Law Practice Management Asked and Answered Blog

Category: Financial Management

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Oct 11, 2017

Law Firm Capitalization – Should There Be a Buy-In?

Question: 

I am a partner in a firm in Los Angeles. We have nine attorneys – four partners and five associates. We are a young firm in that we have only been in business for four years. The four partners started the firm together, we are equal partners, and we split the profits equally. When we started the firm we each made equal capital contributions. We do not have a partnership agreement. We are thinking about bringing in two associates as equity partners and are trying to think through the mechanics and one of our questions is whether there should be a buy-in and if so how should we determine it. We would appreciate your thoughts.

Response:

Law firms have different viewpoints on this subject. I have worked with some larger firms that are in second generation or later that do not require a capital contribution at all. They use end of the year distribution hold backs and credit lines to fund their working capital requirements. Other firms do require capital contributions upon being admitted as a partner and additional contributions over time when additional capital is needed or when partners acquire additional capital interests.

Smaller firms tend to require new partners/shareholders to pay for their interest in the firm. The buy-in can provide additional capital for the firm or can be used to compensate the existing partners/shareholders for their investment and sweat equity in creating the law firm or in growing it to its present size. One approach that some firms use it to include in the partnership/shareholder agreement the formula for determining the value of the firm, to which the new partner’s/shareholder’s percentage interest can be applied. This could include non cash-based assets such as accounts receivable, unbilled work in process, and goodwill. Another approach is to base the buy-in or capital contribution upon a the cash-based capital based upon the number of ownership shares a partner receives. Most firms allow for a buy-in over several years. Firms that do have a buy-in provision also typically provide for a payment to partners/shareholders upon departure for the value of their capital account. In recent years, an increasing number of large firms have adopted a free buy-in. Under that approach, there are no payments to departing partners/shareholders.

I believe that you should require at least a capital buy-in based upon the cash-based capital on the books and the number of ownership offered. This assumes that the partners still have capital accounts on the books. I also think you might consider them buying into the accounts receivable and unbilled work in process as well or be excluded from participating in compensation from those receipts. You should also get a partnership agreement in place as well.

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

 

Sep 05, 2017

Law Firm Key Financial Goals/Metrics

Question: 

I am a newly elected managing partner of a fourteen lawyer firm in San Diego. While I was elected to this position I feel handicapped since I don’t have a financial background. What metrics/measurements should I be looking at?

Response: 

Here are a few metrics that you might want to consider:

Once firm goals, financial and non-financial are formulated, either run reports that are available from your system or develop special Excel reports than measure goal accomplishment.

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

Jun 28, 2017

Law Firm Accounting/Finance Position

Question:

Four of my partners and I have just split off from a large law firm in Phoenix, Arizona and have started a litigation boutique firm with five associates. As we staff our nine attorney firm we are planning on hiring someone to handle our accounting and manage our finances. What type of position should we create and what level of experience should we be looking for?

Response:

The size and skill of a law firm’s financial function usually varies directly with the size of the firm. Larger firms with a larger volume and more complex transactions require more sophisticated systems, procedures, and controls, and personnel with the knowledge and experience to operate effectively and efficiently in a more complex environment. The title for a law firm’s Chief Financial Officer will usually vary with the skill required for the position. Typical titles include:

In a small firm such as your firm, where financial activities are typically uncomplicated and volume is relatively modest, an Accounting Manager ordinarily oversees the Finance Function. The Accounting Manager is often a Bookkeeper/Billing Collections Clerk who handles the accounting, payroll, billing, and collections.

Some firm’s your size hire an experienced firm administrator to handle the Accounting Manager functions as well as managing other aspects of the firm such as human resources, IT, facilities, marketing, etc.

I suggest that you hire a experienced firm administrator or full-charge bookkeeper.

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

 

Jun 06, 2017

Law Firm Collections/Retainer Management – Using a Retainer Follow-up Report

Question: 

I am the managing partner of a nine attorney general practice firm in the Chicago suburbs. We practice in the areas of estate planning/administration and family law. While our estate planning and uncontested family law work is done on a flat fee basis our estate administration and contested family law work is time billed. We collect initial retainers for these matters but we fail to insure that the retainers are replenished. We are having accounts receivable collection problems as a result. I would appreciate your thoughts.

Response: 

This is a common problem that I see in firms doing estate administration and especially family law. The best way of managing your accounts receivable is to have less in outstanding accounts receivable in the first place. You do this by staying on top of your retainer balances compared to your work in process and ask the client for additional retainer before the work in process exceeds the retainer balance. In order to stay on top of retainer replenishment you need to develop what I call a retainer replenishment report and have someone assigned to reviewing the report daily and advising responsible attorneys to contact the client when work in process has hit a certain threshold (percentage of retainer used). Some firm’s present the report at a weekly attorney meeting and determinations are made regarding additional retainers to request. Other firms assign the responsibility to the firm administrator to automatically bill for the additional retainer. It is also important to insure that ongoing work is managed in a way that an excessive amount of work is not committed to a matter until the additional retainer replenishment is received.

A retainer replenishment report is not a standard report in many billing systems. You may have to create a custom report in your billing system using a report writer or in a worst case drop a accounts receivable report to an Excel file and add in some columns for the other information.

Here are the suggested data fields/columns for such a report:

Responsible attorney
Client/Matter name
Retainer Balance (typically this would be the balance in the trust account)
Unbilled WIP Fees
Unbilled Cost
Total Unbilled WIP
75% Retainer Threshold
Amount Over/Under Retainer
Additional Retainer Requested
Total Amount Retainer to Bill (Amount WIP over retainer plus additional retainer requested)

Many family law firms have advised me that after learning the hard way they are now doing a good job at this and advising me that they have minimal accounts receivable issues.

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

 

 

 

 

May 10, 2017

Law Firm Billing Software – Cloud-Based vs. Desktop

Question: 

I am the managing partner of a twelve attorney firm in Toledo, Ohio. Our firm is evaluating new billing software and we are looking into some of the cloud-based solutions. We are currently using a desktop program that we have been using for fifteen years. The program handles our billing as well as our accounting. We have kept up with the updates to the program and the software has worked well for us. Several of our younger attorneys have used a couple of cloud-based billing programs in other firms and are trying to convince the firm to change over to one of these programs. They believe it is easier to enter their time sheets and they believe the software is easier to work with. What are your thoughts?

Response: 

I agree that the subscription cloud-based billing programs are easier to learn and use. In part this is due to limited function and capabilities. However, user simplicity is only part of the equation. The bigger question is whether the software will meet your needs. Many of the cloud-based programs were designed for solo practitioners or very small firms with limited reporting requirements. While these programs are getting better and inheriting more features they are still not up to par with the older desktop programs. Limitations include:

By the time you add in the cost of additional accounting software that you have to buy and maintain and factor in the number of users – subscription cloud-based solutions can get expensive for a firm such as yours that may have twenty users. The cloud-based billing software alone may cost between fifty to one hundred dollars per user per month – in your case one thousand to two thousand dollars per month. This cost will be offset by savings on hardware, IT support, user training, managing software updates, etc.

Cloud-based subscription billing software is getting better every year, is the wave of the future, and is a good solution for solo attorneys and very small practices. However, it may not have the functions and features that you need in your twelve attorney firm. Analyze the reports you are using now and what you need out of your system and then compare your requirements against the capabilities of each cloud-based system that you are considering.

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

 

Mar 29, 2017

Improving Law Firm Profitability

Question: 

I am the managing partner of a six lawyer general practice firm in Chicago. We have four partners and two associates and have been in practice for twenty years. While we are holding our own and doing okay financially we would like to do better. The partners have never earned more than $175,000 – some years not even that. What can we do to improve profitability?

Response: 

Profitability can be increased by increasing revenue, decreasing expense, or increasing leverage – ratio of associates to partners. Most law firms do not have an expense problem – they have a revenue problem. Profitability improvement programs tend to be more successful when they concentrate on improving profits through increased revenue versus programs than focus on reducing expenses. A program that focuses on increasing revenue such as increasing billable hours, raising billing rates, and improving realization rates will yield better results. Programs that focus on expense reduction often do not yield satisfactory results in the long-term.

Improvement in leverage usually can only be achieved as part of a long-term program. Sudden sizeable increased in the number of associates may prove to be counterproductive if there is not sufficient client work to keep associates busy. Another option would be to reduce the number of partners  through retirement and other options must be carefully planned and I am sure is not an option that your firm is looking for.

I suggest that you review your expenses to insure that they are in line and if they are not make reductions that make sense. Then focus on the revenue side of the equation. Review your client base, practice areas, billing rates, flat fee rates, billable hours being worked by your partners and associates, and realization rates. Then identify problem areas and chart out a course of action.

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

 

Nov 29, 2016

Law Firm Retainer Management – Replenishment

Question:

Our firm is a five attorney estate planning/administration practice located in Kansas City. Our estate planning work is handled on a flat fee basis for our clients. We collect one half of the fee upon acceptance of the signed engagement letter and the other half upon signing of the estate planning documents. This has worked well for us. However, we are not doing so well with our estate administration work. This work is time billed against a retainer. We do a good job collecting the initial retainer but then we fail to ask for replenishment retainers and when we bill for the remaining work we have collections problems. We have are over six hundred and fifty thousand dollar in accounts receivable over 120 days old. We would appreciate your thoughts.

Response:

This is a common problem that I see in estate planning/administration and family law practices. Here are a few suggestions:

  1. Assign someone in the firm to review a Summary Work In Process Report or similar report that shows the dollar value of unbilled work in process and the dollar value of used retainer at least once a week. (Some firms do this daily)
  2. Flag matters that are at 90% of retainer (unbilled work value to unused retainer) and bill clients for retainer replenishment in accordance with firm policy.
  3. Advise responsible/billing attorney of the retainer status, that a bill has been sent for replenishment, and again when the payment of the additional has been received.
  4. Responsible/billing attorney should consider the retainer balance status when scheduling work on specific matters that have reached 90% of retainer balance.
  5. Send retainer replenishment bills as frequent as necessary. It is easier for clients to pay small bills than very large bills.
  6. Stay on top of your receivables – smile and dial (call) after bills have been outstanding for thirty days. Reminder bills and statements are a waste of time.
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John W. Olmstead, MBA, Ph.D, CMC

 

Nov 22, 2016

Law Firm Billable Hours – Attorneys Not Meeting Expectations

Question:

I am a partner with a fourteen attorney business litigation defense firm in Los Angeles. I am the member on our three member executive committee that is responsible for financial oversight. This year we put in place an 1800 annual (150 hours per month) billable hour expectation for associate attorneys. No one has ever reached 150 hours. Are our expectations unrealistic? What is our problem? I would appreciate your thoughts.

Response:

I do not think that a 1800 annual billable hour expectation is unrealistic. Litigation defense firms typically have an expectation of 1800 to 2000 annual billable hours. Many litigation defense firms that I am currently working with have a 2000 billable hour expectation with many attorneys working 2200 billable hours.

Typical causes for an attorney not meeting expectations are:

  1. Not working or putting in enough hours.
  2. Not enough work.
  3. Poor time management habits.
  4. Poor timekeeping habits.

I suggest that you meet with each associate and discuss each of these possible causes.

Since this seems to be an across the board problem I suspect that the firm may not have enough work to support these billable hour expectations. Many of our clients are having this problem. They are hiring more attorneys that they actually need, have overcapacity, and simply don’t have the work to support billable hour expectations.

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

 

Oct 11, 2016

Law Firm Management – Valuing a Personal Injury Practice

Question:

I am the firm administrator for a small personal injury five attorney practice in Des Moines, Iowa. The firm's owner is approaching retirement and is planning on approaching other law firms regarding sale of the practice or merger. He has asked me for reports in order that we can value the practice. QuickBooks is the only software that we use. What reports should I use to establish a value for the practice?

Response:

You will want to start by generating a profit and loss statement and a balance sheet from your software. I would run five years of profit and loss statements and the most recent balance sheet. The profit and loss statements will help you illustrate the revenue, expenses, and profit picture for the past five years. The balance sheet will provide a current financial snapshot of the firm's cash-based financial position. However, since most law firms keep their books on a cash-based basis the largest asset – contingency fee cases in progress – is not reflected on the balance sheet. Neither is any value for practice goodwill. Since you do not have a case management system you will have to setup a spreadsheet with columns for the name of the case, date opened, estimated settlement, estimated fee, client costs/advances, and projected date of receipt of fee. You will have to have the attorneys managing the cases help you with the estimates. These will be the key reports you will need initially.

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

Sep 07, 2016

Law Firm Profitability – How Do I Know if We Have Enough Work for the Attorneys?

Question:

I am the owner of an eight attorney estate planning firm in Jacksonville, Florida. Our firm handles estate planning and estate administration. For this entire year our financial numbers are way down and I am getting concerned. For example, compared to last year:

I would appreciate any ideas on what I should do next.
 
Response:
 
Several of my estate planning/administration firms from different areas of the country are advising me that business is way down this year and they can't put their finger on the problem other than demand and timing.
 
I would start by:
 
  1. Take a look an your new matter intakes for the year – month by month.
  2. Examine the referral and marketing sources as to where this business is coming from.
  3. Prepare a open matter inventory report by attorney and matter type to get a count of the number of matters each attorney is handling
  4. Examine billable hours, non-billable hours, collected working attorney fees and realization rates for each attorney.
Compare each of the metrics above with last year and prior years. Meet with all of the attorneys and review their matters in progress and discuss their workloads. Also review your marketing budget and marketing programs to see if changes are warranted.
 
This should give you a feel for what is going on. You could have problems in the following areas:
 
While you may find that you have problems in each of the above areas I suspect that your biggest problem is that attorneys do not have enough work and your business is down. If this is the case I would question how they are using their non-billable hours – are they doing more business development and marketing – or they simply pacing their time so they fill an eight hour day.
 
If your problem is lack of work you are going to have to see if additional marketing can generate the business needed to support the attorneys you have on board or reduce your attorney headcount.
 

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

 
 
 
 

 

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