For personal injury attorneys working on contingency, securing a loan to finance case/trial costs and working capital is a great alternative when compared to partners using their own capital to fund the firm and their cases. In order to get financing however, a law firm must comply with the lender’s loan application criteria and prove to lenders that the firm is ready, able and willing to service and repay the loan.
Experienced lawyers will tell you that securing a loan can be a daunting task as there are few lenders willing to participate in the legal industry. Traditional lenders have historically been and are still unwilling or unable to offer financing to law firms. Fortunately, the last decade has seen the rise of specialty lenders dedicated exclusively to providing contingency fee firms the capital they need. The good news is – these specialty lenders want to provide law firms the capital they need and are willing to work on an individual basis to provide customized financing to law firms.
While all lenders have their own ‘formulas’ and a set of criteria your firm must pass to access funding, they understand that the documents they receive in a loan application are just a small window into the firm. What does this mean? Regardless of whether you handle the accounting for your law firm, in order to ensure a smooth financing process, it is helpful to know what additional information will help show your firm’s financial standing in a good light, how all of your firm’s financial documents are related, and what inconsistencies to look for to avoid raising any red flags during the loan evaluation process.
An Overview of Financial Statements Lenders Request
Law firm owners need to be prepared to show an accurate and promising image of their primarily firm through their balance sheet, income statements, tax returns, and case information.
The Balance Sheet: The Ultimate Snapshot
What my lender is thinking: How capable is this borrower of servicing and repaying the loan they are requesting?
This financial statement should provide an overview of a law firm’s assets and liabilities, from which a lender can evaluate the firm’s general net worth. When reviewing a law firm’s balance sheet, lenders will be assessing the firm’s repayment capabilities, as well as assessing the firm’s current obligations and its ability to meet them. This will affect the amount of money that a lender will potentially lend to the firm, as well as other lending terms (e.g., interest rates, the maturity of the loan, fees etc.) that may be tied to the loan. However the balance sheet will only provide the lender with a view of the law firm at one particular moment in time. For a greater understanding of the law firm’s activities throughout a period of time, lenders refer to income statements.
The Income Statements: How the Law Firm is Run Day-to-Day
What my lender is thinking: Is this applicant able to repay reliably throughout the life of the loan?
Generally, lenders will require income statements covering periods of time, depending on the amount of the loan, to confirm the historical profitability of the firm. Income statements, which detail the profits and losses for a specific time frame, can provide lenders with a clear picture of the range of revenues that a firm generates. Furthermore, this P/L’s give lenders a clear picture of the firm’s revenue and expenses and how they affect the firm’s profitability.
As with a law firm’s balance sheets, the income statements play an important role in lenders’ determination of both the amount and the terms of a loan.
Tax Returns: The Official Snapshot
What my lender is thinking: Is the story told through the Balance Sheet and Income Statement the same story we see reported to the IRS?
As part of the loan approval process, lenders will usually ask law firms to submit complete copies of their tax returns for the past few years. When reviewing these documents, lenders are typically looking for a comprehensive picture of firms’ reported income and by extension, the accuracy of the borrower’s financial statements.
Additionally, lenders will likely want to make sure that the figures on the tax returns match the numbers on the other financial statements. When there is a discrepancy in the reported income for a firm across the firm’s various financial statements, questions are raised as to the accuracy of the financial statements.
Questions to Ask Before Submitting your Loan Application
Presentation and review are key to getting an application on the fast-track. A loan officer will likely be seeing your law firm for the first time, and in this case, first impressions really do matter. It is a worthwhile exercise to sit down with the partners of the firm who are requesting the loan and run through a spot check of the application documents the lender is requesting. Good questions to ask are:
Are there any anomalies in the story the financial documents are telling? (E.g. did the firm earn a particularly large settlement or judgment in a year that is not representative of a normal year?)
Do the income statements accurately reflect the activities of the law firm in the period between two balance sheets?
Does the final application look clean, complete, and accurate?
Have the partners agreed on how the funds will be used for the firm?
Are the partners aware of each other’s credit profiles and how they impact the law firm’s overall financial standing?
The Importance of Accounting Software: What to Look For
Accounting software is critical tool for law firms to properly manage their operations and track the effectiveness of their operations.
There are basic financial concepts specific to contingency fee law firms that partners should be aware of.
Whether you are starting a firm or are looking to modernize your firm’s accounting system, some of the specific things that are important to look for when evaluating new accounting software for your law firm can include (but are not limited to):
Accurate time capture of both billable and non-billable hours
Flexibility in time capture, which can allow your firm’s employees to switch between hourly billing to flat-fee billing, contingency billing and other alternate billing methods
Detailed expense capture of both out-of-pocket and soft expenses
Options for managing trust accounting (if your firm accepts money from trust funds for services rendered)
Effective management of outstanding accounts
Management of client details and specific billing inquiries.
Tracking of case costs
These elements will be crucial to the generation of accurate financial statements both for quarter-end and yearly reports, as well as for lending purposes. However, even if you have chosen to trust a software tool, mistakes may still occur. Common errors include creating duplicate accounts for the same sum or confusing positive and negative numbers for example. Having a professional review your accounting system and documents for accuracy from time to time can help mitigate problems.