Law Firm Loans During COVID Crisis
By Jeff Huff, April 8, 2020
Over the past 20 years our team at American Law Firm Capital has been fortunate to work with thousands of plaintiff law firms and hundreds of mass tort lawyers. This lending experience while we were executing during two of the last three financial crisis serves as the basis of this article. Our goal is to help you with the financially related “Business of Law” practices in order to assist you better.
Acquire Capital During the COVID-19 Crisis
First, we’ll quickly review past financial crashes, lessons learned and what we believe that you can expect from our current COVID- Crash. We’ll then move into suggestions and actionable items to help you better acquire loans for your firm.
The Past 3 Financial Crashes
Over the past 33 years, we’ve had three major stock market crashes 1987, the Dot.com Bust (2000 through 2003), and the Financial Meltdown (2007 through 2008). There have also been at least an equal number of mini crashes in between, with the most recent occurring in the last quarter of 2018.
The more immediate relevance of the past three crashed is the last bear market in U.S. stocks which occurred between October 2007 and March 2009. During that time, the S&P 500 plummeted nearly 57%. The recent Corona Virus Crash reached 35% between February and March of 2020.
What lessons have we learned and as a result what can you expect from this newest crash.
Tighter Credit Criteria for Law Firms Loans: Similar to the 2008 housing crash, COVID-19 will have a significant and most likely a much greater impact on the U.S. economy than the 2008 crisis. Expect the amount of due diligence on your firm to increase from your bank or other alternative capital resources, underwriting methodologies will vary depending on the lender and the requirements they have from their capital partners. Whether the capital sources to those entities are the Federal Government, accredited investors, family offices or hedge funds, your firm will be under much higher scrutiny and their due diligence will get much more granular to obtain attorney funding. As a result, fewer loans will be made to law firms and only to those able to show strong character, collateral and sound business practices.
Availability of Capital – Expect once the U.S. Government’s financial stimulus to small business has ceased, capital resources will be much more limited as various sources of capital have taken significant hits on liquidity and their balance sheets. Capital will be looking to take less risk and again be more particular to whom they lend..
Timelines to Fund – As a result of increased law firm funding criteria, availability of capital and lower risk tolerance, expect funding timelines for you to acquire capital will be lengthened.
Rates – With zero percent interest rates should go down, right? Unfortunately, not for lumpy cash flowing law firms whose assets generally don’t meet Federal Banking guidelines, expect rates to go up. As of April 2020, industry rates have already risen as risk has increased substantially. As a result of more fragile balance sheets and unpredictable sustainability of many law firms and defendants, capital will build in additional loss factors. Rates will vary significantly depending on your portfolio type, diversification, the leverage on your firm, your historic track record, business acumen and stability.
OK, considering THE REALITY of all the above, how does your firm Prepare for new capital?
Although he was referencing Isolation in space versus our current isolation at home due to COVID-19, I believe Scott Kelly our local Arizona Astronaut said it well “This is the new reality put a plan in place”
Key Loan Attributes – Getting Your Plan in Order
Character & Disclosure – The first attribute most lenders look at for is the personal character of the firm partners, not your collateral (cases) or your balance sheet. While lenders are empathetic to the target on your back regarding bar complaints, litigation and other claims against you, your personal character is a major indicator to the lender of your stability, ability to perform and protect the collateral they have secured. Always provide full disclosure of any past issues and be prepared with written explanations and supporting documentation. Most character issues can be explained and overcome however non-disclosure may be the kiss of death.
Corporate Documents – Have these documents readily available. They include your articles of incorporation, state certificate of good standing, bar status, operating agreements or bylaws showing ownership and authority, buy-sell agreements, succession plans, employee manuals, partner vesting schedules and bonus programs, all insurance products and any real estate owned by the firm.
Affiliated Companies, Past or Other Firm’s you own – Fully disclose and have clearly defined agreements between all current and past entities you own and/or make payments between. Lenders are fearful of claw-backs, non-market agreements or diversion of income to any entity you may currently or have owned in the past. Expect loan covenants or disclosures regarding all your entities.
Co-Mingling – Never co-mingle bank accounts or other company assets that could jeopardize your corporate veil or confuse your Lender. If employees or other operational costs are shared, again have clear written agreements, inter-company loan documents or fee share agreements in place. If you have multiple firms using the same case managements systems have clearly defined sub-folders or better yet different versions to eliminate confusion of who owns the portfolio of cases.
Co-Counsel Agreements – Have signed, ethically opined agreements in place with all outside co-counsel clearly defining fee shares, expenses and other key criteria agreed upon, a handshake or short email between firms is almost always inadequate and discouraged. Lenders can’t loan you money if they can’t clearly define what assets you own.
Financial Statements & Tax Returns – Lenders understand the legal financial model you have inherited, we use much of your historic financial information to predict cash flow and your ability to repay a loan. They’re also a good indicator of your integrity and business acumen. Be prepared to provide the last two years of your most recent tax returns, three years of your internal financials including the most recent quarter of any year and the personal financial statements of each firm owner with more than 10% equity. Disclose all outstanding liens and loans, providing your track record of past loan performance can also be very beneficial. If you have engaged a consultant or broker, disclose their written agreement including all fees negotiated.
Budget & Cash Flow –In addition to the previous items addressed, “The Actual Practice of Law” and leadership; understanding, preparing and monitoring cash flow is absolutely one of the most important functions you, your CFO or accountant perform. This exercise will help provide a roadmap to execute and give you a solid understanding of your long-term capital needs. It will also keep you disciplined in spending, especially when you receive those nice settlements. Look at your last few years of historical expense information, also predict any other future non reoccurring expenses whether it’s the acquisition of a new key employee like a CFO, new capital expenditures, PSC fees or others. After assembling your budget and use of funding proceeds be realistic about your case values and settlement timelines. The combination of revenue timing and expenses over the next several years will determine your cash flow needs and ability to repay your loan. And of course, always be good stewards of money.
Collateral & Clean Data – In addition to many other functions, accurate and clean data from your case management system reflects the basis of your firm’s portfolio or collateral value. Vendors and your staff all interface at different times and effect different data points. Training of employees and carefully choosing vendors throughout the entire life cycle of a case is something that needs close attention. Vendors that can provide their specific services and integrate them with other vendors while providing and orchestrating training to your staff is ideal. Members of the Mass Tort Vendor Association are good resources to help you. Basic data points to acquire include unique client ID’s affiliated with, but as a separate identifier to protected HIPPA data. In addition, you should be continually tracking the “worked up” status on each of your client’s cases throughout the entire lifecycle of their case. These data points should include but not limited to the current legal status, all qualifying injuries and/or specific qualifying criteria including any medical exclusions and legal items or milestones such as but not limited to SOL and pending trial decisions. Make sure your employees are entering accurate data and using consistent, precise language in the data entry process. Your Lender will need these clean data points to confirm your cases are viable and to help them determine the total borrowing base value of your portfolio, all of which tie back into your cash flow product that determines the loan amount you qualify for and your on-going borrowing needs.
Finally, for some fun it’s time for you to brag!
Personal & Firm Track Record – Show the Lender you can be a partner who can perform. Assemble all awards and accomplishments, show any leadership positions in law or how you give back to your industry and local community. If you have an area of expertise that is material and supports your portfolio, assemble your past track record, it gives your Lender confidence in your ability to execute.
While we could certainly add items to the above and further drill down in many of the above topics, your ability to execute the above Business of Law items orchestrated and in alignment with the Practice of Law will make you a much more viable candidate and could be the difference in your ability to acquire loan proceeds for your firm and the clients you serve.