Money main issue for would-be solos

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Published on 12/3/07

My last column addressed making the decision to leave a law firm. In this and subsequent columns we'll consider how to successfully start a practice on your own after leaving, because it's not an easy path to take.

The Wall Street Journal recently reported that, during the last 20 years, the inflation-adjusted demand for legal services has risen just 1.2 percent a year (less than half as fast as the overall economy) while the inflation-adjusted income of sole practitioners has been flat since the mid-1980s. And competition continues to increase as law schools graduated nearly 44,000 J.D. recipients in 2006, compared to 38,000 in 2002.

Given these tough, competitive factors, managing money is your No. 1 consideration for success in a new firm. Practice needs should always be met first, and personal needs should be the minimum expense necessary to maintain a standard of living. This assumes that you've built up an adequate cushion of savings — at least enough to cover six months of typical living expenses — before you start your firm. Once you hang out your shingle, these four factors determine how much money you will need for ongoing operations:

  • Volume: The greater your billings, the greater the need will be for cash in the firm. That's because the time between when you send out a bill and when you receive payment averages more than four months nationally. The more client invoices you have outstanding, the more cash you'll need while waiting for payment as you start growing.

  • Growth rate: Faster growing firms will likely need more money for supplies and equipment, staff support and office space. While you're waiting for clients to pay you, vendors, landlords and utilities expect payment immediately.

  • Capital turnover: This defines how often the invested assets of the firm are being returned in revenues. Higher rates of turnover produce more revenue on the same amount of assets. The faster you get clients to pay you, the better your turnover ratio. That's why you should review your receivables weekly to see who has and hasn't paid. Never wait until the end of the month to check turnover — that loses 30 more days in getting the cash you need.

  • Credit terms. The more lenient your terms to clients, the more cash you'll need while waiting payment. Conversely, tough credit terms (such as charging interest on unpaid balances) are likely counterproductive — clients who won't pay their bill won't pay the interest, either. Never give in to the temptation to extend credit in the hope that the client will give you more work. Strive to get paid quickly for the work that has already been done.

The one common theme here is that your new law firm should not be a bank for clients. When you bill clients, you are extending them credit. Lax collections mean you need more cash to stay in business while waiting for clients to pay. The new firm that stays on top of receivables will have the cash for our next two concerns: infrastructure and marketing, to be discussed in the coming weeks.