Successful law firms of 50 or more partners generally have good access to financing to support the firm. These firms also have dedicated financial managers who devote significant time toward managing their relationships with their lenders. With credit amounts well into the tens of millions of dollars for firms of this size, lenders can justify devoting significant resources of their own toward underwriting this type of lending. If you are part of a smaller firm, however, you may face a different set of challenges in acquiring financing.
Loan requests for smaller professional firms are not quite “commercial business” loans and not quite “personal” loans, making them somewhat trickier to obtain from some lenders. A rule of thumb could be that if you are a smaller firm or if you have distinctive needs, maybe you should work with a local or regional bank, while large national firms may be best served by large national banks.
So, let’s say you are a successful law practice evaluating your borrowing needs. In your line of work, time is your most precious commodity, so you want to maximize your efficiency when you evaluate your lender. The key elements to maximize your efficiency are clearly identifying what you are financing, being realistic about the terms, and being prepared to provide information supporting your loan application.
Know Your Financing Options
For professional services firms, financing is usually provided for working capital, fixed asset purchases or contingency work.
- Working capital. This usually refers to supporting accounts receivable, sometimes known as “gap” financing. The “gap” refers to the fact that your business bills out work that you may get paid for after 60 or 90 days; however, you still have to pay monthly bills such as payroll and utilities in the meantime. The work has been performed and billed and there is usually a high probability of collecting the amount owed.
Financing for accounts receivable is one of the most common credit purposes for law and other professional firms, and is usually handled via an annually renewable line of credit. In determining the amount of your loan request, it is probably unrealistic to expect to borrow more funds than your total accounts receivable (since the lender expects that collection of these receivables is how the principal is repaid). As line amounts increase, there are usually more conditions associated with the credit facility. For lines approaching $1 million or greater, it is not unusual to expect availability under the line to be restricted to a formula, such as 70 to 80 percent of collectable receivables. These lines are usually at floating rates, tied to the prime rate, with some margin over prime. The type of ancillary banking business your firm maintains (directly or indirectly) will usually influence the margin over prime.
- Fixed asset financing. Uses for this type of financing can range from a new copy machine to an office building. Equipment loans are usually tied to the estimated useful life of the asset and usually amortize fully over a five-year or shorter period. Larger equipment loans will generally require larger down-payments as a percentage of the purchase.
Financing for an office building purchase is usually considered as an eligible loan to the firm if the property is fully occupied by the firm and its cash flow is utilized to repay the mortgage payment (as opposed to rental income). This does not preclude the firm from creating a shell company and renting the building to the firm. Any property for which third-party tenants are necessary to repay the debt creates aspects of an investment property loan, which is not a “business” loan for the firm. Generally speaking, the business loans are easier to obtain and at more favorable terms than those for investment properties. The terms, however, can vary dramatically depending on property factors. The most important factor to keep in mind is that the equity requirements for the real estate purchase diminishes funds available for the firm. So do not fall into the trap of rationalizing a real estate investment as firm growth.
- Contingency work. Although available, this type of financing is generally more difficult to obtain than accounts receivable (gap) financing. Due to the nature of this work, there is a lower probability of collecting from these cases and there are often many that never have a settlement or collection. Lenders will usually need to obtain more detailed information on specific cases and will look closely at the attorneys’ track records—that is, do they have more “winners” than “losers” within their case history? Lenders are often wary of the contingency attorney who has two or three cases with huge potential. The lender usually prefers an attorney with many small cases, knowing that some will likely work out, so there is less reliance on the big payoff from the one big case.
Expect to pay higher rates for contingency financing and, in some cases, it may be necessary to offer collateral outside of the firm to obtain the amounts desired.
Steps to Meet Your Banker
Whether the loan is for accounts receivable financing, equipment, an office building or contingency cases, there are a few steps to follow to be prepared when presenting your application:
- Expect that you will need to provide as many as three years’ worth of financials on your practice as well as personal financial information for the partners. CPA-prepared is preferred over management-prepared, and the more recent the better. Year-end statements are better than interim ones.
- Inventory all of the banking business managed by your firm as well as your personal loans and bank accounts. Your best terms and best pricing will be achieved by leveraging all of your business at one institution rather than spreading it out at many.
- Solo practitioners in some cases may be required to maintain a life insurance policy with the lender as a beneficiary. Know at the time of application what policies you already own and if they are assignable.
- Disclose to the lender up front any issues that may affect a credit decision. The odds are that they have dealt with a similar situation in the past. It helps to know in advance if there was a divorce that affected someone’s credit score or a health issue that affected billings two years ago.
Once you have obtained financing for your firm, ongoing communication is important, too. It is a good idea to meet regularly with your lender to keep it apprised of the firm’s activities.