In today’s difficult financial environment, when banks are even unwilling to lend overnight to other banks, lines of credit are in danger of tightening or even drying up entirely. The simple fact is that banks need to be assured that they are going to be repaid or they won't loan money. When even large law firms like Heller Ehrman and Thelen Reid run into financial and economic difficulty, banks are going to be much more cautious in extending credit to any law firm customer – especially on a line of credit. In a credit line arrangement, the firm borrows and repays at will up to the amount of the credit line, which is reviewed annually and extended, increased or terminated as circumstances warrant. The cost of such loans varies with factors such as the firm’s bank balance, other services purchased, and credit rating.
Getting credit from a banker today means documenting clear plans for cash and receivables management, marketing and business growth, establishing your qualifications under the “Four Cs” test (character, capacity to repay, capital and collateral), and maintaining a high credit rating. Especially in this era of bank consolidation, when change in ownership and personnel turnover can occur quickly, you need deep and wide relationships with a bank. Don’t just limit yourself to your loan officer or branch manager. Getting to know a senior manager – a vice president or even the president of the bank – will help you in the long run, particularly if the bank is involved in a merger. If your bank is doing the acquiring, it puts you in a good position with a stronger bank that has new referral sources. If it is being acquired, you have to know who the new players are and to be introduced to them as soon as possible.
Given these tough competitive factors, managing money is your number one consideration for firm survival. Even if you can get bank financing for it, never pay staff salaries or partnership draws by using a bank loan. If you borrow for payroll and payroll tax funds in anticipation of collecting on accounts receivable and then fail to collect enough to cover payroll and taxes sufficiently, the result will be a damaged credit rating, not to mention civil and potential criminal penalties. The same risk is even greater for firms that use a line of credit to pay their partners for the month. Their rationale is that they are not going to go too deeply into debt for such a purpose and they have cash that's due in at any time. Even if this is permitted by a line of credit, it is still too risky. Too often the anticipated payment or new work doesn't materialize – and the result is a major problem with a lender who cannot and will not carry customers for any length of time.
By far the best assurance is to have built up an adequate cushion of savings to cover worst case scenarios in the collection and payment cycle. Assuming consistent and effective collections efforts, a topic that we’ve addressed a number of times in this forum, four factors determine how much money you will need for ongoing operations:
- Volume: The greater your billings, the greater the need will be for cash in the firm. That’s because the time between when you send out a bill and when you receive payment averages more than five months nationally. The more client invoices you have outstanding, the more cash from other sources (bank loans, personal savings, etc.) you’ll need while waiting for payment from your clients.
- Growth Rate: Faster growing firms will likely need more money for supplies and equipment, staff support and office space. While you’re waiting for clients to pay you, vendors, landlords and utilities still expect payment immediately. One cannot pay for groceries and rent with accounts receivable, only “greenbacks.”
- Capital Turnover: This defines how often the invested assets of the firm are being returned in revenues. Higher rates of turnover produce more revenue on the same amount of assets. The faster you get clients to pay you, the better your turnover ratio. That’s why you should review your receivables weekly to see who has and hasn’t paid. Never wait until the end of the month to check turnover – that loses 30 more days in getting the cash you need.
- Credit Terms. The more lenient your terms to clients, the more cash you’ll need while waiting payment. Conversely, tough credit terms (such as charging interest on unpaid balances) are likely counterproductive – clients who won’t pay their bill won’t pay the interest, either. Never give in to the temptation to extend credit in the hope that the client will give you more work. Strive to get paid quickly for the work that has already been done.
This last point is particularly significant because, if the client hasn’t paid the fee while you continue to work on their matter, you have in essence extended a no-cost loan to the client. Just as a bank will not carry you in the hope that you will pay on an outstanding loan, it makes no sense to do the same thing with your clients on a vague hope of being paid as expenses pile up. The engagement letter should clearly state the consequences to the client for failure to honor the agreed-upon payment commitment. Keep track of when clients are behind on their payments, and never hesitate to contact clients when they are late with payments. In a worst case situation, cut your losses and end the engagement. The ABA’s Code of Professional Conduct, Rule 1.16, allows lawyers to withdraw if the client has not met an obligation to pay and the lawyer has given adequate warning that representation will end.
Let’s assume the best case scenario, that you have a client’s check in hand. For the most part, lawyers still get paid by personal checks from clients, and must physically deposit those checks with the bank. The first rule of cash management is, never wait to deposit checks. While a check is being held for deposit, too many problems can happen: the client may become angry and stop payment, or have insufficient funds when the check is finally presented for clearance, or become party to a lawsuit or other proceeding in which financial assets are attached.
Deposit all checks from clients . Do this even if the amount received does not match the amount due per the statement. Make a photocopy of the check. After making the deposit, call the client and ask for an explanation of the difference. You will ultimately reconcile the amount paid with the amount due; however, in the meantime, you will have deposited and benefited from the amount sent to you. The only exception is when there is a disputed claim, and a check is marked “paid in full” with the check amount being less than the amount owed to you.
There can be additional deposit difficulties involved. For example, an attorney is not automatically authorized to endorse the client's name to checks. This can be an issue with a two-party check in which one of the parties is not available (out of the country on business, for example) to endorse it. Too many discipline cases involve lawyers forging endorsements to settlement checks, lying to the client about whether the check was received or about the amount, and then walking off with the proceeds.
Banks can refuse any deposit for any reason. By accepting a two-party check as a deposit the banks may feel they have liability if there was a dispute between the parties. But by cashing rather than depositing the check the liability for any dispute is on the account holder, and the bank believes it does not assume liability. As long as you have the funds in your account to cover the check, it should go through.
Funds equivalent to the amount of the check will be placed on hold until the check clears. Any hold can only be until the check actually clears, which is usually midnight the same day according to the newest check clearing rules, although some banks will hold checks for more than $5,000 slightly longer. If the check is refused by the originating bank or is disputed elsewhere, you are liable to make your bank whole.
Technology now offers a way to accelerate the collection process. Firms are taking advantage of the new check scanners offered by some banks to more quickly and securely deposit client checks.
Scanners treat a check virtually as a debit card, making deposit instantaneous. A related but more comprehensive strategy is to negotiate for a lockbox, which many banks now advertise as one of their premier business services. In this arrangement, the bank picks up remittances several times a day, records them and sends details of the transaction to you as the customer. Online technology allows communicating this information on the same day as, or the day following, the deposit. This saves the time of physically processing the deposit.
Much of this discussion involves technical issues, but more important than any of them is the fundamental principle of living within your means. That requires a personal/professional expense hierarchy with these levels: practice needs, personal needs, savings for slow periods or emergencies, and “gravy” – a potential personal bonus after all other expenditure needs are met. Practice needs should always be met first, and personal needs should be the most flexible category. Personal needs, as covered by the lawyer’s “draw,” should be the minimum expense necessary to maintain your standard of living. If the practice produces sufficient income to increase your standard of living, fine. But the better approach is to avoid committing yourself to extensive obligations that you cannot reduce when necessary. Otherwise, when short-term credit dries up, it can mean a short-term lifespan for your firm.