Attorney Loan Myths, Facts and Misconceptions You Should Know

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Law Firm Financing doesn't have to be a HeadacheThe Law Firm Lending division at Case Funding handles plenty of unique considerations when discussing loan options with attorney clients; but there are some standard concerns we run across daily that are likely shared by the majority of your PI colleagues. Some derive from established legal culture, some from a simple lack of information or experience. If you’ve been considering financing for your Law Firm, here are the Myths and Facts you should know:

Myth 1: “Successful contingency-fee based Law Firms just don’t borrow for working capital – they wait it out.”

The general perception is that successful contingency fee based law firms don’t need to or shouldn’t borrow to operate.  Perhaps that thinking emanates from the misconception that it is extremely difficult or unwise for contingency firms and lawyers to borrow in the first place.   Neither could be further from the Fact.

The fact is that law firms are real businesses, and just like most other enterprises, a prudent amount of debt can be key to success – affording the firm (or business) the opportunity to leverage its position in the market, fund growth, compete effectively and maximize its proficiencies in the practice of law.

Fact: “Financing could be part of the normal course of a law firm’s business. While law firms are certainly a unique business model, that doesn’t mean they cannot benefit from the same strategies that work in other businesses.”

We have seen first-hand how law firms use debt effectively in their normal course of business to increase revenue and profit.  Firms borrow for a variety of business reasons.  Some borrow to fund a marketing program – whether focused on specific “Mass Tort” related case types like TVM or Hip Replacement, or to market a core competency such as PI, Maritime and Employment Law.  The most successful firms we have dealt with routinely spend to maintain consistent, ongoing and quality marketing programs.

We have also seen how law firms use working capital loans to hire experts and pay for costs associated with going to trial. These attorneys consider the added expenses necessary to ensure the best possible scenario to earn their clients the settlements or awards they deserve.  They look at each dollar spent on a case in terms of the multiplier effect it can have on their settlement or award.

In most of these situations the money spent for specific case and trial costs are considered advances to the client and are reimbursed at settlement.  In many jurisdictions, if an attorney borrows specifically for case costs, interest on the loan, if segregated from operating expenses and tracked properly, can be included in expenses and reimbursed from the settlement.

The last thing I want to do is to not be prepared for trial or to allow the defense to even think I am not prepared to go to trial” an attorney client of Case Funding’s said recently.  “I view borrowing as a necessary part of my normal business, and particularly in building my case properly – I’d much rather negotiate after a favorable verdict than before one.”

Fact: “Unpredictable and uneven cash flow is normal for trial lawyers, but it doesn’t have to catch you by surprise.”

All attorneys who work on contingency experience ups and downs of cash flow.  It’s not an indication of how good or not they are as lawyers – it’s just the nature of the business and virtually unavoidable.  Having a line of credit in place that can be drawn to alleviate cash shortages allowing firms to continue to operate without disruption. The most successful law firms Case Funding has worked with have ensured that their business has sufficient reserves at their disposal and are never taken by surprise.

Fact: “There can be substantial opportunity costs to your law firm if needed funds are not available.”

Webster’s Dictionary defines “Opportunity cost” in economic terms, as “the opportunities forgone in the choice of one expenditure over others.”

Financial analysis proves that the cost of not borrowing can be much greater than the cost of borrowing.  The true cost of borrowing should really not be viewed as the interest and fees associated with borrowing, but rather as the “opportunities forgone” by not borrowing.  Consider the attorney who is forced to refer a case out and give up a substantial portion of a potential fee.  Or even worse, the lawyer who can’t afford to sign up client or who ceases marketing because of lack of funds. Then, there’s the lawyer that craters and settles for less than a case is worth just to get some cash in the door.

Myth: “Law firms with substantial cash reserves do not need to borrow.”

There really aren’t many reasons to use your own cash for case costs – particularly since in most circumstances interest is considered a business expense and deductible for tax purposes, or interest can be passed to the client. Many law firms flush with cash borrow just so they don’t have to use their own money for case costs so they can deploy it in other areas of the business.

Fact: “There are many Attorney Funding resources available to contingency fee based Law Firms.”

Try your bank first.  Banks certainly have been the traditional source of financing.  Banks will typically look first to the level and aging of your receivables and then to your cash flow to determine how much you or your firm may be able to borrow, and then to the personal net worth of the principals for a personal guaranty.  Unfortunately, most banks get short circuited at the first step because they become uncomfortable with the contingency fee nature of the receivables and stop there.  Banks have also come under extreme pressure from regulators to divest their more “risky” loans.  Many law firms seek alternative financing after their bank has informed them they are pulling their line of credit or severely reducing the loan amount.

Emergence of Legal Finance Lenders

To address the void created by banks’ retraction from legal lending, a Legal Funding industry has emerged and matured.  However, there are but a handful of reputable lenders with the expertise and capital to service the legal community.

Legal Finance firms provide what are known in the industry as working capital loans and lines of credit for law firms.  Although loan terms and structures vary, typically, firms pledge their cases as security for the loan and pay the loan off from the proceeds of their cases as they settle.  Rates are always higher than former traditional bank rates and principals of the firm are generally required to provide a personal guaranty.  The funds can be used for practically any business purpose including general operating expenses, business development and marketing as well as for expert witnesses , litigation support and partner distributions. Loans are typically two to three years, but can be paid off at any time.  In essence, the lawyer is getting an advance on their fees and reimbursable expenses.

Managing Debt

Borrowing is not for everyone and not every lawyer or law firm will qualify for a loan.  In all situations, borrowers and prospective borrowers should consult with their financial adviser before borrowing.