Financial Management of Plaintiffs’ Practices - Meeting Objectives while Avoiding Fatal Mistakes

  

This article introduces a series of investigations into the critical importance of active financial management in operation of the practices of today’s contingency-based plaintiffs’ attorneys:

 

I.            AN INCREASINGLY DIFFICULT MARKET

             “You should have been here ten years ago!” 

             This is precisely what we were told by more than one trial lawyer in early 1996 when we first entered the arena of legal finance. This simple phrase was delivered with a combination of longing for the good old days and dread of an uncertain future unfolding before their very eyes.  Supposedly, well into the 1980s, trial lawyers had been living through a golden age when anyone with a modicum of talent could be successful at the practice of contingency plaintiffs’ representation while gifted attorneys could readily anticipate tapping into a well of inexhaustible wealth!

             “But, those days are long gone.”

             While we watched the spread of tort reform across parts of the country, an even more nefarious movement was taking place. Perhaps influenced by the well-funded tort reform juggernaut, perhaps influenced by uninformed political ravings, perhaps driven by attempts by the medical community to build animosity toward trial lawyers, juries turned negative. As a result, the marketplace has become increasingly more and more difficult. Cases were lost at trial with increasing frequency and jury awards fell in financial value. Pain and suffering awards virtually flew out the window. In response to these changes in attitudes toward plaintiffs and their trial lawyers, settlement values began to shrink – a trend that continues to today.

             Nevertheless, we were able to build a thriving finance company using a proprietary model that (i) provided trial lawyers with critically needed capital to finance their reimbursable costs of litigation; (ii) advanced funds against legal fees that had been finally adjudicated, but not yet collected; and, (iii) provided reasonable amounts of general working capital in order to support operating needs such as advertising or project specific personnel and office expenses. More importantly, a significant percentage of trial lawyers also managed to thrive although, of course, some did not.

II.         FINANCIAL CRISES MAKE IT IMPOSSIBLE TO NEGOTIATE A GOOD DEAL

             What were the factors that differentiated the firms that thrived from those that struggled? Case selection, of course, was a critical factor, though it is an extremely rare event when a trial lawyer can determine which cases will be lucrative before signing a client to a contingency-based contract. There are too many unknowns involved in the selection of cases, a problem that is compounded by issues of timing. In short, with rare exception, the factor of case selection is an uncontrollable variable.

             The other differentiating factor – one that is much more likely to be controlled by each law firm – is financial management. Quite simply, those firms that understand and manage their financial position successfully end up being successful – and those that do not end up running from financial crisis to financial crisis. Why is this the case?

(1.)           Very few trial lawyers receive any training in financial management and even a smaller number make any attempt at active financial management of their firms. 

(2.)           Very few have dynamic, accurate accounting systems in place (not to be confused with accounting software). 

(3.)           Almost none attempt to engage in financial modeling and planning, through which upcoming financial challenges can be identified and protected against. 

(4.)           Only and handful of trial lawyers ensure that they have adequate amounts of credit available to face hard times.

             As a result of these factors, financial crises tend to sneak up on attorneys and, by then, the opportunity to manage finances is long gone, replaced by the need to weather a severe crisis without access to the proper resources. This creates the least advantageous situation for dealing with potential lenders. The ability to negotiate for favorable interest rates will have been lost and the attorney’s influence upon his or her credit facility’s financial structure will be non-existent. In the most severe of situations, financing may be unavailable, resulting in the demise of otherwise admirable legal practices.

III.       THE OBJECTIVE: A CREDIT FACILITY WITH GREAT STRUCTURE AND    FAIR PRICING

             Obviously any business, including those engaged in contingency-based plaintiffs’ representation, desires a scenario diametrically opposed to the crisis situation described above. Instead of being stuck with an inflexible, high-priced credit facility (or no credit line at all), trial lawyers need to develop solid relationships with reputable lenders who understand the business of trial law and are committed to a long-term presence in this industry. This feat is not as easy to accomplish as it may seem. 

             Lenders come and lenders go in the arena of legal finance. Most enter the industry with a perception that the financing of law firms is an easy transaction to facilitate and that, due to the absence of commercial banks, pricing will be highly favorable. In other words, trial lawyers are looked upon by these fly-by-night operators as being fat, easy targets for them to get rich quick and then move on to the next underserved financial market once competition rears its ugly head.

             Trial lawyers, therefore, should seek to do business with people who have been around the industry for a substantial period of time and have demonstrated a thorough knowledge of the underlying business of trial law.

             However, as important as this factor is to successful negotiation of a valuable credit facility, it is not the proper starting point!

             The quest for a properly structured, flexible, and fairly-priced credit facility begins within the operating staff of the applicant law firm.

 

IV.        FINANCIAL REPORTING AND ACCOUNTING    

             Accounting is the mechanism for commercial communication. Without a functional accounting system, it will be impossible to communicate successfully with the types of lenders with whom trial lawyers want to conduct business. It is important to note that this should not be interpreted as: “Buy a set of QuickBooks.”

             The managing partner of an applicant law firm needs to hire and/or develop a qualified bookkeeper who can set up a functional business model for a plaintiffs’ firm. Having analyzed thousands of law firms’ loan applications, Amicus Capital has found that the internally generated financial statements frequently look as if they were designed by someone who was blindfolded and sent to find his or her objective in a large and particularly challenging maze. The opposite is the desired objective – a set of financial statements that clearly and accurately portray the business of each respective law firm, which has been consistently applied over the course of however many years the lender requires.

             This objective appears simple to understand for any lender or financial analyst, but most trial lawyers have little, if any, training in finance and accounting. Despite their impressive training in the field of law and their accomplishments in plaintiff representation (including the ability to master a variety of types of claims and cases across numerous fields of litigation), attorneys tend to lack adequate training in accounting and finance, and underappreciate the critical importance of accurate, informative financial reporting needed to obtain proper financing.

             But is clear, accurate, and informative financial reporting enough?

V.         THE IMPORTANCE OF FINANCIAL PLANNING

             Financial planning? You have to be kidding me! Absolutely nobody can predict either the value of any case or the timing required to bring a claim to successful resolution. Isn’t financial planning a waste of time and resources?

             The answer, of course, is: “No!”

             While it may be true that absolutely nobody can predict either the value of a case or the timing required to bring a claim to successful resolution, those facts are the very reason it is essential for trial lawyers to plan for their prospective cash flow needs.

             Financial forecasting, including sensitivity testing for both controllable and uncontrollable variables, will provide critically important information for attorneys. This analysis will disclose both the likely timing and the amount of funding a law firm might require under any number of potential scenarios. Then, preparing a primary plan to accomplish the most likely objective will be absolutely essential for successful operations. Likewise, preparing an alternative “survival” plan for overcoming the most challenging foreseeable circumstances will ensure that the firm can establish credit facilities that will see the firm through the storms of uncertainty into the safe harbors of financial success.

             In addition to these critical challenges of internal financial management, the existence of responsibly prepared financial pro-formas will allow the firm to simultaneously communicate to potential lenders how well the firm is actually performing relative to the business plan and how the firm can survive even the most challenging of future downturns. Both factors will bring significant confidence to lenders when the time comes to go through the approval process. They will also allow potential lenders to fully understand the nature of the applicant law firm’s business so they can assist in the structure of credit facility that meets the needs of both the lender and the law firm.

             While law firms want to thrive in any scenario, in most instances law firm do not seek financing relationships until a crisis has become overwhelming. As a result, if they can obtain financing on any basis, it is almost always a cookie-cutter program that has been designed for the benefit of the lender with little or no concern for the needs of the borrowers.

VI.        UNDERSTANDING THE FIRM’S CASE INVENTORY

             Equally important to the need for clear, accurate, and informative financial reporting is the necessity of clear and accurate reporting of the composition and value of the firm’s up-to-date inventory of claims and cases.

             In order for a lender to understand a law firm’s inventory of cases, there are a number of things they need to understand. These include an aging of the portfolio, both to understand the nature of the firm’s turnover of potential collateral, but also to determine a measure of the “freshness” of these assets – the only true financial assets – owned by the law firm.

             Also of importance are two seemingly contradictory desires common to almost all lenders; diversification of geographic location and lines of business. This need for diversification is tempered by the lender’s need to ensure that the law firm remains primarily within historical operational boundaries. Simply stated, most lenders are not comfortable bankrolling an inventory of mass tort pharmaceutical claims for a firm that has never before stepped outside the realm of Motor Vehicle Accident litigation.

       

VII.      BECOME ACQUAINTED WITH POTENTIAL LENDERS

             While it is not difficult to find a lender interested in financing law firms, it is challenging to find the right lender to meet the specific needs of each practice. Each lender will have its own approach when it comes to financing law firms. Some look at a loan-to-value type approach built upon the prospective value of case inventories. Others look to a historical cash flow approach. Some are full recourse while others lend on a limited recourse, or even a non-recourse basis. Some require current payment of interest while others allow for deferral. Some look for long-term investment opportunities, such as mass torts, while others look for rapid turnover of cases, such as motor vehicle accidents. Some advance only on post-settlement factoring while others will only consider pre-settlement lines of credit.

             While many lawyers become quickly intrigued by non-recourse offerings, they forget that the concomitant interest rate will be exceedingly high and will likely compound over the lifetime of complex litigation. Aside from exposure to interest rate compounding, there are numerous other risks related to association with the wrong type of lender or improper type of loan product.

             The only answer is to become acquainted with lenders well in advance of the occurrence of a precipitating event that will force an attorney into the financial marketplace.

             Our experience at Amicus Capital is that attorneys actively try to avoid meeting lenders until there is a desperate need for funding. As mentioned above, this is absolutely the worst time at which an attorney should seek to establish a relationship. No one should ever try to negotiate favorable terms for large sums of money during desperate times! Instead, relationships are best established when the time clock is not running and creditors are not (figuratively, at least) pounding upon the front door.

VIII.    PRESENTING THE RIGHT PACKAGE

             Each lender uses proprietary analytical procedures to determine whether or not to approve loan applications from law firms. While each lender relies upon common factors, it is important to know in advance which factors are of highest importance to the lender of choice and how best to demonstrate why the applicant law firm is a good fit for said lender. Our experience indicates that most law firms tend to simply throw together the minimum amount of information requested by the lender’s sales representative, and then moves into waiting mode while the lender puts together the analysis.

             To avoid this situation, it is important for the applicant law firm to either thoroughly come to understand the preferences of the targeted lenders, using both attorneys and accounting personnel, or to work with a fully qualified management consulting team like Amicus Capital. Either approach will allow the applicant law firm to tailor the presentation to the particular preferences of the lender, thereby dramatically increasing the probability of approval and the negotiation of the most favorable credit facility possible.

IX.        ACCURATE, TIMELY REPORTING

             Gaining approval is only part of the battle. A useful credit facility is an important long-term weapon in a law firm’s quiver. However, from our experience, very few law firms tend to dedicate adequate resources to this critical piece of management. As a result, the relationship between lenders and law firms can tend to become contentious over time. Law firms resent the numerous requests for information sent by lenders, and lenders resent the recalcitrance of law firms to provide this information, despite the fact that lenders normally require even more information from corporate borrowers. As a result, lenders question either the attitude or the ability of the law firm to be trusted with large sums of cash.

             Maintaining a talented accounting/bookkeeping staff is critical to long-term access to funding sources. It reflects both adequate capability and a cooperative attitude, both of which are critical to keeping a solid long-term relationship to any lender.

X.         CONCLUSION

             Due to the fact that attorneys are, for the most part, extremely well educated and adept intellectually, they frequently fall into the trap of failing to recognize the need for accomplished financial management. This capacity can either be added through the recruitment of highly trained staff or can be brought to bear through utilization of knowledgeable, highly specialized consultants, such as those who comprise the team at Amicus Capital. 

             Failure to successfully navigate the waters of the credit approval process before the storms of financial crises arise is critical to any attorney’s success. Yes, it might have been easier to have been in the marketplace ten, twenty, or even thirty years ago. However, the current environment can still be managed successfully, giving talented attorneys access to the financial resources that are so critical in today’s world.

Look for future discussions prepared by Amicus Capital relating to each of the sections of this introductory article, as well as other topics of interest to trial lawyers in this increasingly competitive marketplace. For any particular questions, please call Bill Tilley, our president, at Amicus Capital Group, (877) 926-4287.