Law Practice Management Asked and Answered Blog

Category: Financial Management

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Apr 05, 2016

Law Firm Debt – Impact of Debt and Other Liabilities Upon Future Growth Options

Question:

I am a member of a three member management committee of a 16 lawyer firm located in Akron, Ohio. We have 10 partners and 6 associates. Several of our partners are in their 50s and 60s. Recently, we have had discussions with a couple of potential merger partners and laterals and in all cases they have backed out advising us that they were uncomfortable with our balance sheet. What can we do to better position ourselves. We desperately need to bring in new talent with books of business?

Response:

First there are the obvious balance sheet items – bank debt, large tapped out credit lines, equipment leases and other liabilities. Then there are the items that are not recorded on the balance sheet – namely unfunded partner retirement buyouts and long term real estate leases. These are often major deal breakers in mergers and scare away laterals. If you have bank and other debt on the balance sheet work at cleaning it up. More importantly if you have unfunded partner buyouts begin either rethinking the desirability of these programs or begin funding this liability now with a goal of the liability being totally funded over the next five to seven years. Then shift to a retirement program that is totally funded. Unfunded partner retirement programs are becoming a thing of the past.

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John W. Olmstead, MBA, Ph.D, CMC

 

Mar 15, 2016

Law Firm Alternative Billing – What Do Clients Think

Question:

Our firm is a 18 attorney firm based in Tucson, Arizona. Our practice is a boutique general liability defense firm. Our clients tend to be self insured large corporations and smaller business firms. Currently all of clients are billed by the hour. Recently we have been discussing whether we should propose an alternative billing approach to our clients. We would be interested in your thoughts.

Response:

I do not want to discourage alternative billing – there are a lot of benefits that can be obtained – however I find that firms practicing your type of law and that have your type of clients that alternative is talked about more than actually implemented. You may find that your clients like the thought of the certainty of fixed fees but have concerns about the quality of representation under such arrangements. Recently, a litigation defense law firm asked me to interview their clients concerning their satisfaction with the law firm. When asking one general counsel about his thoughts regarding alternative billing he told me:

"My concern with fixed fee billing is that there might not be the financial incentive for the law firm to dedicate all the resources and best efforts to obtain the best results for our company. I prefer hourly billing with case management plans and budgets. I want our law firms to be financially successful as long as they achieve results for our company and not be penalized or constrained by fixed fee arrangements."

You may find that your clients are open to discussing alternative billing arrangements but may be hesitant when it comes to implementation. They are comfortable with hourly billing.

With this said I think you should explore the dialog with maybe one pilot client and see where the discussion leads. Insure that you do the proper analysis of that client's billing history, overall risks, and develop a fixed fee strategy that not only allows you to attain your desired billing rate but provides for a risk premium as well. Also build in ability to take exceptions for matters that fall outside the scope of the fixed fee arrangement.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Feb 23, 2016

Law Firm Partner Capital Contributions – How Much?

Question:

Our firm is an 18 attorney firm in Chicago that was formed by the existing four equity partners ten years ago. We have four equity partners (founders), eight income (non-equity partners), and six associates. The income partners are not required to contribute capital. We are considering admitting a couple of the income partners as equity partners and also approaching possible laterals. What should we require in the form of buy-in or capital contribution?

Response:

While capital contributions are all over the board ranging from zero to $100,000 in firm's your size I often see capital contributions ranging from $25,000 to $50,000. All depends upon the number of ownership shares being offered. I am seeing firm's requiring more as many firms are resisting the temptation to take on bank debt to finance their short-term working capital requirements. Citibank's Private Law Firm Group reports that between 2004 and 2007 capital contributions averaged 20 to 25 percent of a partner's income. Citibank's recent survey reports that partners are now contributing an average of 30 to 35 percent of their earnings. Thus, a newly admitted partner that will be earning $150,000 upon admission would be expected to contribute $45,000. Contributed capital is returned when a partner leaves the firm in full upon withdrawal or more commonly according to an incremental installment payment schedule.

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John W. Olmstead, MBA, Ph.D, CMC

Jan 20, 2016

Law Firm Partner Compensation – Setting Up an Eat What You Kill System

Question:

I am a solo practitioner in Orlando, Florida with two secretaries and I am planning on merging my practice with another attorney in the same office location. He has three staff members. We have both been on our own for twenty years and have enjoyed our independence. We have decided that we want to setup an eat-what-you kill type of compensation sytem. We would appreciate your thoughts.

Response:

While I am not found of such systems as they lead to separate silos – separate firms within a firm - there are situations where they are appropriate. In some situations, the approach is to simply allocate revenue and use the percentage of fee revenue collected to determine a partners interest in the profit for the year. A determination must be made as to what the firm means by revenue collected for each attorney – working attorney allocated dollars, originated attorney dollars, or responsible attorney dollars, or a weighting of all of these. This only works if each consumes overhead at the same level.

If you are not consuming overhead at the same level some form of cost allocation must be made and included in the mix. Direct overhead items such as bar dues, auto expenses, CLE seminars, etc. could be allocated directly to each partner with each sharing equally in the rest of the indirect overhead. Then a net figure would be calculated to determine each partner's compensation based upon their share of the profit.

If you want to really get detailed your can setup a separate profit center for each of you in your accounting system, allocate all revenue and expenses using an agreed to allocation formula, Click here for sample allocation guidelines and then have the ability of generating a separate profit and loss statement for each of you. If you are using QuickBooks Pro you can setup classes to accomplish this. Your compensation would be the profit from your profit and loss statement. 

Good luck with your merger.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

 

 

 

Dec 22, 2015

Law Firm Financial Management – Protecting the Firm from Employee Embezzlement

Question:

I am a partner in a eight attorney firm in downtown Chicago. Last week you participated in a discussion at an Illinois State Bar Association meeting where you indicated that four out of ten of you law firm clients have had an employee embezzlement at some time or another. I would appreciate any thoughts you may have on how we can protect ourselves.

Response:

Even though a firm trusts their accounting staff segregation of duties is appropriate and should be implemented in firms of all sizes. Here is an overview of such a system that we generally suggest:     

Internal Control is the plan of organization and all of the coordinate methods and measures adopted within a business organization to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency, and encourage adherence to prescribed managerial policies.

The four basic elements considered essential in a satisfactory system of internal control are:

  1. A plan of organization that provides appropriate segregation of functional responsibility and duties.
  2. A system of authorization and record procedures adequate to provide reasonable accounting control over assets, liabilities, revenues, and expenses.
  3. Sound practices to be followed in performance of duties and functions of each of the organizational areas.
  4. A degree of quality of personnel (competency) commensurate with responsibilities.

Here is a link to an article outlining specific steps:

The goal is not to catch an employee that is stealing but to have a system of checks and balances in place so they will not even consider stealing.

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John W. Olmstead, MBA, Ph.D, CMC

 

Nov 17, 2015

Law Firm Fee Increases – Should We Increase Our Fees?

Question:

I am the partner in charge of finance at our 12 attorney litigation boutique firm located in downtown Chicago. For the past two years our profits have been down and we are considering raising our rates but we are concerned that we may lose some of our corporate clients. We welcome your thoughts.

Response:

Raising fees is one approach you might consider. Clients are starting to push back more and more concerning legal fees. If you are at the high end of the rate scale I suggest that before charging off and raising rates you step back and conduct a process review by using an approach similar to the following:

  1. Pull a random representative list (by timekeeper and type of matter) of matters that have been concluded during the past six months. Say 10-20 matters.
  2. Calculate the effective hourly rates for each matter overall as well as by timekeeper class. (partner, associate, paralegal)
  3. Compare the calculated effective rate to your internal standard time billing rates as well as to external benchmarks. (Other firms from published survey data) How do they compare? What did it cost to staff the matter?
  4. Review the time detail for each of these matters and ask questions. You might want to flow chart and document the work flow. Is the firm working smart? Is time being dumped on these flat rate matters so that a timekeeper's hours look good on the production reports?  Is the firm using the right mix of paralegals and attorneys to staff the work? Is there wasted or duplicative effort? Is technology being used? Can work steps be eliminated or reduced? Should the firm consider a "limited representation" unbundled option?
  5. Pilot test a few new approaches and measure the impact upon profitability.

Keep in mind that raising fees is one way of improving profitability. There are other ways as well. In today's competitive environment. Working smarter, efficiently, and more effective is another.

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John W. Olmstead, MBA, Ph.D., CMC

Sep 29, 2015

Improving Law Firm Profitability – Revenue vs. Expense Control

Question:

I am a new recently elected managing partner of our 14 attorney firm in Orlando, Florida. For the last three years our financial performance has been stagnant and my partners are asking me to cut all the overhead expenses possible in order to improve profitability? Suggestions?

Response: 

I am often asked to help law firms design and implement profitability improvement programs. In most of my engagements, the real problem is insufficient gross income and lack of sufficient investment (spending and time) on marketing and initiatives designed to stimulate client and revenue growth. For most firms increasing revenues is the most effective way of impacting the bottom line.

Many law firms waste considerable time trying to find ways to cut a pie that is too small up differently by implementation of new compensation systems or increasing the size of the pie by decreasing costs. While unnecessary expenses should be reduced – once they are reduced a repeated effort to slash costs proves fruitless as a strategy to increase the firm pie. The vast majority of law firm expenses are fixed or production-related. The percentage of costs that are discretionary is low, typically in the 20-30 percent range, and the number of dollars available for savings is small. The available dollars available for reduction disappear after a year or two of cost-cutting, leaving the firm with dealing with the effects of further cuts on production capacity.

The lesson here – certainly get control of run away expenses – but focus on revenue generation.

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John W. Olmstead, MBA, Ph.D, CMC

 

Sep 22, 2015

Law Firm Budgeting – Is a Budget Necessary

Question:

I am the managing partner of our six attorney firm in Fresno, California. I recently went to a management seminar that stressed the importance of creating a budget for the firm. We currently do not have one. The budgeting process looks like a lot of work. Is it really worth the effort?

Response:

I believe that a revenue goal budget is the most important aspect of the budget and it does not take that much time to develop. It establishes revenue accountabilities for the revenue producers (attorneys). Insufficient revenue is the most common financial challenge that most law firms face.

While expenses are important and should be managed as well – the bulk of a law firm's expenses are office rent, employee cost, and in some firms marketing expenses. Most of these costs are fixed and once set in motion can't be managed.

Unless you have an office administrator that you want to hold accountable for managing the operations of the firm and the expense side of the ledger – you could start by just budgeting the revenue and see how that works for you. If you have an administrator a revenue and expense budget is important so that you can delegate and allow the administrator to manage operations without having to second guess each and every operational decision that they need to make. The budget provides the accountability tool.

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John W. Olmstead, MBA, Ph.D, CMC

Sep 08, 2015

Law Firm Profitability – Increasing Fees & Risk of Losing Business

Question:

I am the managing partner of a 14 attorney estate planning firm in Lexington, Kentucky. We took a hard hit in 2008 when the recession hit and have just been recovering over the last couple of years. Business is up but profits are still flat. We have not raised our hourly billing rates for several years for fear that we will not be competitive and will lose out on business. However, we believe that we must increase our billing rates and are concerned. What are your thoughts?

Response: 

I would bet that you are leaving money on the table and you should in fact increase your billing rates. Often I find that law firms are more concerned about their rates than their clients are. You must remain competitive for the value package (including your experience, expertise, and reputation) that you are delivering. This does not mean being the cheapest estate planning firm in town. Some of my most successful estate planning firms are those charging the highest fees. 

Here are a few thoughts:

  1. Do some research on the going rates in your market area for estate planning law firms of you caliber.
  2. See if there is data available from your professional organizations such as The Academy of Estate Planning Attorneys, The Academy of Elder Law Attorneys, etc. 
  3. Determine if your competitors are using other than time billing fee arrangements.
  4. Explore alternative billing arrangements for estate planning matters. Many of my client law firms are using flat fee arrangements for estate planning.
  5.  Since your clients are individuals and typically single matter clients (at least initially) experiment (pilot test) with new prospective clients with increased rates and determine whether there is "pushback" and to what extent your prospect/client conversion ratio is being impacted.
  6. Offer prospective new clients more than one option.
  7. Initially leave your old rates in place for existing clients with open matters.
  8. Measure and evaluate impact.

You may find that clients are not as concerned about your fees as you are. 

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John W. Olmstead, MBA, Ph.D, CMC

Aug 18, 2015

Law Firm Financial Management – Concern With Income Statement Showing Operating at a Loss

Question:

I am a new partner in our law firm of 6 attorneys. I was an associate for seven years and was just made an equity partner and just received a copy of this month's income statement. The income statement shows the firm operating at a loss. I was startled and took a look at past years' statements as well. All are showing a small loss. Am I looking at these correctly? How can a firm operate at a loss for seven years in a row and still be in business. I would appreciate your comments.

Response:

My guess is that the firm is running all or a portion of equity partner compensation though as expense on the income statement. Other personal items may also be run through the firm as well. Check with the firm's bookkeeper or outside accountant to see if this is the case. If this is the case add the total paid to equity partners back to the net income or loss on the income statement. This will give a better picture of the actual "pie" .

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John W. Olmstead, MBA, Ph.D, CMC

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