare” and do fine. You need to consider, though, what property you currently have to protect and the cost in time and treasure of defending a lawsuit brought by a dissatisfied client. An uninsured claim, even if you win, can put your fledgling practice into a hole you may never climb out of. Uninsured claims for injuries sustained in your office or loss of personal property used to operate your practice can also send you back to square one, so investigate the cost of premises liability and renter’s insurance. You may find that policies of this type are much more reasonable than you ever would have imagined.

Minimum initial cash outlay. Next, make a list of all of the things that you need to acquire in order to start an effective practice. Sharing an office or renting a furnished “executive” suite can sometimes smooth your way into practice because they help you avoid up-front expenditures on furnishings, telephones, and other office equipment such as scanners and copiers. But if you must make purchases, we suggest that a desk, a comfortable chair for you, two chairs for clients, a good laptop computer (more expensive but much more versatile than a desktop model), and a multifunction printer/scanner/copier are the minimum that you need. You will also need an accounting system. If you are going to be handling trust funds, it is wise to acquire a dedicated legal system that can handle general and trust transactions. And it goes without saying that a lawyer starting on a shoestring should figure the cost of a good smartphone into his or her calculations.

Living expenses. Putting together the things that are needed to set up a suitable office is seldom too big a stretch for a lawyer trying to establish a practice. With Craigslist, yard sales, and innovative decorating ideas garnered from HGTV, most lawyers can put together a decent-looking office without too much trouble and expense. The single issue that we see doom more fledgling law firms, however, is the failure of owners to set aside enough money to cover personal living expenses during the period while they are launching the practice and developing enough legal work to cover their expenses and begin to turn a profit. This is the aspect of determining how much personal savings are needed that is most often overlooked.

Establishing a law practice that will support and sustain you over a lifetime is a marathon, not a sprint. For that reason, unless you have a spouse who earns enough to support your family at a minimum acceptable level without your help and is committed to continuing to do so until your practice becomes profitable, we recommend that you have sufficient savings to cover one year of personal living expenses (or at least your expected contribution) before you start your practice. We know that many lawyers take a leap of faith and are successful without such a safety net, but we know of many more who have failed financially, ended up with stress-related health and marital problems, or both.

The current low rates paid by banks and credit unions on personal savings have made this a very good time to borrow from friends or family members who may have uninvested or under-invested cash. When certificates of deposit are paying 1 percent or less and even the ten-year T-bill is hovering around 3 percent, getting a slightly higher rate of interest may make investing in your practice, if your business plan is sound or your existing practice is successful but cash-strapped, look very attractive. Borrowing from friends or relatives is not without its potential problems, however.

Because you may have previously represented the lender or may do so in the future, this option is fraught with the potential for conflicts of interest. Also, transactions between friends or relatives tend to be handled informally, often leading to later disagreements over the terms of repayment. For that reason, it is important to draft a simple but comprehensive agreement regarding interest rate and repayment terms and allow the lender the opportunity to have the agreement reviewed by independent counsel. Also, be sure to consult a tax advisor prior to taking a loan from a relative, as under-market rates may have adverse tax consequences for both lender and borrower.

Back before the Great Recession, when two or three pre-approved credit card applications landed in your mailbox every day, getting a card that could be used as a line of credit was usually fairly easy. Banks are no longer handing out credit cards like candy on Halloween, but a low-rate credit card may still be a viable source of capital for a growing law practice, or a good way to eliminate existing higher-rate credit card debt that you or the firm already owe.

If you have reasonably good credit, shop for a card with no annual fee and a low interest rate, or consider transferring to such a card the balances on which you are currently paying higher rates. Although we never recommend that lawyers take on debt that they cannot repay, many people are able to make substantial reductions in their existing credit card debt by transferring their unpaid balance to a new card offering 0 percent interest for a stated period of time, using that time to make the largest monthly payment they can afford, and then transferring the remaining balance owed to yet another new card with a 0 percent introductory rate when the old card begins to charge interest. The secret to this approach is to make sure you can handle the card’s interest rate in the event that you are unable to move the balance at the end of the no-interest period. Only do this as an absolute last resort; this “credit card kiting,” as it is known, can damage your credit rating and financial stability.

Sites such as Bankrate.com. CreditCards.com. and CreditCardGuide.com allow you to compare credit card offerings from many different banks and also apply online.

For those with good credit, a commercial bank can often be a good source of funds to finance a law practice. The interest rate charged will generally be more favorable than with credit cards, but a lawyer seeking a bank loan for his or her practice must be prepared to jump through a few hoops. Banks make loans based on a borrower’s character, capacity, capital, and collateral. Your character will probably already be known to your banker, but it will be up to you to provide financial information about your practice that will demonstrate the firm’s capacity to generate income to repay the loan and capital of your own already invested in setting up the firm. The bank wants to be certain that you also have a stake invested in making sure that things turn out well. You may or may not need to provide collateral, depending on the amount of the loan, the purpose of the loan, your capacity to repay it, and the capital you already have invested in your firm.

Banks generally loan money to lawyers for one of two purposes. Law firms usually seek bank loans to purchase assets for use in the practice over the short or long term (such as a new telephone or computer system or even a new building), or to fund growth activities (such as adding new employees) that will allow the firm to generate more income in the future. These loans will take the form of either (1) lines of credit, which may be drawn on from time to time but must also be repaid periodically, in part or in full, between draws, or (2) loans for a specific term, which are usually paid back in structured monthly payments, although some may call for a final balloon payment at the end to keep payment from stretching out too long. You should never expect payments on a loan to purchase equipment to extend longer than the depreciable life of the equipment, no matter how high its initial value or how long you may actually be able to continue to use it.

Regardless of the purpose of the loan, you will need to be able to show the bank that your firm currently generates sufficient income, or will after the infusion of new cash, to repay the loan. This is why it’s a good idea to have a written business plan that (1) sets out your budget and projected income, including financial statements for your practice for the last three to five years (or if you are just setting up, a pro forma budget that forecasts income and expenses demonstrating an ability to repay the loan); (2) defines your target clients and outlines ethically appropriate marketing activities to reach them; and (3) sets forth your plans for actually providing legal services, including facilities, equipment, and key employees needed.

Before going to see your banker about a loan, be sure to assemble your operating agreement (if in a firm) and financial statements for the last several years, including aged accounts receivables and cash flow projections, and the firm’s tax returns. Most banks will not make a loan to a small law firm entity (PC, LLC, or LLP) without also obtaining the personal guarantee of the firm’s owners, so be prepared to submit personal financial statements and your personal tax returns for the last three to five years, too.

In limited instances, a Small Business Administration (SBA) loan may be an option for a small law firm.

The U.S. Small Business Administration does not make loans directly to borrowers, but it can provide loan guidelines and loan guarantees that will induce a commercial bank to make a loan to a borrower. There are special programs to benefit women and minority business owners, those with disabilities, and businesses in rural communities. But because you will have to meet both the bank’s and the SBA’s lending requirements, be prepared to jump through twice the hoops of a normal bank loan.

To find out if an SBA loan might be right for your particular situation, check out the SBS’s loan search tool .

A relatively new option for a lawyer seeking to start a firm is a local small business incubator.

Often called small business resource centers, these havens for entrepreneurs sometimes offer inexpensive, though usually Spartan, office space including amenities such as administrative support, phones, copying, faxing and Internet, meeting rooms, and audiovisual services, as well as counseling with financial planning, marketing, and future growth strategies. Although primarily aimed at nonlegal businesses, a business incubator can be a good alternative to a home office for the lawyer who has almost no capital with which to get started.

Recently, the University of Missouri–Kansas City, in conjunction with the Missouri Bar Association and the Kansas City Metropolitan Bar Association’s Solo Practitioners/Small Firms Committee, opened its Solo and Small Law Firm Incubator. the first business incubator designed specifically to help new law school graduates launch practices. Hopefully, this will become a trend and will be a resource available to new practitioners across the country in the future.

If you are a litigator who acts for plaintiffs, then you know that the cost of discovery and trial of a personal injury or other lawsuit, particularly a complex one, can be formidable. These costs make taking one of these cases out of reach for most start-up lawyers and for many existing firms. There is, however, a new and growing class of financial institutions that is very, very interested in financing proposed or ongoing lawsuits, on a case-by-case basis, for clients or their lawyers. As various opportunities for lending have dried up over the last few years (think sub-prime mortgage lending), many investors, from small private lenders all the way up through banks and hedge funds, are eagerly looking for other options for big returns on their unemployed cash.

How they work. You can find quite a few of these lenders simply by Googling “lawsuit funding” or similar terms. Although there are variations from company to company, they all have certain elements in common.

Most of the online lenders are aimed at clients, and the text and graphics run the gamut from a “title loan” sort of feel all the way to very professional-looking websites that offer services allowing participating lenders to compete for a given client’s business. Some offer loans of as little as $500 up to tens or even hundreds of thousands of dollars, in the form of pre-settlement funding for items such as living expenses or post-settlement or appellate funding to get clients over the hump while waiting to learn whether the judgments they have already obtained will stick and be paid. Many also offer discounting of structured settlements for clients who are receiving regular payments in connection with a settlement but would rather have a big wad of cash right now.

These websites usually have a place for clients to enter their own and their lawyer’s contact information, along with a consent form allowing the company to contact the lawyer to find out more about the case and to evaluate the potential range of monetary recovery and the likelihood of success. Some require the client to submit certain documentation, such as the complaint and specified medical records or reports, before the application will be considered.

Other lenders in this field aim directly at lawyers—preferably those handling class actions, medical malpractice, or other complex and expensive litigation. According to industry participants quoted in The New York Times (“Investors Put Money on Lawsuits to Get Payouts,” November 14, 2010), the total sum now invested in such lawsuits exceeds $1 billion.

Whether the lender is aiming directly at needy clients or at firms looking for help in financing high-end litigation, the loans they provide are not cheap. These loans are considered high risk, often both because of the client’s lack of creditworthiness and the possibility that the plaintiff will not prevail in the suit or recovers less than the amount advanced; these factors drive up the interest rates at which these loans are offered.

Interest rates are often not published, but based on the websites that did provide rate information, as well as on reporting on this type of lending in the national press over the last couple of years, interest rates can range from around 15 percent up to 24 percent per year—and sometimes even more. Although some lenders advertise that their loans are non-recourse, meaning that if the client does not win, the loan doesn’t have to be repaid, the high-end lenders and many that seek lawyer and law firm borrowers require their loans to be repaid, regardless of the outcome of the case.

As of the time that this article was being written, we found three legal funders that stated on their websites that they are non-recourse lenders: Lawsuit Financing. LawMax Legal Finance. and Litigation Funding Corp. When dealing with a lawsuit funding company, read the fine print and make sure your client also understands and agrees to both obtaining the financing and its terms. We can’t stress enough that, although lawsuit funders may make the difference between winning and losing, some law firms that have dealt with them have ended up in bankruptcy as a result.

Are they ethical? First-year law students learn about champerty and maintenance, and lawyers thinking about using this type of funding for a potential or ongoing lawsuit, or advising a client on whether or not to do so, should carefully review the statutes and ethics rules for their particular jurisdiction. Although some jurisdictions continue to uphold old rules against lending in support of pending lawsuits and refuse to enforce such contracts, others are beginning to view the practice as helping to level the playing field and provide access to justice for clients who could not otherwise receive a day in court. As the Massachusetts Supreme Judicial Court observed in upholding such a contract in 1997, “the decline of champerty, maintenance and barratry as offences is symptomatic of a fundamental change in society’s view of litigation—from a ‘social ill, which, like other disputes and quarrels, should be minimized’ to ‘a socially useful way to resolve disputes.’” Saladini v. Righellis, 687 N.E.2d 1224 (1997).

Even if these loans are valid in your jurisdiction, they may cause other problems by raising the specter of loss of attorney-client privilege. Some courts have ruled that materials that have been provided to lenders during the loan evaluation process are no longer privileged and must be turned over to the opposing party if sought through discovery. Other courts have upheld the loans but refused to allow the attorneys who incurred them to pass interest costs on to clients as expenses of the litigation, particularly when the expense wasn’t explained to and approved by the client before the lawyer took out the loan.

Lawyers who resort to this type of financing should ensure that both they and their clients understand all of the terms of the loan and are willing to live with the potential consequences.

One of the most overlooked sources of financing for ongoing solo practices and small firms is better management of the firm’s existing cash flow. Many lawyers could do without loans or other sources of capital, such as forgoing their own salary or draw, if they would only better manage the way they handle the funds that are due to them. Requiring payment up front, getting bills out quickly, offering discounts for early payment, and making it easier for your clients to pay you are just a few things you can incorporate to improve your own cash flow.

Evergreen retainers. Abraham Lincoln is reported to have said that if a lawyer takes in a retainer from his client, the client knows that he has a lawyer and the lawyer knows he has a client. A corollary to that statement is that if the lawyer has a retainer, she will not have an account receivable as long as her fees and disbursements never exceed the retainer.

If you require something in advance from every client and you make sure that retainers are replenished periodically, you will know both that your clients are as financially invested in their matters as you are, and that you will have on hand the funds necessary to allow you to prosecute their cases as you go along.

But don’t just ask for a cost and fee advance at the beginning of the representation. Get in the habit of reviewing your trust balances and asking that retainers be replenished as needed in addition to sending out statements for current work to your clients.

Get those bills out now. Your work in progress (WIP) is your inventory. The problem with inventory is that it doesn’t produce income for the firm as long as it’s sitting on the shelf. So the sooner bills go out after work is done, the more quickly you’ll get paid and the less money you’ll have to find from other places (borrowing, forgoing salaries or draws) to keep the firm running.

Review your WIP report periodically to make sure that bills are being sent regularly. Divide your WIP more than 180 days old by your total WIP. The results should be between 20 and 40 percent. If it’s over 40 percent, consider making some changes in your billing process. For example, you might want to divide your clients in half and bill twice-monthly. This will help ensure a more regular cash flow. Big firms have policies in place that require their lawyers to bill monthly. If you want to grow, it isn’t a bad idea to emulate the policies that bigger firms have found successful.

Despite the need to carefully manage cash flow, many lawyers make it hard for their clients to pay them. They do this by failing to accept debit and credit cards. But for most individuals and smaller businesses, paying by credit card is the preferred method—they get a little longer before they have to come up with the cash, as well as travel points, cash back, or other benefits provided by the credit card company. By accepting credit cards, you also allow the client to pay out the credit card company over time rather than you. For those who are moving into the virtual practice of law, taking credit card payments is practically required.

There are many merchant accounts around, and almost as many fees associated with them, so it behooves you to investigate your options before jumping on board. Which Merchant Account is a website that claims to provide unbiased, independent reviews of merchant accounts, and it can be a good source of information when sizing up an offer from your local bank or even a member benefit offered by your bar association.

But there are several new entrants into the payment market, and we expect more to come. Here are a few you should also look at before making a decision:

Square. Square is a device that turns a smartphone or iPad into a credit card point-of-sale terminal. Imagine being able to take credit card payments anywhere, anytime—such as in the client’s home, at the client’s office, at the courthouse, even in the supermarket aisle. Well, maybe not in the supermarket, but it sure would be nice when your neighbor sidles up for the umpteenth time looking for free legal advice. Launched by Twitter co-founder Jack Dorsey and Jim McKelvey, this little device stands to change how lawyers get paid.

Based on information available as this article was being written, there is no contract, no rental cost, no extra equipment aside from the reader and the associated software, and neither monthly fees nor merchant accounts are required. Receipts are sent electronically.

So what does it cost to use something this new and innovative? You pay 2.75 percent of the charged amount plus $0.15 to swipe a card or 3.5 percent plus $0.15 if you have to key in the card number. The reader is free.

Contrast this with existing merchant account contracts where you have to pay a monthly fee for the card reader equipment, enter into a contract, incur setup fees as well as possibly face monthly minimum usage requirements, and pay a penalty fee if you don’t meet the minimum usage amount. There may also be other fees and charges levied based on the type of credit card being processed as well as “customer service fees” and such.

Square also provides management reports that track your top clients, taxes, payments by location, and more. Square works with the iPhone, iPad, and iPod touch as well as many Android phones from Motorola, HTC, Samsung, LG, and Dell. All transactions are stated to meet all standard industry security practices, as detailed on the Square website.

PayPal and NFC technologies. Anyone who has ever used eBay is probably also familiar with PayPal. But what does PayPal have to do with law firms? Since its earliest days as an escrow payment system created to allow distant buyers and sellers to confidently consummate their transactions without the buyer having to provide the unknown seller with debit or credit card information, PayPal now operates in 21 countries and allows its customers to send, receive, and hold funds in 24 currencies around the world. If many of your clients already have PayPal accounts, and many of them probably do, this is yet another option for making it easy for them to pay. PayPal services allow you to accept payments through your website, and they can even help you with online invoicing, including a “Pay Now” button built into the invoice.

Another option that lawyers will soon need to consider is near-field communications (NFC). Because most of us carry a smartphone with us at all times, NFC technology will allow a client to wave his or her cell phone at the NFC terminal in a lawyer’s law office and pay for a transaction. PayPal, Google, and others are jumping on this technology. Android, BlackBerry, and iPhone are all looking to incorporate this “digital wallet” technology in upcoming products, and payment by smartphone is already common in some parts of Europe. (For more information on the latest in payment technology, see the online articles PayPal to Throw Weight Behind NFC Technology for Digital Wallet and Zetawire Acquisition Could Help Google Replace Your Wallet with Android .)

XIPWIRE. XIPWIRE is another up-and-coming payment method. Once you have enabled your XIPWIRE account, to receive payment for your legal invoice from your client you would enter the client’s XIP ID into your iPad or iPhone. A picture of your client then appears on your phone (allowing you to verify that this is indeed the right person). Enter the amount to be paid before hitting the “Charge” button, and XIPWIRE then sends a text message to your client. They reply with their PIN, and you and your client receive a confirming text message that the payment has been made. The advantage here is that your client need not be physically present to authorize payment. Fees? In 2010 the charges were 1.5 percent of the transaction. There is also a charge to deposit funds from a linked card account. XIPWIRE states that it works from any cell phone and is as simple as sending a text message.

You can also speed up collections by discounting the amount you charge if payment is made immediately. Extending a discount for immediate (usually within ten days of invoice) payment is common in commercial transactions but not in legal circles. Some lawyers and legal financial experts argue that offering discounts devalues a lawyer’s services, but we have no problem with it as long as the lawyer makes clear that the discount is given in exchange for the client giving up the right to extend the payment due date out the customary 30 days. Clients know that it is beneficial to take advantage of these discounts, and lawyers are beginning to recognize it, too. After all, if you are paying 18 percent on your credit card, it makes much more sense to give a benefit of 2 percent to your client—you are ahead by 16 percent! This is a classic win-win option, and one that lawyers should be using, especially in tight financial times.

We always recommend that a lawyer or firm prepare a monthly “financial dashboard” to keep the practice on track. This is a compilation of information such as hours billed, fees billed, fees collected, WIP, accounts receivable, cost write-offs, fee write-offs, accounts receivable write-offs, and cash on hand for the current month, all preceding months in the current year, and the same month for the last couple of years. This information will tell you immediately if your firm is climbing or headed for free fall.

If preparing various financial reports is just too much for your legal brain, or you simply don’t have time for it, there is a new cloud-based service that helps you monitor the financial health of your practice called inDinero. To get started, you sign up and provide inDinero with your credit card (presumably only those that you use in your practice) and banking info. From there, inDinero syncs with your banking info daily and provides you with a financial dashboard by configuring the notices and alerts that are most relevant to you. You can also invite your bookkeeper or accountant into the service. inDinero states that the service can provide you with insights into how you are spending, what you have earned, and how your finances are changing over time.

The service will break down your spending into categories and allow you to see what areas of your practice are most profitable. Most importantly, because most start-up practices have difficulties in managing cash, inDinero states that it will project your cash on hand over the next 30 days as well as alerting you of any upcoming cash flow crunches. It will also recommend short-term bridge loans to cover any anticipated cash flow problems.

Of course, security would have to be ensured, and the inDinero site claims to have 256-bit SSL encryption. Furthermore, it states that the access you provide is “read-only” and that it doesn’t allow the movement of funds into or out of your accounts. We haven’t tried it and can’t vouch for it, but it certainly looks like an interesting alternative to preparing your own reports and might be worth investigating.

Today, with the wealth of information available at your fingertips, it shouldn’t be too difficult to at stay on top of the numbers, forecast your budget and upcoming cash needs, and manage the cash flow of your new practice. New payment methods reduce the risk of not being paid for your services, while tried-and-true methods such as taking in retainers will give assurance that you will not have to chase a client for payment. Prudent planning and execution should allow you to set up a practice, one desk at a time, and not overextend yourself while your practice is building. Despite all the advances in technology, however, there is still no substitute for planning for the needs of your practice in advance and sitting on a nest egg of capital to help you ride out the financial squalls.