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Starting Up: If You’re Hanging a Shingle in 2011, Financial Strategy Begins Now

Posted Jan 1, 2011 5:49 AM CDT
By Susan A. Berson

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Jennifer Knapp. Photo by Jason Wood

Good financial management is necessary to the success of small-business owners, and lawyers who start their own firms are no exception.

Whether the entrepreneurial spirit of solo practice was lit from the current economy or was burning since you passed the bar, here are five guidelines for better money management to help your firm thrive financially.

LOW OVERHEAD

Keeping overhead low is fundamental to financial success. For every dollar you earn, if you can reduce your overhead by one dollar, there’s your salary.

Distinguishing between a want and a need is key to controlling overhead expenses. Malpractice insurance coverage categorizes as a need. Similarly, a backup server is a need—ask anyone who has seen firm records, including clients’ files, vanish—as is a disaster plan binder and electronic folder that detail who does what, when, how and where in emergencies.

There are areas, however, where the line that separates need and want can become blurred, such as office location, staff and expansion.

Can you ditch the rent? If your days are spent at the courthouse or solitarily on a laptop, paying office rent may not be a need. Conference room rental and receptionist services are available via virtual office services.

Concerning staff, the use of virtual workers is also a possibility. Office-sharing arrangements can be found, or solicited, in your local bar journals’ advertisements. Or be creative in negotiating “space for legal services” with an established busy practitioner.

An often overlooked way to reduce client file storage expense is including in your representation agreement that closed files will be returned to the client or destroyed, consistent with the period specified in your state bar association’s retention guidelines.

Meanwhile, the problem with expansion, in either space or staff, is that it increases spending. When you can look at a roster of paying clients, then you know you are at a place to consider expansion. And never expand without factoring in how the additional expense could impact your overall economies of scale. Analyze whether:

• There are different areas where you can eliminate or reduce expenses to balance increases.

• The increased costs can be passed on by increasing client fees and still be competitive.

• An additional attorney who brings in equity, more paying clients or both could bolster your asset base to cover the increases.

• Client feedback supports expansion. In my experience, clients disfavor it if the result is that their work will be delegated to a different attorney.

An alternative is assuming an established practice in order to expand your client base. Occasionally lawyers, especially in small-town settings, will post ads when they are ready to scale back or retire. Jennifer Knapp discovered a 100-year-old, third-generation firm posted on Craigslist.

After conducting extensive due diligence, including whether and how she could accomplish a smooth transition, “the deal that the seller and I structured made sure that it was in both of our interests that everything work out and that the firm remained successful,” explains Knapp. Two years later, Libera Knapp continues to thrive in Winona, Minn.

Importantly, lawyers cannot “sell” clients. However, many state ethical rules permit an “earn-out over time” payment structure. Consult the state’s particular rules before proceeding.

COMPETITIVE FEE ARRANGEMENTS

Expertise, service and fees are the key factors most clients evaluate when selecting an attorney. And solo and small-firm practitioners can have the edge over big firms because they have more flexibility when it comes to setting their own rates.

For new solos, a fee depends on the size and complexity of the case or transaction and your expertise. Estimate how much it will cost you to do the work to determine whether an alternative fee structure such as flat fee or contingency engagements are options to a standard, billable hourly rate. Factor in also the nature and duration of the attorney-client relations.

If you are incorporating a new business for a new client and hope for future work from the enterprise, a lower rate may be appropriate. (To see how rates can vary, see the Colorado Bar Association’s 2008 economic survey online.)

Our economy has renewed the concept of legal services in exchange for equity among many entrepreneurs. Exploring a “stake for fee” arrangement may be mutually beneficial to both client and attorney. For example, entertainment lawyers may accept a percentage of royalties earned to help a new recording artist negotiate with a label. Whatever the arrangement, attorneys must abide by Rule 1.8(a) of the ABA Model Rules of Professional Conduct.

“Look at your own state’s ethics rules and keep it at arm’s length, communicate well, maintain proper documentation,” advises Fort Collins, Colo., attorney Kevin Houchin, who routinely receives inquiries from startups to represent them on a stake-for-fee basis. Since most solos’ financial success is heavily dependent on cash flow, researching the client’s background and experience is a must.

“Don’t invest in anything that you wouldn’t enjoy doing for free,” cautions Houchin, “because sometimes that might be what happens. I limit my equity position to a small stake of no more than 5 percent.”

MARKETING NECESSITIES

Though the best referrals are from current and former clients, as well as other lawyers, marketing is necessary to get to that point. Marketing elevates your firm’s presence, and it takes many forms with varying costs.

An important component of marketing is networking. Basically, the more lawyers you know in different practices areas, along with geographic areas, helps to build your client roster. In fact, all attorneys should build a referral base. That way you know other attorneys for referring potential clients, and other attorneys know when to refer potential clients to you. Essentially, networking is about developing relationships. If you’re shy, use this mantra to become more extroverted: Increasing your referral base increases your earnings.

An inexpensive way to introduce your practice or firm and specialties is to e-mail a downloadable vCard to everyone you know. Targeted newsletters or e-mail alerts to lawyers and current or former clients are also helpful to spread the word about your expertise. Contact your local and state bar associations about their referral services. With online commercial referral services, measure the quality of referrals in proportion to the cost of the service being provided.

Finally, especially to new attorneys and new firms, befriend at least one experienced lawyer in your specialty so that when you encounter uncertainty about a situation, you know whom to consult. Notice I said “when” you encounter uncertainty, not “if.” Every seasoned solo or small-firm practitioner has experienced your “new” situation. Bar association lunches, meetings and other networking events offering mentor opportunities are resources for finding that trusted colleague.

Likewise, Knapp advocates becoming involved with nonprofits as she did when she found the 100-year-old Winona firm. “I met other lawyers, bankers, Realtors; that also led me to joining a few boards and organizations. It has a ripple effect on your business.”

A website presence is also a necessary marketing tool. For many practice areas, today’s legal consumers are migrating to the Internet. A single website page that lists a bio and contact information can be crucial to attracting clients who are searching in markets where the lawyer supply is great.

Be cautious, however, because it’s easy to get “design envy” when surfing other sites. A grandiose design is beautiful; the price tag quite ugly. A website designed by a professional can easily run $2,500. That’s not to say if you have the money in your budget, you shouldn’t do it. But, to keep overhead low, it’s possible to do it yourself for much less. There are free guides, as well as consultants, discussing the how-to’s and costs in selecting an Internet domain name for your firm, and registering it with the search engines. A corresponding blog can also be used for marketing purposes, and will require registration, too.

Developing a specialty, or niche within a specialty, also furthers your marketing efforts. Additionally, it can maximize your earnings because it optimizes your time. Specialization directs your time to the case type with which you are most experienced, helps you become more time-efficient, and exponentially increases earnings over time. Ultimately, becoming known as the go-to attorney for a particular area, case or problem will allow you the luxury of becoming more selective when client referrals are pouring in.

ORGANIZED RECORDKEEPING

Billing invoices, projected cash-flow statements, balance sheets and tax records are important to maintain. Handling these administrative duties is made easier by software programs (e.g., QuickBooks, Acclivity, Peachtree, Microsoft Office or Excel spreadsheet). The more organized these records, the better for your time management. Organization can also minimize potential liability.

Here are some details:

Taxes. Preparing returns and issuing Form 1099s are just the start. A small-business tax calendar is available online from the IRS. Many bar associations have made compliance with tax obligations a requirement for attorneys to maintain “good standing.” That includes reporting requirements.

Because the tax code is continually subject to legislative tinkering, a general rule for small-business owners is to calculate the added cost of higher taxes and reduce operating costs by that amount to maximize earnings.

And maximizing deductible contributions to a Simplified Employee Pension plan is a good practice. Pay attention to asset allocation—based on your age and time horizon to actual retirement and risk tolerance—and rebalance the investment mix when big swings in the market or life events occur. To determine your retirement savings needs, calculators are available on the Internet.

Billing invoices. Retainers are recommended, but should you decide to forgo a retainer, closely watch the accounts receivable. Send invoices on the first day of every month. For billing methods, consider Web-based time-and-billing software such as Time59 or the QuickBooks Premier Professional Services Edition, which allows for hourly billing with written descriptions for each entry.

Cash-flow statements. Prepare a monthly projected cash-flow statement. Knowing your anticipated income and expenditures for the next several months helps avoid a cash crunch.

Balance sheet. This is a snapshot of your firm’s financial health. It should show your firm’s assets (cash, equipment and money owed to you) along with liabilities (debts, including taxes and payroll). Assets minus liabilities equal your net worth.

SAVE UP

Before starting a new firm, it is recommended you save 12 months’ worth of living expenses. Building a financially thriving practice takes time, and the savings will carry you through the lean months.

Think you’ll just get a loan or credit line? Consider that in a 2010 National Small Business Association survey, 41 percent responded that they were unable to get needed financing, and in 2011 the lending landscape is likely to be equally restrictive.

Should you decide to obtain a credit line or loan for some working capital, evaluate the financial impact, especially if someone else could suffer adverse consequences when the lender asks for your personal guarantee. This means for solos with family responsibilities, remember to solicit their endorsement of your firm’s general direction.

And, bottom line, entrepreneurship is never something to do on a whim. Successful entrepreneurs are not merely risk-takers, they are calculated risk-takers.

Susan A. Berson is a partner with the Banking & Tax Group of Leawood, Kan. An author of several finance books for lawyers, she may be reached at sberson@banktaxlaw.com.

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