Why Lawyers Should Get Law Firm Financing
Running a law firm as a business comes with unique challenges. A law firm requires great results, good lawyers, lots of client relationships, and creative ways to acquire new clients. Case flows are not necessarily predictable, which means that law firms can be subject to fluctuations in revenue and cash flow. At the same time, law firms are expected to be able to keep pace with their expenses.
The high labor costs of a law firm create a circular problem. High labor costs make managing the stability of a law firm harder in the event of slumping cash flows. At the same time, if you have to eliminate staff at a law firm, you will not be able to bring in as much cash flow, which can lead to the shrinkage of your law firm. This problem is compounded by the fact that law firms usually do not have a lot of collateral for a potential loan.
Unlike restaurants, retail stores, manufacturing plants, or other types of businesses with a lot of equipment or inventory as collateral, law firms usually have just real estate or computers. Law firms may not even have real estate as collateral if they rent office space. As a result, law firms have problems getting traditional financing options from lenders.
As a result, many law firms turn to law firm financing. Law firm financing is a financing model designed specifically to help lawyers get the funding they need for their law firms. You might be wondering if this model of financing is right for your law firm as compared to alternative law firm financing options. There is no need to worry, as in this article, we will review all you need to know about law firm financing, the difficulties of alternative financing, the reasons for getting law firm financing, the differences between other financing options for law firms, and alternative financing options available to your law firm. We’ll cover the following topics in detail in this article:
What is Law Firm Financing?
Law firm financing is a special type of financing designed to help attorneys and lawyers in different practice areas, such as personal injury, class action, or others, secure financing through the use of non-recourse capital. Non-recourse capital is the profits of a law firm project for which the loan is funded. In other words, there are no assets on the line for this type of loan. Instead, commercial lenders accept this risk alongside the lawyers as borrowers they lend to.
This means that collections on payment are assisted by the lenders that lend to banks. This additional interested party tends to help law firms collect on the outstanding revenue that they need to collect. There are also no fixed payments with law firm financing, as this risk is shared by the lender.
This type of financing is usually better for law firms because bank loans tend to target contingency fees that are unearned by a lawyer. This can make future profitability and operations more financially difficult. Moreover, bank loans can be harder to acquire than law firm financing and take a long time, whereas law firm financing is much better suited to quick funding. The repayment mechanisms for your law practice will be better aligned with the lender as well, so law firm financing may tend to make more sense than bank loans.
Why Traditional Financing for Law Firms is Difficult
Traditional financing for law firms tends to be difficult due to the structure of a law firm’s business. These difficulties come in the availability of assets, predictability of revenue, and other problems related to the collection of revenues in legal services.
First, law firms do not usually have a lot of assets. A legal practice might have a lot of cash on hand to be able to pay its employees and general expenses related to its law firm funding, but other than cash, there are usually not that many assets. If you think about what a law firm might be able to offer in the way of a traditional loan, you might first think of real estate. While the land a law firm is located on or the building that the law firm is located in can be used as collateral on the loan, this may not be the case with every firm. This is because some law firms will rent the location where they are located.
Aside from real estate, law firms might have a few computers in their office or maybe equipment in an office kitchen. Depending on the size of the loan that a law firm is interested in, this may not be enough in collateral, or the collateral may be too much worth too little to sufficiently function as collateral on a traditional loan. As a result, an alternative structure is needed for a loan to be able to provide sufficient funds while reducing the risk for a bank or other lender.
While a law firm might turn to law firm loans such as from a bank or other form of a financial institution, the financial institution will likely use unearned contingency fees. This type of litigation finance will diminish the amount of cash flow your law firm will get later. This can contribute to recreating the same cash flow problems that your law firm is experiencing right now, as the diminished revenue going to your law firm can create further problems with staffing, legal fees, or other expenses.
The reason that banks use unearned contingency fees in law firm loans is not only the absence of collateral but also the inability of law firms to make regular payments. This is because law firms deal with regular revenue problems. Law firms are not necessarily able to have the same amount of revenue each month due to a varying amount of client work. This makes law firms unable to make a traditional monthly payment on a loan as easily. As a result, different financing structures are pursued.
The relative lack of liquidity of law firm businesses, their lack of assets, and occasional irregularity of revenue usually push lawyers to consider getting law firm financing as a specific way to fund the projects and cases that they need.
Why You Should Get Law Firm Financing
If you are a lawyer considering getting law firm financing, you should consider why you are interested in the financing option. For law firm financing specifically, your law firm can expand, have better cash flow management, more flexible payment terms for your clients, and improve the case outcomes for your clients.
Help Expand Your Firm
One of the best reasons to get law firm financing for your law firm is that it can help you expand your practice. The cash advance from law firm financing can help you invest in your law firm. Some investments might be software to help your law firm better manage its time, resources, and business development. Alternatively, you can hire more people.
One of these options is to pay for a paralegal who can help with some of the legal work at your law firm. By having more capital able to deploy for additional employees, the overall productive capacity of your law firm may increase, which can allow you to take in more revenue.
Better Cash Flow Management
Your law firm may be able to achieve better cash flow management with law firm financing. This is because, in the absence of law firm financing, your law firm may experience problems with being able to continue normal operational expenses. These might include marketing campaigns, advertising, or other expenses intended to bring in more business.
In the absence of these operations, a law firm may have less future revenue. This can harm cash flow. With a negative effect on cash flow, you will have less ability to recover your business in the future and will run into similar problems that you are dealing with now. As a whole, cash flow management is very important, and taking out law firm financing can help support your cash flow.
Flexible Payment Terms for Your Clients
One of the important aspects of a law firm for clients is how clients are charged for services at a law firm. Since law firms can charge a lot for hourly work or to be on retainer, some clients will like the ability to have fixed payments for services. Moreover, a client may be interested in flexibility when it comes to payment, such as having multiple payment options.
Without law firm financing to fall back on, your law firm may not be able to support a lot of different payment mechanisms for your clients. If your flexibility is hindered, clients may be more likely to select competitor law firms. This may result in less revenue for your law firm, compounding the current cash flow problems that you might be experiencing.
Improving Case Outcomes for Your Clients
Your reputation is incredibly important as a law firm. As a lawyer, you need to be sure that the reputation of your firm is protected. Your case outcomes form part of this reputation. As such, you want to be sure that your law firm can produce great outcomes for the clients that you serve.
Law firm financing is important in that it provides you with the capital that you need to succeed in your cases. For some clients, the costs of a case or litigation may be much higher than you initially anticipated. As a result, you need to be sure that you have enough funds or bandwidth to be able to cover the case that you have and the obligations you have to your clients.
One of the things which can improve your case outcomes for your clients is to have great witnesses or experts in a case. This can cost your law firm a lot of money upfront, so your law firm needs to be prepared to pay for them. You may also need some research for your law firm’s cases, and this can require some out-of-pocket payment from your law firm. This can be made more difficult by the fact that a lot of money from settlements or client cases can take some amount of time to collect. Your law firm needs to be able to cover its position in the meantime.
Law Firm Financing Versus Alternative Law Firm Funding Options
There are many good reasons to pursue law firm financing. Law firm financing allows a unique financing structure that can help your law firm afford the investments you want to make. These include growing your law firm, maintaining or growing your cash flow, offering clients flexible payment terms, and improving case outcomes for clients. While these types of benefits can be accessed with some other types of law firm funding options, the structure of law firm financing specifically makes it a great option for lawyers.
Alternative law firm funding options, however, provide your law firm with some flexibility in terms of meeting current or future financing needs. Your law firm might have different preferences in terms of the funding structure. Your cash flow might also be able to support more traditional financing options not specific to the legal industry. In any case, there are some different costs and benefits associated with alternative law firm funding options. You also have the flexibility to choose from debt options in the present with a lump sum infusion of cash or more long-term options like lines of credit to support your law firm’s needs as they come.
In any case, the selection of the right financing option for your law firm will depend on its unique financial and operational situation. As the lawyer in charge of your firm, you should consider the benefits and structure of law firm financing alongside alternative law firm financing options to determine what is best for your firm.
Alternative Law Firm Funding Options
If law firm financing does not sound right for you, there are also many alternative law firm funding options available to your law firm. However, these alternative options come with unique benefits and drawbacks that ought to be considered in light of the different structures of the financing from law firm financing. Some common alternative financing options available to law firms like yours include SBA loans, term loans, lines of credit, working capital loans, and credit cards.
SBA Loans
SBA loans are small business loans designed for small business law firms. If you are a lawyer/owner in your small business law firm, getting a Small Business Administration (SBA) loan might be right for you.
The United States Small Business Administration was formed to help small business owners find affordable financing and favorable repayment terms on loans. Entrepreneurs face different challenges in the modern economy, and sometimes it can be difficult to compete with larger corporations based on typical financing structures. The SBA recognizes these difficulties, and as a result, has created loan programs with low-interest rates and good protections for small business owners.
One of the best examples of an SBA loan program applicable to your law firm is the SBA 7(a) loan program. The SBA 7(a) loan program is designed for small business owners like lawyers who run their own law firms and are having trouble finding funding elsewhere. The good news about these loans is that they can be used for essentially all purposes that you might need, including working capital needs, buying office inventory, remodeling, or buying office real estate. These loans can amount to up to $5 million, depending on the exact loan and the use of the funds.
This allows your law firm a lot of flexibility. This is especially true in the low-interest rates that the loan program offers. The SBA 7(a) loan program prohibits lenders from charging your law firm for early repayment on the loan, which means that your law firm can more easily get out of debt and find the debt more affordable. This might make particular sense for your law firm since the revenue from your cases can vary throughout the year. Another great part about SBA 7(a) loans is that the interest rates that they offer are usually lower than market rates.
You cannot get a direct SBA loan from the SBA, but you can get one from SBA loan lenders. The SBA can help by directing you to lenders that have SBA loans. The SBA ensures that these loans have ideal rates and terms by guaranteeing a portion of the loan in the event of a borrower default. This makes the loans less risky for lenders and, as a result, much more favorable for borrowers.
If an SBA loan sounds right for your law firm funding needs, you can read more about the qualifications and application process on the SBA website. The SBA can also extend help to you by giving you more information about SBA loan lenders.
Term Loans
While your law firm may not qualify for SBA loan funding, you can also go with a term loan. This financing option is very similar to a bank loan and can be used for many things. The best uses of a term loan are likely short-term investments that can yield returns for your law firm. The exact use of your term loan could depend on your lender, so it is best to check what kinds of uses your law firm might have with a term loan.
Term loans typically come along with a fixed interest rate. They infuse a large lump sum of cash into your law firm for various uses. Lawyers can apply for term loans from both banks and online alternative lenders.
If you apply for term loans from a bank, you might be able to get a lower interest rate. However, the application process is often longer, more difficult, and results in more rejections. Your law firm will likely have your bank account statements analyzed, your financial statements reviewed, and an in-depth search of your credit score, credit history, and more. The processing times for your application will be long, and you may be rejected. Banks will likely take your unearned contingency fees as collateral. The due diligence process for banks may be inconvenient.
However, if you are looking for financing for your law firm quickly, you should consider applying for financing with alternative lenders (like Biz2Credit!). The application process is much simpler, you will have to go through less due diligence, and you will likely have more of an opportunity to get accepted, even if you have had past problems with your credit. To compensate for the added convenience and less due diligence, interest rates with alternative lenders will likely be slightly higher due to the added risk for a lender.
Lines of Credit
SBA loans and term loans will provide your firm with a lump sum of capital to use for the needs that you see fit. However, the terms and structure of these loans usually support a pretty large amount of capital that you need to deploy. If you are looking for something to fund smaller expenses related to ongoing litigation or similar expenses, you might find a business line of credit to be a more helpful form of financing.
Another large benefit of a line of credit is that you do not need to immediately start using the funding. You can get a line of credit for your law firm for future expenses that you might anticipate affecting your cash flow. For example, if you are low on revenue in a particular time period and you need to fund witnesses or certain casework, you may need to draw down on credit. A line of credit is great because it is an inexpensive form of credit to hold on standby until you need it. Moreover, once it is granted, the ability to get funds is rather quick.
A line of credit functions similarly to a credit card. A lender will grant a maximum amount of money that you can draw down on for a line of credit. As you need the money, you can draw down on the total lending amount to pay for things like litigation expenses. Then, you start to pay interest on the money you have drawn down and pay back the money on the line of credit of the money that you have borrowed. Typically, lines of credit are revolving, so you can re-borrow money from the line of credit once you have paid it back.
Lines of credit are lent from both banks and alternative lenders, and they usually come with variable interest rates. The decision on which type of lender is best for you depends on your preferences and the profile of your law firm. Yet, if you are interested in being able to cover unexpected expenses, improve your working capital balance, or increase your cash flow, a line of credit could be a great option for your law firm funding needs.
Working Capital Loans
Similar to a line of credit, if you are looking for a solution to seasonal revenue for your law firm, a working capital loan might be right for you.
Depending on the type of law that you practice and the nature of your industry, your law firm might experience a fluctuation in revenue depending on the time of year. To help cover your expenses, you might be able to get a working capital loan. A working capital loan can help your litigation funding and sustain the legal professional salaries at your firm during periods of low revenue.
A working capital loan focuses on your cash flow. If you have a lot of assets and not a lot of liabilities, you can help leverage this to get a working capital loan for your law firm. Your law firm can use the funds during the times of year when revenue is low and repay them when you have a lot of cash flow. This can temporarily help your law firm, but it may not be a good long-term solution for your law firm.
Credit Cards
If your law firm does not have a lot of serious expenses, you might be interested in shorter-term fixes to funding issues you might have. If you need to buy certain things for your law firm, such as inventory, deal with travel expenses, or have certain kinds of related purchases, you can use credit cards to help your business.
If you do not have enough cash on hand at your law firm to cover certain expenses that can be paid with credit cards, then you can consider using credit cards. As a temporary solution, your business credit card can provide you with enough credit to cover small eligible expenses. You can later pay these expenses off. Credit cards allow businesses to earn rewards like cashback to travel rewards points. While the APR is high for this solution, it can work if you need a short-term fix for small expenses.
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