Your firm is likely the biggest wealth creator you’ll have in your life. Instead of starving your firm by pulling out all the profits, continue funding growth — and accelerating profits — by feeding your firm’s war chest.
It’s hard to start a law firm.
There are a lot of moving pieces and a steep learning curve — especially on the management side. You pour your blood, sweat and tears into this, your new baby, and give it everything it needs to grow and fulfill your dreams.
And then one day, it happens: You get through a month and have money left over. Hallelujah! You do what any sane person would do — you clean out the account and take the money home.
You start to turn a profit pretty much every month. The relief is amazing. You have money! You can make payroll. You start paying some of those bills you might have been stretching out. You start to look at paying down debt.
But what debt do you pay down? Business or personal?
Does it really make a difference? All the cards are in your name anyway. You could pay down a chunk of debt each month — or you could pay down some debt and take more money home to your family.
Suddenly you are back in a cash crunch.
When the Money Starts Rolling In
This is a common place where we meet clients. They are finally profitable in their business. They are starting to take home the money they want to take home and paying down debt — maybe not quickly, but it is going down. Then suddenly, they find themselves back in a cash crunch and they wonder what happened. The P&L says they made money, so why isn’t there any in the firm’s bank account?
As the owner of the firm, you should be properly compensated for the time, energy and risk you are putting into the firm. However, we see this phenomenon frequently when firms start to hit that $1 million mark and are finally making money: The owners start taking 100% of the profit, leaving nothing in the war chest to fund growth.
We call this starving the firm. And I completely understand why it happens.
- Financed the firm on personal credit cards.
- Haven’t bought a new car for a long time.
- Haven’t had a nice vacation for a while.
I think of this as “deferred spending.”
As soon as the owner starts making money, they take it all out of the firm — and this deprives the firm of the money it needs to grow.
Feeding the War Chest and Funding Growth
The downside of funding this extended personal spending is that you are now deferring spending in your law firm. You might have cut back on marketing activities that help your firm grow. You may not be able to afford to hire more people. And let’s face it, the only way a law firm makes money is to bill hours. Without more people, even if you have the cases, your firm isn’t going to grow.
What happens when you have a lot of cases that aren’t getting worked? Client dissatisfaction grows. The last thing you want is to ruin the reputation you have spent so much time building.
In the beginning, the firm received all the extra money at the family’s expense. Then the firm made money so the family got all the extra money at the firm’s expense.
The solution is a balance.
Nobody should get “all the extra money.”
We recommend that half the profit goes into the firm’s war chest and that you take home the other half.
What’s the Purpose of the War Chest?
Your firm is most likely the biggest asset and the biggest wealth creator you have in your life. Having money sitting in an account, ready to deploy as opportunities arise is what will drive and accelerate that wealth and fund growth. Here are good uses of that cash:
- New marketing. Most attorneys would have loved to have a giant stack of cash when Local Services Ads (LSAs) debuted. Firms that had the cash to invest dominated before anybody figured out LSAs even existed, and the effects are residual.
- Hiring a great attorney. Having the cash in the bank to fund a new associate’s first few months of employment until you ramp up marketing and new cases to keep them busy means you can take advantage of the opportunity.
- Funding contingency cases. If you are contingency-based, you know how hard it can be to fund cases. There are lenders out there that have “low cost” lines of credit whose effective interest rate is well over 20%. Funding in-house can save you a lot of money.
- Funding if you are hourly. A few times in your career contingency cases come along that can secure your retirement. Having cash to cover the loss of hourly billing is huge. As an example, I was the CFO at my family’s law firm before I started CathCap. As a corporate litigator, my father had a few large contingency cases come along and he holds the highest judgment ever awarded in multiple counties in Texas. Financing those cases was hard and took many years, especially when you factor in all the appeals. Cash on hand is a safety net for all the unknown factors.
The war chest funds opportunities.
If you take advantage of the occasions opportunity comes along and invest the money in them, your firm will grow. As the firm grows, profit grows, and growing profit means you take more money home. And isn’t that why you started this firm in the first place?
From Panic to Profit: More from Brooke Lively
“Understanding Law Firm Profits and What to Do With Them”
“Building a Law Firm That Pays You First”
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