Securing A Sustainable Future
The short-term impact of the pandemic on the legal sector and the problem now
When the pandemic struck in the spring of 2020, all businesses including legal businesses rightly worried about whether they would survive a disruption to their income and with considerable expenses that still needed paying. The Government came to the rescue of most businesses with the availability of emergency funding. These loans provided a safety net and allowed firms some time to implement necessary changes. It was great that these loans were provided but they do need to be repaid and they were only interest free for the first year.
When firms repay these loans, they might find themselves once again to be short of cash and this is why it is probably sensible to reflect again on how we can run our business in future in a more secure and financially stable way.
Ensuring long term survival
There are a few questions that firms should be asking themselves now if they do not want to have further cash issues in future: –
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1. How much capital does the firm need?
Firms need to finance their fixed assets such as buildings, furniture and equipment and their current assets being work in progress and debtors. Firms that have more assets require more capital. Clearly less capital will be required if the firm leases an office rather than buying it and if it allows less credit to clients than other firms. So, if a firm does not buy a property, has fee income of £3,000,000 and allows clients 4 months credit from work being done to be paying paid, then the firm will need about £1,000,000 of capital.
It is the partnership agreement which explains how capital is introduced and withdrawn from a firm. Reviewing the agreement periodically is wise. Should partners who leave or retire from the firm be allowed to remove all of their capital immediately? How quickly should partners be allowed to withdraw profits from the firm? Should the firm require partners to retain a share of profits each year so that capital is increased as the firm grows? Firms continue to change but partnership agreements are rarely updated.
2. Would we need less capital if we manage our lockup better?
If working practices are improved, then it should be possible for a firm to be paid earlier for work undertaken for clients than is currently the case. The speed with which a firm is paid is heavily driven by a firm’s terms of business. These too should be reviewed regularly to ensure that the terms are appropriate for the services being provided and for current market practice. The three key commercial terms deal with whether clients are asked to provide any money up front, the frequency of billing and the credit which is allowed after the issue of an invoice. A good starting point is to say that the firm requires money up front, the firm requires monthly billing and that bills are payable on presentation. It is not unreasonable to ask for some money up front, other service providers would do so. Monthly billing ensures that the client should not get any nasty shocks at the end and allows them to plan their cashflow more easily than if they receive a large and unexpected bill. It is also not unreasonable to say that an invoice is payable upon presentation given that the firm may have already allowed thirty or more days from when the work was done to the raising of the invoice.
Not surprisingly, clients will normally suggest that they only pay at the end when the invoice should be delivered. It is therefore important to share the expectations of the firm with the client at the beginning and while a firm should be willing to negotiate with the client, a robust opening position should be adopted. It is vital that all fee earners are aware of the firm’s normal terms of business and that they do their best to ensure that these terms are used on the matters they manage.
3. Where will we obtain the required capital?
Once the appropriate amount of capital has been determined, some thought should be given to how this capital should be raised. Many firms do not want to be influenced by banks and ensure that the partners provide all necessary capital. Other firms accept that some borrowing is acceptable but recognise that too much borrowing is dangerous. There are some useful yardsticks to consider about whether a firm is overborrowing. Borrowing up to half of what the partners are contributing is usually seen as cautious borrowing. Borrowing between 50% and 100% of partner capital is more aggressive and riskier but is normally sustainable. However, once borrowing exceeds partner capital it is probably excessive, and it may not be sustainable or acceptable to lenders.
If money is to be borrowed, then it needs to be structured in the right way. If it is long-term borrowing, then it should be taken out as term loans. As little as possible should usually be obtained by overdraft as this will normally be more expensive and it is riskier as it is repayable on demand. It is concerning to see how many firms have all their borrowing on overdraft and then when the firm grows and requires more cash the firm simply increases the overdraft.
Taking some time away from the daily pressures to reflect on how your firm should be financed will probably help you to avoid more serious problems later.
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