For the law firm that depends on financing to operate, the relationship between a law firm its lenders is key to the firm's successful operation.  When carefully established and properly developed the relationship can be of enormous value to both parties.

Part One The Relationship

First, from the banker's perspective, law firms as customers have the potential to be of great value. Law firms generally have the need for a variety of the banks services including:

  • Borrowing facilities
  • Depository arrangements
  • Checking accounts
  • Trust accounts
  • Wire and other money transferring services

Law firms can also provide access to the firm's lawyers and staff as potential customers who not only routinely have banking needs, but can be an important referral source to other individual and corporate clients.

From the law firm perspective there is an equivalent level of value in the business relationship. Although the banking needs of law firms vary from firm to firm, most law firms not only have the general needs described above but depending on the firm needs may include financing for:

  1. Growth – lateral hiring or the addition of a new office can create a current year cash flow pinch that can be eased by using a line of credit to bridge the gap.
  2. Uneven collections – all law firms have fluctuations in their cash flow and many find using a line of credit an essential tool for delivering a consistent level of payment to their owners.
  3. Fixed asset purchases – the addition or replacement of furniture and equipment is part of everyday life for most law firms. The financing of those assets allows a firm to match the cash payment for the assets with the book expense associated with them.
  4. Partner capital loans – many firms assist newly promoted or laterally hired partners by arranging for partner capital loans through their bank.

All of this is to say, law firms are an attractive market for banks, and law firms have a fundamental need for the services that banks provide.  The combination of the two can be dynamic and positive or a nightmare depending on the selection process and how the relationship is managed.

Part Two- Knowing Your Needs

In many ways the relationship between a law firm and banker is like a marriage and selecting a bank(er) should be approached seriously.

The key to identifying the right bank for your firm is first evaluating your firm and its needs. You must have a solid understanding of your operations, finances and plans for the future. That information will position you to understand how a bank fits into your current and future needs.

The basic tools used by most firms to anticipate future financing needs are:

  1. Operating budget – a basic monthly budget that anticipates cash inflow and outflow from operations.
  2. Capital budget – a planning document that projects what changes will be made in the firm's furniture, equipment and offices in the coming year, and what has been budgeted for those items.
  3. Strategic plan – an important planning tool that describes how the firm intends to evolve and develop during the next 1-5 years.

With these basic tools you are left with the question of which portion of your financing needs will be met with internal capital (either through partner capital contributions or deferred draws), and which portion will be provided externally.

Perspectives on what amount of financing should be provided internally vary greatly. The greater the proportion provided internally the more conservative the operation of the firm and the lower the risk. There are no absolute guidelines for what is appropriate, but generally we recommend that firms consider the following as a means of establishing an internal capital level:

  1. Percent of revenue method – internal capital in the range of 10-20% of gross revenue.
  2. Monthly expenses method – internal capital at somewhere between 3-5 months of total expenses excluding partner compensation.
  3. Percent of owner budgeted compensation – internal capital in the range of 25-45% of total owner budgeted compensation.

Part Three Selecting a Bank(er)

Once your financial, operational and strategic plans are known, and the external financing needs are determined, you are prepared to interview and select a bank and banker. There are numerous factors to consider in the selection process.

  1. Understands law firms – it is essential that the banker that will lead the relationship have a solid understanding of law firms and their unique characteristics, or is willing to learn;
  2. Understands law firm finance--a banker's knowledge of the law firm business is particularly important in times of stress because law firm financing has subtleties which need to be appreciated.
  3. Size – a law firm needs a bank that is big enough to meet its current and prospective needs but not so big that the relationship is insignificant and unimportant to the bank.
  4. Capabilities – the bank must have the capabilities, facilities and capacity to meet the law firm's financial and operational needs.
  5. Proximity – you want to grow to know your banker on a personal level, which argues for a bank that is close enough that you can meet with bank personnel face to face on a regular basis.
  6. Competitive pricing – the appropriate bank will have a rate and fee structure that is competitive in the market for a firm of your size and strength.
  7. Financially strong – because banks can fail, take the time to understand the financial strength of the bank. A deeply developed banking relationship abruptly ended by bank failure not only means that you have wasted a lot of time, but a course of dealing developed with your former bank may be difficult to continue with the regulators.
  8. Business relationship – The bank you select may help you reinforce an existing client/attorney relationship or provide the entrée to jump start a new one.

Finally, as we will discuss in Part 4, managing your relationship with the banker is critical.  To that end, be certain that the bank is willing to assign an individual to your account that you can reasonably expect to be your primary interface.  To be assigned to a group where any one of several bankers are your point of contact dilutes the personal nature of the relationship.  That personal relationship will be important when you need your bank the most.

Part Four Managing the Relationship

Once you have selected a bank and banker, it is time to start developing the relationship. Establishing a credit facility (loan) and bank accounts are typically the first steps.

When establishing your credit facility you will not only address issues like facility size and repayment terms but virtually all bank loans include "borrowing covenants" which, from the bank's perspective, are early warning indicators for the bank. Your bank will use these covenants to determine whether conditions within your firm have deteriorated in a manner that makes your firm a bigger credit risk than when the loan was made.  Typical covenants address conditions including:

  1. Falling lawyer/partner count and/or revenue
  2. Significant decreases in the level of current accounts receivable
  3. Decreasing profitability
  4. A deteriorating net equity position

It is typical that once the loan is in place, the borrowing law firm is expected to "self-test" monthly on the covenant measures and report them to the bank along with other financial and performance information. Consequently, it is vital that you test any proposed covenants against your historical performance metrics and projected budgets before agreeing to them.  Not only does this testing help you determine if the loan offered is appropriate for your firm, but it also can guide you in your negotiations with the bank concerning the covenants.

To maximize the value of the banking relationship, you have to get to know your bank and your banker. To that end you should:

  1. Establish a routine review of your firm's performance in a face-to-face meeting at least quarterly, but preferably monthly.
  2. On an annual basis review the coming year's budgets and strategic plan to keep the bank familiar with where your business is headed.
  3. Seek introductions to other key members of the bank including your banker's boss and the bank's credit manager. You will be served better, particularly when you need the relationship the most, if those people can put a face with the firm's name.
  4. Introduce your banker to other key members of your firm including members of your attorney and non-attorney leadership group.
  5. Find the time to get to know your banker on a more personal level through events as simple as lunch or a sporting event.
  6. Invest your time in continually educating your banker on your firm, its operations and the legal industry generally. A better-educated banker is of more value to you.
  7. Do what you can to promote the bank and its capabilities to other members of your firm,

Finally, it is often said that the three most important considerations for a successful real estate venture are location, location, location.  Similarly, the three most important factors in a law firm's relationship with its bank are communication, communication, communication.  Thus, the Number One Rule in managing your relationship with your banker  is that your banker should hear all news about your firm, whether good or bad, from you first so as to avoid surprise.  Frequent and clear communication is critical for managing the relationship in good times and bad.

Part Five When Things Go Wrong

In virtually every business there are periodic bumps in the road. For a law firm the bump can range from minor issues such as slightly slowed collections or loss of a few people to major issues such as a loss of key clients, lawyers or a major lawsuit against the firm.

No matter what the degree of bad news, there are a few steps to seeing that it doesn't lead to bigger problems for the firm.  These include:

  1. Manage internal communications in a way that creates internal trust and confidence among your attorneys and non-attorneys.
  2. Review your loan documents to understand fully how contractual obligations to the bank may have been impacted, and develop a solution as appropriate.
  3. After completing the appropriate internal communications and performing a loan agreement review, immediately seek a face-to-face meeting with your banker. As mentioned above, you don't want a surprised banker and you never want bad news to reach them through "hearing it on the street" instead of from you. During that meeting:
    1. In a frank, confident and most importantly honest manner describe the situation and your solution.
    2. Commit to keeping the bank aware of future developments.
    3. Make yourself available for follow-up meetings or calls.

Whether the problem is big or small, there is a good chance that your bank has encountered similar situations previously.  That experience vests it with a skill set that can be employed to help or harm you.  Getting your bank to aid you in implementing a positive solution is more likely if the relationship has been nurtured from inception.

Part Six The Lesson Learned

Unfortunately, not all law firm/bank relationships are positive.  In many instances, any negative or ambivalent feelings between a law firm and its bank can be traced to the lack of effort expended to building that relationship.  Sometimes that lack of effort is exacerbated by a lack of candor, whether caused by the law firm, the bank or both.  Such an adverse dynamic most often could have been avoided.

We have seen law firms in transition whose issues were manageable and others whose circumstances were dire.  We have worked on situations where the problems facing the firm were so severe that the only remaining solution was to close down the firm; yet the bank helped. In another situation the firm's already difficult problems were increased because its bank was unwilling to help. shut off credit and called the loan. In those and virtually every other instance, whether the law firm's banker was a help or a hindrance in designing and implementing a solution, turned on the quality of the relationship that had been previously built.  If this is understood when the law firm/bank relationship starts, and is remembered and acted on through out its existence, any problems faced by a law firm in transition, whatever they may be, should not be with its bank.

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