Profits and Cash

Very small law firms are a pass-through structure like an LLC. Ones that are a little bigger are usually partnerships, and that structure works right up into Big Law, with some variations. As a profession, attorneys are moderately paid, with the national median being nearly $130,000. The average could be $93,000. Or even $50,607. It depends on which statistics you’re looking at. Lawyers who work for other lawyers make a lot less than lawyers who own firms, unless their skills are quite specialized. But no one makes much money if the business isn’t run reasonably well.

Lawyers as a group aren’t known for being good at financial wizardry or even being interested in the business of law. A surprising number of lawyers treat the firm like a piggybank, and as long as there is some money to draw out, they’re happy. This can lead to problems. For instance, was the money there really “there,” or was it earmarked for payroll taxes? That way lies problems. Possibly really serious problems.

While this happens simply and directly in solo practices, partners in Big Law are not necessarily on top of the firm finances either. I talked to a Big Law practice leader who had no idea what the profitability margin of his firm was. Given his position, that was surprising to me.

The piggy bank approach can conceal the true state of the profitability of the firm. Just because there is money there doesn’t mean that profits are being made.

A lot of money must go to the expenses of the firm, the overhead. This includes everything going out: salaries of staff and attorneys, the building, organizational software, insurance, legal research, etc. Overhead is going to be lower for a solo attorney on his own, but much higher once the attorney starts hiring staff, even an assistant. It’s not just the salary. There are matters to consider like payroll tax, unemployment insurance, workers comp, health insurance, employment practices liability insurance, etc.

A rule of thumb for billing staff (attorneys and paralegals) is that they should be earning three times their salary. The 3x number is: 1/3 for salary, 1/3 for other overhead, 1/3 for profit. If they are not earning 3x their salary, they might be working inefficiently, or might not have enough work—or something. To put this in perspective, the load under this formula often works out at around 100 billable hours a month—hardly a crushing burden.

One thing many owner attorneys forget is that their own salary for doing legal work—at a fair market value—is actually an expense of the firm and not a profit. That salary is the attorney’s “job.” If the firm does well and makes a profit, the profit is the reward of the entrepreneur.

A good profit margin to shoot for in a law firm is about 25%. Some firms can do better than that, and others, with a lower profit margin, may not hit that. Some types of law are more profitable than others. But if there isn’t any profit, or a very low profit, something is wrong in how the firm is run. There may be not enough clients, or the attorneys are selecting the wrong type of clients (for instance, ones who don’t pay their bills). The firm may be overstaffed, or be staffed with the wrong kind of people (who cannot get their billing done). There may be inefficiencies on expenses, perhaps extravagances or just unnecessary spending (like subscriptions that aren’t needed). It’s important to identify the problem (or multiple problems). And then the solutions. Maybe you need better business development, better servicing of clients, better training of staff, better financial management. Or some combination of all of those.

But why do we care if there is profit? Isn’t the salary enough? First, running a law firm is a lot of work, and an owner should think twice about doing all that work, on top of the legal work, only to receive a salary that she could get more easily working for someone else. If you’re going to be an entrepreneur, it’s better to be a profitable one.

On a side note, I’ve had people question whether it is truly spiritual to make a profit. Jesus tells a story of an owner who gave his servants money to invest while he was away. Two of the servants made a nice profit and were commended. The third one didn’t even try, and lost both his seed money and his job. (Matthew 25:14-29, ESV). The moral of the story is that if we are faithful with what we are given, it makes our master joyful. It doesn’t sound to me like God objects to profit.

Profit isn’t just nice for the owner/s. The profit is what you use to build up a reserve fund for the firm. A reserve fund is useful in so many ways. It keeps things going in a down time. It creates stability that lets everyone feel more secure. It helps the firm invest in the future, whether in equipment, training, hiring, etc. It lets you make repairs, like fixing the roof. It lets the owner jump on an investment opportunity, perhaps acquiring another practice, or buying a building for the firm.

Remember, if things are bad, the employees must be paid. It’s the law, and it’s also pretty clear from Scripture that is the right thing to do. (The owner does not have to be paid—the way the game is played is that entrepreneurs take all, or almost all, the risks, and they get—if they are lucky—the rewards.) Having that reserve fund lets you plow forward through the bad times. When billing is low, you don’t want to be laying off valuable employees because you have no reserves.

And how do you profitably track your profit? The best way is to physically remove it from the operating fund every month and place it in a different fund. From there, you can build up reserves, pay dividends, etc. Check out the book Profit First by Mike Michalowicz for an indepth explanation of how profit can and should be handled.