Your law practice's financial plan 
(and how to protect yourself from failure)

Issue March/April 2016 March 2016 By Damian Turco

As the great law practice management guru Jay Foonberg once said, "You must have positive cash flow if your practice is to survive." That's a true statement and, unfortunately, a lesson learned the hard way by many lawyers and law firms out there. But the reality of practice is that cash flow is rarely consistent for a lawyer month-to-month, particularly in the first few years of practice and particularly in certain practice areas.

Nearly every well-established lawyer who started his or her firm from scratch has dealt with the stress of scraping by at one point or another. As we build our practices and do good work, cash flow tends to become more consistent and predictable and, hopefully, our financial safety net grows in the process. So, how do you get your practice through the difficult financial times? Part one is plan a budget within your expected cash flow. Part two is to ensure you have a financial cushion available.

Part 1: Establishing a Budget

"Every great business starts with an idea followed by an expense."

That's a quote from Eastern Bank Senior Vice President of Business Lending Joseph Bator, who we'll hear from in part two of this article. The statement really speaks to the difficulty of figuring out a budget when first starting out. We are naturally excited about the prospect of something new and exciting. Starting a law practice is no different. We tend to focus on all the great parts -- the fancy new office, the shiny new desk, the business cards, website, computer, software, etc. It's pretty easy to get wrapped up in buying the stuff for our practices without considering the burden of its ongoing expense. How many lawyers have walked out of the office supply store excited they only spent $99 on a printer only to learn later that the annual toner cost is triple that? Ugh. Well, you need a printer, right? And you need lots of other things, but it's a far better plan to map it all out ahead of time, rather than spend and then worry as the operating account falls. Thus the importance of an operating budget.

Your budget should include your expected cash flow and your expected expenses. Cash flow will be easier to estimate as you build the practice, but do your best to be realistic. Most accounting and practice management software programs provide the benefit of financial reports. Pull cash flow reports for the past three years (or less if you haven't been in practice that long) so that you can see your revenue and expenses monthly, rolling up to an annual figure. Note the trends and see if you can assess why the ups and downs occurred. If you've previously gone through this exercise (you should do it no less then annually), note where your actual numbers came in compared to budget. If you were way off your budget, figure out why and do better this time around.

Now, considering your expected revenue, review your expenses to determine what, if anything, needs to change. The proper way to do this includes a review of your marketing expenses and the corresponding return on investment. If there is opportunity to generate more business with a greater investment, you might want to work that change into your overall budget. At a minimum, you need positive cash flow or you'll eventually go out of business, so if your budget doesn't provide for a profit, keep at it until it does.

For the lawyer just starting out, there are certain expenses every lawyer should consider. While this is not an exhaustive list, there are other resources, including On Demand MBA CLE programs on starting your own practice. Generally speaking, you should consider certain essential expenses including office rent, parking, payroll or service provider expenses, taxes, professional association and licensure dues, insurance (malpractice, workers' comp., medical, general liability), phone service, fax service, website development and hosting, stationary, furniture, office equipment, banking fees, office supplies and the servicing of any professional fees, such as that of an accountant.

Part 2: Establishing a Financial Safety Net

The reality of business (and life, for that matter) is that sometimes things go awry. When things go awry in business, there are often financial consequences. The prudent practitioner, therefore, should plan for the likelihood of periodic financial challenges by creating a financial safety net. There are two ways we lawyers ordinarily do that. The first way is to save up an adequate cash reserve. That's nice when possible, but more difficult to accomplish than the alternative. The alternative is a business line of credit. Getting a business equity line is easier and less expensive than you may realize. Because the LPM Section of the MBA is partnering with Eastern Bank on May 25 to present a law firm financing program, I thought I'd sit down with Joseph Bator and Shawn Ford, two of Eastern's financing experts, to learn more about what's available and how the process works.

Joe and Shawn, what can you tell me about your backgrounds in business lending?

Bator: I've been at Eastern Bank since 2002 and am the director of business lending. I started Eastern's business banking division in 2006 and have run it ever since.

Ford: I've been in lending since 1995 and have been a VP in Eastern's business lending division, assisting clients, including many lawyers, in Massachusetts, New Hampshire, and Southern Maine for the past two years.

Joe, is it common that lawyers seek out financing and, if so, what products do they typically consider?

Bator: We do a lot of financing for law firms and other professional practices. When you have a professional degree, you're educated, can work for almost forever, and you generally understand when utilizing financing makes sense. Lawyers consider business lines of credit and term financing.

Are lawyers eligible for financing immediately upon becoming licensed?

Bator: No. In order to extend credit, the lawyer would need to be in business for at least one year. Once a lawyer has been in business for a year, meaning they've set up a business entity and have been practicing under it for a year, the lawyer would be eligible for an SBA-backed line of credit.

Shawn, in what circumstances do most lawyers seek out financing?

Ford: At first, lawyers typically approach us for a business line of credit. A line of credit is a lending vehicle that the lawyer can use when he or she wants or needs. There's no obligation to use it and no cost associated the line if it's not utilized, except for the $100 application fee. After the first year in business, which is often a challenging year, lawyers typically look to establish a better safety net. That's precisely what the line of credit is for -- cash available when it's needed most. Lawyer income can be inconsistent, especially in the practice areas of personal injury and real estate, which may have fewer larger payouts or seasonal trends. Lawyers also sometimes use equity lines to fund the buyout of a partner. Once a firm is more established, the lawyer or lawyers may come back for a term loan. A term loan is a loan with fixed payments, an amortization schedule, and a specific term end date. A term loan would make more sense when a lawyer is more established and is taking on a bigger expense, such as to fund the build-out of an office space.

Joe, what is the typical amount of a line of credit for a lawyer and what's required of the lawyer to get the line?

Bator: That varies, but our standard business line is $50,000. Eastern Bank currently extends business lines in that amount to lawyers with good credit who have been in business for a year. There's no additional documentary requirements. When a lawyer seeks a larger amount, there's more to the qualification process. Generally speaking, a lawyer needs positive cash flow of 1.25x to qualify. So, to illustrate, if the lawyer's monthly payment on the line is $100, the lawyer must have $125 a month in available monthly funds - that is, profit or expendable income.

So, Shawn, how would you calculate available funds for this purpose if the lawyer's income is inconsistent?

Ford: That also depends. The whole point of the line is usually to provide a safety net during inconsistent periods of income. The answer is that it depends on the individual practice. Some practices may have choppy income and the review of a three month period may be adequate to assess the lawyer's ability to pay the line back. So, for some practices, we may look at a larger period of time, like a 12-month cycle. Additionally, we sometimes have to look to the personal expenses of the lawyer because lawyers, mostly in solo and small firms, tend to distribute nearly all profit to themselves at the end of the year. That distribution may eliminate the firm's profitability and so we'd need to look to the lawyer's personal expenses to assess whether there are adequate resources to pay the line back.

What should the lawyer or firm seeking financing expect in regards to personally guaranteeing the debt?

Bator: Unless there are significant assets of the firm, the lawyer practicing on his or her own or the lawyers of a smaller firm, should expect to personally guaranty the line of credit and term financing. When the firm size and loan amount is larger, we'll move onto a non-recourse loan. That's because the firm income and assets tend to be more substantial and, if the line is large as is typically the case with more lawyers at the firm, it becomes uncollectable from any one lawyer.

Any final tips for lawyers seeking to protect themselves from financial hardship with business lines of credit or term financing?

Ford: I'd just caution lawyers from putting business debt on a personal credit card, especially mixing both personal and business expenses on that card. One problem we see with newer lawyers is that they've done just that and are now seeking to pay the credit card off with a business line of credit. We can't, however, finance the payoff of personal debt with business debt. So, the lawyer using credit cards should have a separate card for the firm on which he or she puts all such business expenses.

Bator: The only other piece of advice I'd give is to keep good financial records. Keep your accounting current and employ a bookkeeper if necessary to keep your books in order. Your trust accounting is required under your professional rules, but if you neglect the operating account accounting, you won't have a clear picture of the health of your business.