One of the biggest mistakes law firm owners can make is not investing enough money in the firm
There's nothing like the adrenaline rush of starting a new firm. The roller coaster ride can be stressful: determining which clients make the transition from the old firm to the new one, calculating expected billings and wondering whether profits will materialize. Dealing with banks and firm co-owners regarding paying for everything compounds the pressure. But lawyers can ease the stress of starting their own firms by creating a basic business plan.
Writing a business plan for a new firm is not that difficult. Start with an outline. Include broad categories, such as practice areas, culture, operational details and financial goals.
The new firm's practice areas and cultural aspects will largely determine the financial portion of the plan. Consider a hypothetical insurance-defense firm. One of the cultural decisions should include amounts and types of current and prospective client entertainment. Should the firm budget for sporting-event suites to entertain, or should it budget minimal amounts for entertainment and maintain lower billing rates? Looking to clients and defining the firm culture will lay the foundation for the rest of the business plan.
Once attorneys make cultural decisions, the next step includes determining and documenting operational details. Assume the hypothetical insurance-defense firm decides to purchase a sporting-event suite. The business plan should document pertinent operational details. Who will shoulder responsibility for managing the suite? What procedures will ensure the firm fully utilizes the suite for the intended client-development purposes? What procedures should be in place to approve and document the related entertainment expenditures? Defining the practice area and cultural aspects of the plan will lead lawyers to develop the financial portion.
The financial portion of the business plan includes two distinct aspects: capital and operations.
The capital plan should estimate the amount of money needed to start the firm and document the amount of money the owners intend to keep invested in the firm on a continuing basis.
The operations plan estimates the amount of money the firm and/or owners should make. Both plans should include the following significant in-between details.
• The capital plan should detail expenditures such as furniture, computers, leasehold improvements, client costs advanced and losses during the start-up phase. It should reflect the financial sources used to pay for capital plan expenditures. This almost always results in some combination of bank loans and owners' contributions of their own money.
For example, assume estimates for furniture, computers and leasehold improvements total $200,000. Further assume the firm will lose an additional $300,000 before monthly income from fees exceeds monthly expenses. Firm capital needs to total $500,000. The owners then must determine the appropriate amount of debt and personal finances to fund the $500,000. I prefer loans from owners at higher interest rates, generally 6 percent to 8 percent. Owners are on the hook for any loans anyway, so why not pay themselves the interest?
One of the biggest mistakes owners can make is not investing enough money in the firm. A lack of funds often will create significant negative energy, both internally and when dealing with bankers, financial advisers and other owners.
• The operating plan should lay out sources of income and estimated recurring overhead costs, with the difference reflecting profits to the firm or owners. For hourly firms, income estimates ultimately should reflect chargeable hours collected. Underlying assumptions getting to the collections amount will include combinations of hourly rates, chargeable hours generated, chargeable hours billed, and allowances for time held or written off.
I like to start with something simple such as income collections by timekeeper. These amounts show the income necessary to meet owners' goals for compensation and profits. Then, I prefer to back into all of the other assumptions supporting this amount.
For example, assume a solo practitioner wants to make $500,000. Further assume overhead costs under the business plan total $500,000, including costs related to four additional timekeepers. To make the $500,000, the five timekeepers must collect $1 million of fee income. In other words, if the solo wants to make $500,000, he or she needs to collect $1 million to get there.
Firms tend to get hung up on the production process and become fixated on billable hours. But at the end of the day, what ultimately determines firm profits and owner compensation is how much fee income hits the bank account. In light of this, measuring cash collected by timekeeper is equally -- if not more -- important than measuring the production process. Collections should not be an afterthought but a key focus.
Finally, a strong team of vendors and professionals streamline the start-up process. Detailed capital and operating plans point to necessary vendors and professionals. A new insurance-defense practice should use consultants familiar with the economics of such a practice. Office managers, controllers and outside accountants who work for insurance-defense firms understand financial operations and may be helpful developing the business plan. Seek referrals from trusted colleagues to find knowledgeable, honest and fairly priced resources. These usually result in the best long-term relationships -- the relationships lawyers need for their new ventures to succeed.
Chuck Duff, a certified public accountant, is owner and shareholder of Duff, Kitchel & Co. in Houston. He serves as chief financial officer and financial consultant for a number of closely held businesses. He works with a significant group of law firms, as well as energy, homebuilding, retail and manufacturing companies. He focuses his practice on financial planning, internal reporting, and tax planning and reporting, in addition to consulting projects. His e-mail address is email@example.com.
By Chuck Duff