Where Will The Money Come From?

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Published on 2/15/10

Panic and fear of financial disaster are no longer part of the daily headlines, but, as most law firms (and other businesses) know, plenty of business challenges remain after two years of economic crisis. One of the biggest is fundamental: If a firm suddenly needs cash, where will the money come from?

It was recently reported in the Los Angeles Business Journal that Small Business Administration-guaranteed loans, funded by banks, have fallen by 53 percent from 2008, which itself was down from the preceding year.

Despite receiving hundreds of billions of dollars in TARP funds aimed at jump-starting the economy, banks continue to lend anemically. If the bankers were to spend the funds to help as intended, there likely would be less anger over their salaries and bonuses and less rush to enact new, stricter banking regulations.

Law firms seeking either an extension or increase in their lines of credit are faced with the cold realities of this environment. It's tricky, at best, to rely only on a credit line, because banks are far more cautious than they used to be in extending credit to any law firm customer. Banks require assurance that they will be repaid. And there are tough tax consequences for maintaining the kind of substantial capital balance that banks want as collateral.

Thus, as a New York Times story observed last summer, "like such ventures as the Mafia or the ice-cream vendor, many large [law] firms operate on a cash-in-hand basis, with insufficient reserves to weather a slump."

When I wrote about this issue some months ago, the managing partner of a small firm complained to me bluntly that the tax code too often prevents the accumulation of capital.

"I would love to find a way to accumulate capital without tax consequences," he wrote. "I hate debt. But the only way I know to avoid using a bank line of credit to fund operating costs, especially early in the year, would be for my partners and me to make personal loans to the firm with after-tax money. There is no way to hold money past Dec. 31 without suffering a major tax hit."

And he was absolutely right.

The "either-or" dilemma of tight credit or tax hit is not easily resolved. The only real solution for most firms is to maintain and enhance a trustworthy relationship with a bank just as they do with their own clients.

In this era of tighter credit standards, bankers view and understand every law firm as a business, with cash flow, receivables, revenue and profits. Lawyers should demonstrate their business soundness to their bankers in order to build a relationship of trust. That means documenting clear plans for cash and receivables management, marketing and business growth. It also means documenting their status as a reliable borrower by maintaining a high credit score on any of the various systems used.

All this should be established before the firm ever needs to seek funds. Then, when "crunch" time comes, the foundation established will be one on which the firm and the banker can rely comfortably in a loan transaction.

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