Most people find it difficult to talk about finances. Law firm financing is an especially uncomfortable discussion topic for lawyers and legal professionals. But law firm financing is critical for lawyers and legal professionals to learn and talk about, especially when running and managing a law firm.
In this blog post, let’s find out why law firm financing is vital to a law firm’s success, what your firm’s financing options are, and the best types of loans for law firms. With this knowledge, let’s take a step together towards financial competency.
What are the benefits of law firm financing?
Law firm financing vs. law firm loans
Your accountant or Certified Public Accountant (CPA) friend will tell you law firm financing has the power to improve your firm’s cash flow. They’re right—the benefits of law firm financing are significant, partly because this financing structure is uniquely tailored for lawyers and attorneys.
For example, banks won’t acknowledge unearned contingency fees as collateral. Bank loans can take a long time for lawyers to secure. But traditional bank loans would not work if your firm needs capital quickly.
Law firm financing and non-recourse capital
Law firm financing allows attorneys and law firms to get paid for future income by using non-recourse capital, as explained below.
What is non-recourse capital? It’s also known as non-recourse finance. Non-recourse capital is a type of commercial lending that allows the lender to receive payment only from the project’s profits the loan is funding. The lender can’t receive payment from any other assets of the borrower. Another benefit is the borrower does not make fixed payments.
When it comes to getting paid, law firms face unique challenges. Depending on the lawyer’s financial situation and area of practice, applying for law firm financing could help solve the problems around law firm collections.
Grow your law firm faster with law firm financing
Your firm’s growth depends on what resources you have to scale your business. Law firm financing can help. In particular, external law firm funding can provide you with the capital required to invest in practice management software, hire a paralegal, build a virtual law firm, and more.
Improve your law firm’s cash flow
Your firm requires consistent cash flow for hiring, marketing, client intake and acquisition, and more. Good cash flow is also essential for growing your firm. Pausing marketing campaigns and other business operations due to cash flow problems can have detrimental effects on future business. Law firm financing can help you ensure you have enough funds to maintain revenue-generating activities.
Reduce financial risk for your law firm
With high interest rates, taking out a more traditional loan can be risky. In fact, interest rates can be anywhere from 27% to 60%. And oftentimes, the interest rate is compounded monthly.
Offer your clients a better client-centered experience
With more working capital—thanks to law firm financing—you can provide clients with the option of flexible payment options, also known as alternative fee arrangements. Unbundled legal services, subscription-based models, and fixed fee billing structures are all examples of alternative fee arrangements. Specifically, according to the 2020 Legal Trends Report, fixed fee billing structures ranked highly among consumers when asked what makes a lawyer hireable.
How do you finance a law firm?
You can finance a law firm with law firm financing—also known as law firm funding. Law firm financing is a financing structure specifically created for lawyers and legal firms. Some of the best ways to finance a law firm include law firm loans like Small Business Administration (SBA) loans, business loans, and private equity. In addition, you can finance a law firm through credit cards, lines of credit, revenue, and personal cash.
Read on for more information on the best loans for law firms and what your firm’s financing options are.
What are your law firm’s financing options?
Cash savings, retirement funds, and home equity loans are some ways you can financially support your law firm using personal finances.
Putting personal money—opposed to other forms of financing—into a business has its advantages and disadvantages. If you have the financial means, using personal money is a great option so long as you are careful. No matter your circumstance, you need to carefully assess the risk of putting personal money into your firm.
You also need to be aware of tax implications if you finance your firm using your own money. We recommend working with a small business financial expert if you do choose to finance your law firm with personal cash. These financial experts can help you take advantage of any grants, low-interest financing, or tax incentives you’re eligible for in your state.
Revenue-based financing allows firms to raise capital by pledging a percentage of future revenues in exchange for money invested. Law firms give a portion of earned revenue to investors at a pre-established percentage until the firm pays part of the original investment back.
What are the pros of revenue-based financing? It’s often faster than other law firm financing options. Also, some revenue-based financing firms will allow you to pay based on monthly cash flows.
Lines of credit
Like a small business loan, an unsecured line of credit gives a law firm access to money to address any business expense. In comparison, small business loans require law firms to put a lump-sum payment into the account when opening. Then, law firms need to provide monthly payments to the small business loan account. With lines of credit, firms need not necessarily provide monthly payments.
For example, a small business line of credit involves a credit review and annual renewal. It’s revolving, like a credit card—this means interest starts accumulating once you remove funds. Also, you can borrow up to the amount you pay (except for interest) again as you pay your balance. Similar to a credit card, the lender will set a limit on the amount you can borrow.
Nearly half of all small businesses in the US use personal credit cards. And according to MasterCard® research, many of those small businesses fail to separate business and personal expenses. A significant risk to using a personal credit card to finance your business is that you are personally liable for any debt you acquire. While the lower interest rates of a credit card might be enticing, your firm might not be generating lots of revenue at the start. And racking up credit card debt might exempt you from other options of borrowing in the future.
Law firm loans
Newer firms might not qualify for business financing. Banks will want proof of business credit and assets as collateral—if you don’t have this, there are other options. Besides the traditional business loan, you can take out a personal loan from a bank. Or asking friends and family is another option, although this is not feasible for many law firm owners.
Regardless of your financial situation, you can choose from many different loans, each with its unique advantages and disadvantages. Let’s discuss these different loans in more detail below.
What are the best loans for law firms?
Choosing the best loans depends on how much capital your law firm needs and the amount of time you will take to repay it. Law firm financing offers many advantages because of its specific structure to attorneys and their legal work. The best types of loans for law firms include Small Business Administration (SBA) loans, business loans, working capital loans, and business acquisition loans. We’ll go into more detail about these types of loans below.
What types of loans are the best loans for law firms?
Small Business Administration (SBA) Loans
Pros: SBA loans often have the reassurance of interest rate caps.
Cons: SBA loans can include long loan closing processes and significant collateral requirements.
Business loans from a financial institution
Pros: If you already have a good relationship with a bank, they might be able to offer you additional financial services and other perks if you take a loan from them.
Cons: New business owners can find it tough to qualify for loans through banks. Also, the application processes are usually long. Additionally, your assets are at risk if you can’t pay the loan back.
Working capital loans
Pros: Borrowing and repaying is quick—you won’t need to plan for repayments for months or years. Cons: Just like acquiring a traditional business loan from a financial institution, you might have to use collateral if you can’t pay the loan back. Additionally, the lender may charge you high interest rates. Shop around to avoid getting trapped with high interest rates.
Pros: Private equity firms can help you assess all areas of your business. Of course, this can also be a con (see below). Additionally, private equity firms have vested interests because they have investors to pay back. Ultimately, these private equity firms will want the best for your firm in terms of revenue generation. You can also often secure much more financing from private equity firms than other institutions.
Cons: It is up to you to ensure you don’t sacrifice providing a client-centered experience for law firm revenues. Better yet, show the private equity firm how prioritizing the client’s needs will support reliable business growth.
While securing more funds is a big win, this money comes at a cost. In some instances, you might have to give up management control or ownership stakes. The equity firm might steer you away from your law firm goals based on your values and beliefs.
Pros: In most cases, you can count on receiving your loan quickly. Another advantage—short-term loans are easier to qualify for and have shorter applications.
Cons: Short-term loans usually come with high interest rates, creating a higher likelihood of incurring debt and require frequent payments.
Merchant cash advance (MCA)
Pros: MCAs don’t require you to use collateral to secure funding. The amount you also owe never increases—interest doesn’t accrue, and there are no late fees.
Cons: Annual percentage rates (APRs) make this loan one of the most expensive borrowing options. APRs are the annual rate of interest that investors charge borrowers. Often, MCA lenders will deduct payments directly from your credit card receipts daily. This daily deduction can significantly harm your cash flow. Firs- time small business owners should especially consider these risks.
Accounts receivable financing
Pros: Accounts receivable financing doesn’t require you to use collateral to secure money. Additionally, unlike private equity loans, you will maintain complete ownership and control of your business.
Cons: Rates for this kind of financing are likely higher than others. Be sure to go through lengthy contracts for this type of financing thoroughly.
Business acquisition loans
Pros: This is another financing option that doesn’t require collateral. Business acquisition loans are helpful long-term solutions, unlike some of the fast, short-term financing options mentioned above. You can also get approved fast–sometimes in as little as 24 hours.
Cons: Lenders will require cash flow and credit score checks. Interest rates can vary, so be sure to shop around to get an idea of the average interest rates. Occasionally, business acquisition loans will require you to verify that you’ve pursued other types of financing before. Or they may also require you to prove if there was an owner of the firm before you—you’ll need to show proof that they no longer have any stakes in the business.
Know your short and long term financial goals
When starting and running a law firm, you need a written financial plan to forecast critical financial aspects of your business. Having a comprehensive law firm business plan will also help you understand your expected cash flow. A business plan may also include information about the financial health of your firm. The more objective and accurate information you have in these plans, the better prepared you are to select the best law firm financing framework for your firm.
This is a big project, so working with financial advisors and accountants with proven success with small business owners is a great idea. Preferably, you’ll work with financial vendors who’ve worked with attorneys who also started their own firms
Some non-profits or other organizations also offer valuable resources, business plan templates, and even discounted services to lawyers looking to start their own small businesses.
Law firm financing is integral to expanding your business
When it comes to law firm financing, you need to investigate all of your options. Take your time making the best financial decision for you, your law firm, and clients. This guide to starting your own law will help you identify what you need to do when getting your law firm up and running.
Get familiar with the various financing options outlined above, and talk to professionals. Finding a legal mentor who has started their own firm is also an excellent way to learn about their challenges and wins.
Note: The information in this article applies only to US practices. This post is provided for informational purposes only. It does not constitute legal, business, financial, or accounting advice.