How do Banks make money? They lend it to customers. What’s one of the biggest challenges for legal firms? Cash Flow. What’s usually a high priority for principals? Drawings.
With all the firms that I review, I see the same trend occurring over and over again. There is a constant strain on the cash flow due to the competing interests for the funds:
- payment of wages, rent and overhead
- funding growth in WIP and unbilled disbursements
- the constant (and deserved) need by principals for consistent drawings
Most firms, be it a partnership or company, grow by retaining their profits within the firm. Usually retained profits are locked up in WIP, Debtors, Unbilled Disbursements and Office Equipment and Fittings. The firm takes this approach from day 1, because they can’t obtain any funding. But as a firm grows and continues to be successful, it creates something that banks will lend against. CASHFLOW. Because of the past trends and the success of the practice, banks recognise the security of this cash flow, and are therefore prepared to lend against it. This is not the case for all banks in relation to legal firms, but some banks recognise legal firms as clients they want to have and develop lending policies to support these businesses.
Let me give you an example of a recent law firm restructure where as part of the restructure, we considered the firms funding needs. We approached their current bank as well as other banks. Some of which I had strong relationships with, others I approached to gauge their interest. As always with any funding, it is easiest to first approach the existing bank. They have a relationship and should understand the business. In this case, the existing bank made it extremely hard to do the business. They did not have a policy for legal firms. They recognised the cash flow of the firm and were willing to extend some funding, but not all that we wanted. This compared to another bank that had a written policy for funding law firms and prescribed ratios and guidelines that are acceptable to their credit department. Credit departments have taken a much more active role in the past 5 years in terms of reducing manager discretion. Our application ticked all the boxes, and so it went through the bank, from application to approval in under 2 weeks. The total facilities provided were in excess of $3 million, with approximately $1.1 million secured solely against a $2+ million revenue practice.
My advice to you is not to take your bankers word for it, they will lend you money, after all that is how they make money. Appropriately funding your practice will allow you to achieve many outcomes, including:
- unlock the retained profits locked up in your practice over the years
- retire some personal debt
- reduce the cash flow strain on the business from continuously having to fund growth via retained profits