After reading the words financing and funding on this page, you may have gone for the “x” in the top-right corner of your screen to make a quick escape. But since you’re still lingering here, you must know that to grow a successful law firm, you have to care about the numbers, regardless of where you are in your firm’s lifecycle.
We know that you’re focused on delivering great legal services to your clients. After all, that’s why you went to law school in the first place. But to serve your clients in the best way, you must be profitable.
You might be overwhelmed by the many law firm financing and funding options available. Or, maybe you have no idea where to start. We’ve all been where you are now, ready to build a law firm that’s both successful and secure. As we’ve continued to build our own businesses, we’ve discovered what it takes to make it happen (albeit the hard way).
You need a long-term plan, some basic financing knowledge, and the ability to see beyond the traditional way of doing things.
Creating a Long-Term Strategy Model for Your Firm
Tim, after taking a random glance at his books, realized that after five years as a law firm owner, he was nowhere close to the financial level he expected to be at by now. In fact, he was still struggling to get ahead.
Tim, like a lot of other business owners, started a new law firm without a clear strategy in place. Is that where you want to be in five years? We didn’t think so.
Any healthy business, including law firms, should have a written plan to forecast revenue, expenses, net profit, and cash reserves. But this isn’t something you do just to check it off your list. It’s more important than that. This strategy is the tool you use to manage your day-to-day business so you can reach your future financial goals.
The Next 1-5 Years
First things first, you must consider where you want to be in one year, three years, and five years from now. Once you visualize those goals, you can start outlining the steps you’ll need to take to get there—the backbone of your financial strategy.
For example, do you want to double your income in the next five years? If so, how might you accomplish that goal? You might need to offer a new service, level up your marketing game, and increase your service pricing.
Now, consider what doubling your income will cost your business. Will you need to hire employees or outsource work? As you consider these questions, you’ll start to see a roadmap taking shape.
It’s time to break those big-picture goals down into benchmarks. It’s time to define your numbers. For example, if you wish to double your yearly income in five years’ time, what’s that exact number? You can create your benchmarks based on this goal by breaking down that number by year and then by month.
This will help you visualize the amount of revenue you’ll need to add each month and year to reach your goals. Benchmarks are more attainable when broken down each month and they keep you on track.
Let’s break it down with an example. Say you want to add $200,000 in revenue over the next couple of years. You’ll need to add $100,000 in revenue each year, which breaks down to roughly $8,400 each month. You can now consider how many clients you’ll need to add each month to reach that benchmark goal.
Document Your Systems
As you formulate your plan, document it to help avoid fraud or errors. As a bonus, by documenting your financial systems you’ll have a much easier time applying for credit, seeking insurance or even selling your law firm. You may also have access to better loans you wouldn’t have otherwise without those well-kept records.
Understanding Your Need & Use of Cash
You know what they say, cash is king. You certainly can’t run a successful law firm without it. But when we talk about cash, we’re not envisioning a stuffed briefcase full of bills under your desk. Instead, you must have cash in its two basic forms: capital and cash flow.
Cash Flow: Daily Operations
Cash flow, or short-term cash flow, is the money you use to fund your daily operations and pay your bills. For example, you’ll need adequate cash flow to pay monthly expenses such as software fees and utility bills. Cash flow is also the source you need to pay your employees.
Capital: Larger Purchases & Investments
Capital is the money you use to invest in future growth. If your firm’s circumstances change suddenly, you’ll need access to capital to stay afloat. Examples of capital include stocks, bonds, funds held in deposit accounts, and more. You can also access debt capital via credit cards, bank loans and other forms of credit.
Where Does Cash Flow Come From?
Money doesn’t grow on trees. So, where does the cash flow you need to run your business come from? In the beginning, we recommend you fund your firm with your own personal cash. After that, cash will generally come from day-to-day business operations.
Personal Cash: How Much Should You Use?
To open your own firm, you’ll need some initial cash to deposit. You’ll need to have enough set aside to run your firm while understanding you may not make much money for several months. We recommend using the cash from your own personal savings so you have some skin in the game, which will help keep you dedicated to your initiative.
Whatever you do, don’t drain your personal savings. You still need personal funds set aside for life outside of your firm.
To estimate what you’ll need for starting out, look at your budget or what you estimate you might use until you start generating sufficient working capital within your business. Set this amount, plus a bit of cushion, aside to get you started.
Liz knew she had just completed a case that would bring in the revenue needed to pay for next month’s bills. Suddenly, she found herself halfway through next month, still without payment. Unable to pay the bills, she found herself scrounging for cash wherever she could, making it through by the skin of her teeth.
Are you sweating yet? Sure, most of your cash flow will come from your business operations or the money you generate from serving your clients. You must be prepared, however, for the real threat of lock-up that could cause financial ruin. Quite simply, it can take months to be paid after you produce the work.
When that cash doesn’t arrive on time, you may be left frantically searching the couch cushions like Liz. You may have to resort to not paying yourself or using debt capital such as credit cards or loans. Unfortunately, this can create a financial burden on your firm and your personal life.
It doesn’t have to be this way. Instead, we recommend saving at least two months of operating expenses from your revenue. That way, if you have a hiccup one month, you’re covered without dipping into additional sources.
Credit & Loans
If you can demonstrate long-term profitability and feel some extra cash flow would benefit both you and your firm’s wellbeing, you have options. So, which options are best for you and your law firm?
Before we dive into your options, one caveat: We recommend avoiding the use of your personal credit cards for your law firm funding or financing. After all, keeping your business and personal expenses separate will greatly benefit your financial upkeep and, dare we say it, your taxes.
Lines of Credit
A line of credit is typically offered by a bank or credit union. It gives you access to money as you need it, and you can draw up to a maximum amount for a set period of time. Lines of credit are flexible, allowing you to continuously borrow the funds you payback. You also don’t pay any interest until you borrow.
Business lines of credit are often unsecured, which means you don’t need to put forth any collateral to secure the credit. These typically come with higher interest rates, however. Lines of credit are best for short-term projects such as office renovations or upgrading your equipment.
Credit cards are similar to lines of credit, with a few key differences. For example, a credit card doesn’t have a draw period, so you can use it as long as the account is open. If you want actual cash in hand (like you’d receive from your line of credit), you’ll need to perform a cash advance on your card. This often comes at extremely high-interest rates, which can cost you.
Speaking of higher interest rates, credit cards come with higher rates than the other lending options listed here. With some cards, you may be able to pay the balance off each month and avoid interest charges. That makes them an often ideal choice for day-to-day spending within your firm.
Small Business Loans
Small business loans are tailored specifically for business owners just getting started. In general, we recommend avoiding the use of small business loans for law firm financing or funding. Typically, these loans require you to leverage your own home or other assets to secure it, bringing a fair amount of risk to the table.
Friend & Family Loans
Although loans from friends or family may come with the added benefit of a low-interest rate, they often come with strings attached that can strain a relationship if you don’t pay it back on time. Before you reach out for help from a friend or family member, seriously weigh your comfort level with the relationship.
Using Credit & Loan Funds for Cash Flow
Although credit cards and loans are available, you should only use them if you are confident in your profitability. If you can demonstrate that you will have the cash on hand at a later date, feel free to access the credit if you need to. If you’re not sure when you’ll have the cash to pay your debts, though, accessing credit or loans may not be the best option for your firm.
Should You Reinvest Your Profits?
Your capital is used when you need to obtain big investments such as a new office or new technology for your firm. And if you were wondering when the long-term strategy would pop back up, it’s now. Law firms prepared for the future will forecast these large expenses ahead of time, ensuring they have access to the capital they need.
Most firms will typically distribute any profit to the partners of the firm at the end of the year to avoid higher taxes. Unfortunately, draining your firm’s bank account in this way also drains your ability to grow your firm. Smart firms will instead decide to reinvest their profits.
You Must Stay in Control Over Your Law Firm Funding & Financing
Whew. We know that’s a lot to take in. If you’ve made it this far, grab yourself a celebratory espresso shot and let’s discuss the last step: creating effective financial controls. Effective financial controls can help you avoid negative situations within your finances.
With all the money coming in and going out of your firm, you must protect it to avoid theft, misuse, and even malpractice claims and disbarment. Here are several controls to define:
- Who’s responsible for financial duties? What checks are in place to ensure that everyone is doing their job properly?
- What policies the entire firm should follow such as invoicing, payment processing, etc.
- How bank statements will be reconciled each month
- How you’ll use your processes and software to create an audit trail
Take a moment to consider what would happen if someone stole your account number. Without proper controls and a lack of active eyes on your finances, you may lose every dime before you even realize something’s wrong. Avoid losing your business and put some controls in place now.
Learn How to Fund & Finance Your Firm the Lawyerist Way
After being shocked by his financial standing after five years, Tim took responsibility for his finances and put a strategy into place. He managed to save three months’ worth of operating expenses and is now meeting his monthly benchmarks. In the next five years, he’s planning to double his income and grow his firm.
Remember Tim? After taking responsibility for his firm’s financing and funding, he’s now on his way to becoming the owner of a profitable and successful law firm. Are you ready to be more like Tim and learn more about funding and financing your firm the right and sustainable way? Become a Lawyerist Insider today to learn more attorneys and Labsters just like you.