Law Practice Management Asked and Answered Blog

Category: Capital

May 17, 2016

Law Firm Equity Partner Capital Contribution

Question:

I am the sole owner of a twenty-five attorney litigation boutique firm in Los Angeles. I am the only equity partner with nine non-equity partners and fifteen associates. I am concerned that if I don't provide a path to equity partnership some of my senior talent many gradually defect to other firms or split off to create their own law firms. I also believe that providing a path to equity partner for deserving non-equity partners is the right thing to do. Therefore, I am planning on admitting two non- equity members this year. Should I require capital contributions?

Response:

I believe that all new partners should be expected to contribute capital and have some "skin in the game." Whenever a firm admits a new partner, the firm should require the new partner to contribute capital. Increasingly, a partner's capital requirement should bear a relationship to the partner's share of profits. You may want to allow new partners a reasonable period of time to fund their capital accounts – say one or two years via a capital note or help them arrange favorable terms at your bank to finance their capital accounts. Usually capital accounts are tied to working capital needed to operate the firm and the percentage of ownership/income that each partner will have.

While capital contributions are all over the board ranging from zero to $100,000 in firm's your size I often see capital contributions ranging from $25,000 to $50,000. 

There are only three ways to increase a firm's working capital to cover cash flow requirements and fund growth:

1. Have partners put more money in
2. Have partners take less money out
3. Borrow

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

 

 

Feb 23, 2016

Law Firm Partner Capital Contributions – How Much?

Question:

Our firm is an 18 attorney firm in Chicago that was formed by the existing four equity partners ten years ago. We have four equity partners (founders), eight income (non-equity partners), and six associates. The income partners are not required to contribute capital. We are considering admitting a couple of the income partners as equity partners and also approaching possible laterals. What should we require in the form of buy-in or capital contribution?

Response:

While capital contributions are all over the board ranging from zero to $100,000 in firm's your size I often see capital contributions ranging from $25,000 to $50,000. All depends upon the number of ownership shares being offered. I am seeing firm's requiring more as many firms are resisting the temptation to take on bank debt to finance their short-term working capital requirements. Citibank's Private Law Firm Group reports that between 2004 and 2007 capital contributions averaged 20 to 25 percent of a partner's income. Citibank's recent survey reports that partners are now contributing an average of 30 to 35 percent of their earnings. Thus, a newly admitted partner that will be earning $150,000 upon admission would be expected to contribute $45,000. Contributed capital is returned when a partner leaves the firm in full upon withdrawal or more commonly according to an incremental installment payment schedule.

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

Sep 30, 2014

Law Firm Capitalization – What is the Proper Level for Partner Capital Accounts

Question:

I am the chair of the finance committee for our firm – 17 attorney firm in Chicago. We have 6 equity partners in the firm. We are in the process of admitting a new equity partner and are reviewing our capital accounts and trying to determine our capital needs. I would appreciate your ideas and thoughts.

Response:

There are two categories of capital – short-term or working capital which is used to fund daily operations and long term capital which is used to pay for capital assets such as furniture and fixtures, computers and other office equipment. I guess I am old school but I believe that short term working capital should be funded as much as possible with partner capital and long term capital funded with bank borrowing or leases. I have more and more clients that are funding working capital with partner capital and have no bank debt at all. I have other clients that finance all working capital with their bank line of credit – these firms could find themselves in dire straits if bank credit should tighten in the future.

The amount of working capital needed by a firm depends upon your practice, billing and collection cycles, whether you do contingency fee work, and whether the firm is growing and adding attorneys and staff. As a rule of thumb I suggest that a firm have three times one month's expenses excluding draws in working capital. This would need to be increased if the firm has lengthy billing and collection cycles, does contingency fee work, and is in a growth mode.

Partner capital contributions are usually made proportionately based on partner earnings or ownership percentages.

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

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