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By David Bilinsky and Laura Calloway
An earlier version of this article appeared in The Lawyers Weekly (Canada), Feb. 24, 2006.
Ben Franklin advised that in this world nothing is certain, except death and taxes (or as an IRS auditor was quoted as saying, “The trick is to stop thinking of it as ‘your’ money”). But our point is that the only certainty is that things are bound to change.
There are signs that the recent strong growth period in the U.S. economy may be ending. Bloomberg.com reported (March 6, 2006) that according to the National Association of Realtors: “Contracts to buy previously owned homes dropped in January for a fifth month.” As the housing market cools after five years of record sales, consumer confidence and spending may drop off, indicating that the U.S. economy may be headed for a mild “correction”—or it may be headed for something much worse.
Certainly there is optimism that business spending may offset a drop in consumer spending. Furthermore, there are signs that the world’s economy will continue to grow even as the U.S. economy slows. However, even if other national economies stay buoyant, the U.S. economy could take a hit at any time. And if the economy goes into a tailspin, law firms will feel the drop.
Even if a recession is avoided for the moment, the cyclical nature of business holds that, sooner or later, the economy will slide, the bear will come out, and times will be tougher. Since the Eagle Scouts tell us to “be prepared,” here we take a hard look at the top 10 ways that law firms can prepare—now—for the next economic slowdown—when, not if, it happens.
First, if you think that things are going to stay the same, you need to change your way of thinking. Revise your budget for this year and the next. In particular, reduce your revenue forecast and increase both your debt payments and accounts receivable to see how this will affect your cash flow, your income statement and your partner compensation. Present these adjusted budget numbers at the next partners’ meeting, and use this as a way to adjust everyone’s thinking regarding a possible turn in economic fortunes. Let this exercise serve as a catalyst for change.
The most vulnerable firms in a recession are those that are heavily encumbered by debt, as this highly leveraged position leaves them open to the dual poison of increased interest rates and decreased payments on account. Firms should focus on taking in revenues and using them to reduce debt to increase the firm’s financial resiliency, to reduce the impact of rising interest rates, and to limit the future impact on income and compensation.
Build a cash reserve. Examine your monthly cash requirements and compare them to the average balance in your general account. Accumulate cash 2, 3 or even 4 times your average balance—placing it in a term deposit or money market account—to serve as a nest egg. The alternatives to not having sufficient cash if receivables take a hard hit—namely, going to the bank for further debt, taking drastic measures such as laying off staff, or reaching into your personal bank account—may not be possible. Or they may have an unacceptable price in terms of reduced capacity or inability to maintain quality of service. Given that law firms are notoriously undercapitalized even in the best of times, increasing your cash will give you a degree of independence and resilience.
Examine your rental costs. Do you need all your existing space and storage? Can you sublet unused offices to other lawyers or renegotiate your lease with your landlord for a reduced footprint and lower costs? Is your landlord amenable to an early renewal for a longer term but at a lower overall monthly rate? Can you move storage or unused library books to a lower-cost location? Are you paying other rental costs that can be reduced or eliminated? Consider all the options.
Are there other big-ticket items on your income and expense statement that seem okay in flush times but look questionable in a leaner period? In particular, determine whether there are any expenses not strictly related to the running of the office. For example, food and entertainment items, personal expenditures, and membership fees masquerading as marketing expenses are all ripe for reduction or elimination.
Look at your personal and household expenses. Can you reduce your own cash needs so that, in turn, you reduce the pressure on the business for cash production and lower your need for draws? By reducing your monthly cash requirements, you provide yourself with greater ability to survive a downturn and increase the firm’s ability to use available cash for internal purposes should it be necessary. This is particularly important if you are a solo practitioner.
Seek ways to reward loyal clients and to drop those that are troublesome. Loyal clients will help sustain you in darker times, but all of us have clients who are slow payers, unnecessarily lengthening the firm’s average time when accounts are outstanding (thereby increasing the firm’s interest expense). Examine your accounts receivable, particularly those over 60 days old, and see if there is a common pattern. Kindly but firmly ask those who have a consistent slow payment record to take their business elsewhere. Use the increased capacity to provide even better service to your loyal clients and keep them thrilled with your services. When you do so, they will reward you with more of their business and with their continued prompt payments, during good times or bad. Even in the 1929 recession, there were law firms that continued to do work for their best clients. That kind of loyalty cannot be bought, but it can be earned.
Invest in technology and work-flow improvements that will reduce your costs and increase your productivity. The time to make positive changes is when times are good—not when times are bad. With your new, lower-cost structure, you will be primed to continue to provide services at a profit even in a competitive market. Recessions reward those who are efficient and serve as an acid test for those who are not—and they provide you with the ability to surge, rather than crawl, when the tough times are over.
There are legal services that are always in demand. Realizations, foreclosures, collections, family law—all this work can be profitably done even in bad times. Encourage practice groups that perform this work to start to market their recession-proof services today, providing your firm with ‘”top of mind” presence if and when a recession should materialize. Begin to look for the opportunities now, since recessions are, after all, opportunities in disguise. Most often there is great talent readily available, increased need from certain clients, and rewards for those that can provide the right mix of services when they are needed.
Lastly, move into new markets. There is a world full of clients who are not U.S.-based or who are seeking a foothold entry into the U.S. market. These potential clients might be smaller businesses located in China and the Far East, Europe and other areas that are showing signs of a surging economy even as the U.S. slows. Accordingly, by focusing your business development work on clients that are in these other markets, you have diversified your client base (the same concept that applies to your investment portfolio) and provided your firm with an additional financial leg to stand on. Furthermore, you have taken a strategic response to what is traditionally a tactical cost-cutting, hunker-down exercise.
So there you have it. There is, however, one further improvement you can make now (yes, we said 10 tips, but we never know when to stop), and that is to improve your business performance management to provide yourself with the reports and numbers that will tell you if you are succeeding in reaching your goals. Properly prepared, you can view an economic slowdown as an opportunity to surge past your competitors and emerge a far stronger strategic player than you were before.