First published in the Legal Business World 1st May 2020.
Many Law Firms are today experiencing significant stress. The impact of COVID19 is evident across all sectors of the economy and legal services is particularly exposed. With numerous clients seeking to preserve their own cash by delaying payments, or deferring projects, income for many law firms will be down. And with significant fixed costs of well-paid staff and expensive prime location rents, there is considerable overhead which cannot easily be reduced. As many firms are thinly capitalised, the need for suitable sources of finance which have short term benefit but don’t constrain the firm in the long term has never been greater.
Of the myriad finance options out there, five are likely to be under active consideration by law firm leaders: working capital optimization; bank overdraft facilities, internal funds (partner calls); government coronavirus support; and litigation finance for cases or portfolios. Each has benefits and costs. Some of these levers will be more familiar to management teams than others.
1. Working Capital.
Managing Lock-Up is familiar to many law firm partners. Timely issuance of bills and chasing payments are established disciplines. The challenge today is that clients who themselves are under pressure are pushing back on paying bills already issued. Partners may, therefore, be reticent to chase unpaid bills let alone issue new ones to avoid damaging relationships. Some firms may look to use a factoring company to provide immediate cash flow, but this may suggest the firm is distressed. Others may seek to delay payments to their own suppliers, but this risks reputational damage. A balance must be found to secure cash today without causing longer-term damage.
2. Bank overdrafts.
Firms will have established credit facilities with one or more lender. Where good relationships exist, and covenants allow, it may be possible to seek an extension of agreed facilities in the short term. Whilst base rates have fallen, banks will apply risk-based pricing to any new facilities granted, which may mean costs are prohibitive. Firms will also need to consider the long-term impact of liabilities taken onto their balance sheets – debts will one day need to be repaid. For many firms, bank facilities will be low down the list of preference but may be the default choice where limited knowledge of alternatives exists.
3. Partner finance.
Often seen as a last resort, seeking funding from partners remains an option for many. For some firms, this may be in the form of delaying or reducing partner distributions. This will probably be unpalatable but is usually speedy to implement. Other firms may look to tap partners to inject further equity. This is likely to be particularly difficult in current circumstances due to the personal impact it will have on colleagues in both short and long term. Partner finance is politically unpopular but is likely to be on the agenda of many management teams who have not yet explored other options.
4. Government support.
This is a rapidly evolving area with numerous options, the benefits and costs of which are yet to become clear. Facilities coming on stream include grants for ‘furloughed’ and sick staff wages, deferred VAT bills, loans for SMEs and debt facilities for larger business backed by the Bank of England (though in practise the collateral for these lines of credit may not vary from what bank’s required pre-scheme). Managers should explore all options, but be aware that these facilities are unlikely to be long-lasting, nor cover the full extent of lost income.
5. Litigation Finance.
A perhaps unfamiliar option, here clients or the firm take funding from a third party to cover legal bills. Funding can be structured so that it is non-recourse so is neither on the client’s nor the firm’s balance sheets. This method guarantees payments to firms in the short term and may add a competitive edge in winning work today and for the future. There are few downsides for the law firm providing they ensure a reputable funder is introduced to their client, to protect valuable relationships. Firms may seek to introduce such funding on a case by case basis or engage firm wide on a portfolio of cases.
Law firm leaders are undoubtedly considering all the options available to them. Whilst familiar levers will initially rise to the top of the list, thought should be given to those that firms may yet have fully engaged with. Litigation funding is likely to be one of these. And with such funders in the UK having raised significant sums in recent years, support is likely to be available at both the speed and quantum that firms need to both shore up for today and ensure the firm is on a solid footing for tomorrow. When considering all the options for immediate cash needs, leaders should keep an eye on longer term impact, in both financial and reputational terms.