Your law firm's fee structure can affect financial planning
When starting a law firm, there are many considerations you must make to ensure its success. Two essential focus points include choosing a fee structure and organizing financial planning systems.
The fee structure a firm chooses can have a tremendous effect on that firm’s finances.
While not every lawyer is a financial expert, attention must be paid to these money matters from the outset. A firm’s chosen fee structure and how its finances are handled can lay the foundation for the entire life of the business and sometimes provides early indicators in determining whether it will grow and thrive or eventually crumble.
There are two separate models that firms can choose from when developing a fee structure. Each structure has its positives and negatives, but firms will want to be diligent in researching what option will best serve the goals of their business.
Hourly or flat-rate billing
This highly structured model allows a firm to have a solid idea of what revenue it can expect from each client or case it accepts. Under an hourly or flat-rate billing structure, clients know what costs they will incur and may sometimes pay money upfront. Traditional defense-side law firms typically utilize this approach to billing, making it familiar for clients and a straightforward way to organize finances for the firm.
An hourly or flat-rate billing structure also makes growing one’s business easier. By knowing what to expect in terms of revenue, a firm can make projections on everything from office space to hiring decisions.
Firms that are just starting can also build their financial plans for the entirety of their business around this consistent structure. It is a very upfront way of practicing law and may be the more appealing choice for firms that are just getting started.
The contingency fee approach may be most associated with personal injury firms. We have all seen the advertisements that make promises like, “We don’t charge unless we win your case!” The lack of an upfront charge is a key element of any contingency structure, as there are no fees billed to the client until the firm can win a settlement for them.
Contingency fees can apply in all kinds of litigation, however, not just personal injury. There are plenty of commercial cases—such as class actions and breach of contract actions—in which contingency fees can apply.
Choosing this approach can be a positive in terms of marketing and endearing your firm to the public. Many clients will be more apt to give your firm a chance if they know their out-of-pocket cost hinges on you doing your job well and winning their case.
On the other hand, this fee structure can be nearly untenable for a new firm with few resources. Firms need to pay for overhead and staff costs, and partners also need to pay themselves. Along the way, lawyers still need to work on their cases. The cost of doing so—and all other expenses—come directly from the capital reserves of the firm. The firm does not get paid until that “win” is earned. It’s a gamble, and it is one that new firms may not be able to make if their capital reserves are low.
Once a new firm decides on its fee structure and goes all in on making that structure work, it must then focus on organizing its financial management system.
One of the biggest mistakes new firms make is not investing in growth from the onset. At the beginning of any business, you’re running lean. You’re pinching pennies to get your firm off the ground, and it can be very easy to get stuck in a pattern of frugal behavior. Many businesses miss shifting to a growth mindset, even when they begin to bring in revenue.
Those striking out and opening their own firms should be laser-focused on growing (and sustaining growth) from the beginning. It’s also integral to the initial and future success of the firm that dedication to excellent service is woven into the growth mindset.
To achieve this growth, I highly encourage law firm owners to be focused on increasing their caseload over time. That increase can come either from the number of cases they take on or the size of those cases. In either instance, focusing on that growth is going to keep that law firm sharp rather than stagnant. Lawyers should always be focused on client satisfaction by providing the best services possible. All of these are highly influenced by a focus on growth.
Ultimately, it’s up to the firm to decide whether it wants to grow. If the firm doesn’t want to grow, this will influence the choices that it makes. Conversely, if the firm wishes to grow by expanding the number of clients it serves or the number of attorneys that work within the firm, the firm must be capable of investing in growth.
Nevertheless, there is nothing wrong with stabilizing your firm before considering ways to grow. In fact, when you first start out—especially if you’re a contingency fee firm—you’re essentially working off reserves. You’ll want to establish that steady revenue, or at least the ability to project revenues, before you make investments that you’re unsure you can cover or will create a return. It is important to know that you have a business model that works before you can start investing in growth.
Yes, there are all kinds of alternative fee arrangements lawyers should consider, including mixed fee arrangements.
For instance, a typical contingency fee arrangement might be 33%, or one-third of whatever is recovered minus expenses.
In a mixed-fee arrangement, you might charge a flat fee at the outset, which serves as guaranteed revenue, and then take a lesser contingency fee on the back end instead of the usual one-third—perhaps 15% to 20%, depending on the arrangements.
Things can rapidly go south if a firm’s financial management is not secure. Adverse effects of bad financial management include the inability to pay staff, a lack of resources to move cases forward—resulting in bad service to clients—and eventually an inability to operate.
This story was originally published in the December 2022-January 2023 issue of the ABA Journal under the headline: “Choose Wisely: Your law firm’s fee structure can affect financial planning.”
Omar Ochoa is the founder of Omar Ochoa Law Firm.
This column reflects the opinions of the author and not necessarily the views of the ABA Journal—or the American Bar Association.