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The following discussion thread excerpt is from a recent law.com online seminar, “Concerns of Going Solo or Starting a Small Firm,” moderated by Michael Garrett of Garrett & Lynch. For more information on this program and other law.com seminar offerings please visit www.law.com/seminars. MICHAEL GARRETT, GARRETT & LYNCH, HOUSTON, TEXAS Well, here’s the topic of all topics. Let’s face it — we aren’t starting a firm because we love the law so much. We want to earn a living! Financial issues have already been appropriately mentioned in earlier posts. Rather than post some pontifical stuff, let me throw out some general questions for my fellow panelists. � What’s the best way to approach budgeting (aside from the fact that one must actually write it down!)? � What item(s) or category(ies) of expenses do lawyers typically forget or underestimate? � How do you approach budgeting if you’re fresh out of law school? Or, for that matter, if you’ve been with a large firm and had no involvement in finances? � Should you hire an accountant to help you budget? How much will it cost? � What should a business plan look like? � How hard is it for a startup to borrow money? Is it a good idea to borrow? � Should you set your billing rate based upon your budget, or something else? Does it matter? � What percentage of billables should be assumed to be uncollectible? � Practically speaking (if there’s a cash flow crunch) who do you pay first — yourself or your creditors? Why? � What’s the difference between cash flow and budget? P.S. I have a hearing tomorrow, but I promise to check in with my thoughts on the above (for whatever it’s worth). RICHARD HECHT, MARKS, PANETH & SHRON, NEW YORK Michael, thanks for asking just one or two pertinent questions. I guess I should take the first cut at your questions since I’m a CPA. The best way to approach budgeting or preparing a projection for a starting business is to identify someone who is familiar with law firm economics. This doesn’t necessarily have to be an accountant; what’s most important is that the person have experience working with law firms so they know the terminology and the business cycle. A CPA is often a good choice. (Have to plug us a little.) An experienced person will know the normal expenses a law firm incurs, the normal cash flow cycle and how all the financial elements work together. Having a law firm experienced person helps because people often forget nonexpense cash items such as client disbursements needed to be paid to carry cases. These require an outlay of cash but are not considered expenses of running the business since they ultimately are refundable by the clients. You ask how a person fresh out of law school should approach budgeting if they expect to start their own firm! I would refer back to others’ comments that relate to the need to develop expertise that is saleable and a network of people who can refer business. Many people who are thinking of starting their own firm come from large firms and want to control their own lives. Many have been successful if they have worked with their old firms to get them to refer clients that are too small for the old firms to handle. We have a saying that small clients grow into large clients; this doesn’t happen all the time, but happens in enough cases to make this a good strategy for an attorney leaving a large firm. This may be better than taking one large client from the old firm. Coming from a large firm has other advantages; you can use the banking contacts of the old firm for your firm. They are often more eager to lend you money than another bank. There are some downsides in leaving a large firm to start your own. You are accustomed to a level of service from administrative and legal personnel you won’t get in your own practice. Thus, it is important to work with an adviser who will help you develop a financial plan and set up your accounting procedures. It is wise to hire a knowledgeable accountant in the planning stages. It should cost about $2,500 for him to help you put together your financial plan. It is important that the owners of the new firm be active participants in this process. They will learn a tremendous amount about the economics of running a law firm and the financial requirements they must meet. A financial plan should have a revenue and expense piece. The revenue piece should be prepared on two bases. One basis takes into account revenue based upon billable hours; the second, revenue based upon cash collections. Revenue calculated on billable hours is to be compared with the budgeted operating expenses of the firm. If the excess is not enough to compensate the owners, then changes must be made in the plan, i.e., personnel initially hired, rent expense, how much liability insurance to carry. Revenue calculated on cash collections allows the new owners to understand the initial cash shortfall they will have and how much cash they must either invest or borrow to get the firm going. Borrowing money to start a firm is OK as long as the owners also make a significant investment so that there is enough of a cushion to withstand cash flow variances that occur in any business. If you generate collectible time charges (which you also bill in a timely manner), using a bank to fund part of the operations will work. A bigger bank question may be who will guarantee the loans. Banks normally want partners in a law firm to jointly guarantee their loans. The question then arises as to which partners really have the assets to support the guarantee. The billing rate should be set like any other pricing mechanism, what the traffic will bear. Understand that the rates that were used in a large firm cannot be used in a smaller firm, as lower rates for the same personnel is a major reason clients use smaller firms. Ask around and find out what other lawyers in comparable firms are charging their clients. As you quote your rates to prospective clients, it won’t take long for you to find out if they are too high; it’s harder to determine if they are too low, as most clients don’t tell their professionals if they feel they are getting a good deal. On the question of who do you pay first, a part of your projections should be payment to the owners. The cash flow projection will show when these payments can actually begin. The projections will tell the owners how long they need to live off of other resources and at what level of cash receipts they can begin taking draw or salary. It doesn’t make sense to take draw or salary (in a corporate entity) if you have to put the money back into the business. The tendency is that money once taken out of a firm will not be available to be reinvested. A major problem in starting your own firm is figuring out how you will provide yourself cash flow to live on until the firm begins generating enough positive cash flow for the owners to take draw or salary. This is why revenue and cash flow projections are crucial. If the revenue projections are being met, an owner can be more confident in using debt to finance the business and payments to themselves. Without these tools, the risk that you will run out of money, supplied either by the owners and/or the banks is substantially greater. Does this posting scare away some of you potential legal entrepreneurs? It shouldn’t. I only mean to emphasis that this is like any startup business with the same financial, marketing and management requirements. EDWARD POLL, EDWARD POLL & ASSOCIATES, VENICE, CALIF. Michael, your questions are many-faceted and quite inspired. Because you’ve asked so many questions, though, this is a long post in reply. I’ve answered your questions in order and respond in this way: � What’s the best way to approach budgeting (aside from the fact that one must actually write it down!)? There are three parts to a good plan for the sole and small-firm practitioner that I think are important. The first is to develop your goals, things we’ve been talking about until now. What is the area or type of practice that you want to have; who are the people/organizations you want to help; how hard do you want to work, how much time do you want to spend with your family, etc., etc. …? — in other words, your goals. The next part of a good plan is the marketing segment. What do you need to do to get the word out so that you can go from where you are today to where you want to be as set forth in the first section, goals? There are many ways in which to market your services. And I’ll leave that part to Phyllis and others better qualified to do so. But I do want to make one point here: Determine an industry and/or a set of clients you’d like to work with; find out as much as you can about that industry/set of clients, certainly more than any other lawyer … and help them to succeed in ways they never expected a lawyer to be able to do … . Be their “counselor” at law; help them avoid legal pitfalls before they occur … and add value to their business … . In other words, exceed their expectations! And you will have all the business you want. The third part of the good plan is the financial aspect. Put the numbers to paper and use this as your measurement for success. If you meet or exceed your budget, you’ve succeeded. Make changes as time passes and you get more information. I usually approach this part by estimating what my revenues will be and then inserting my expectations for expenses. A client of [mine] said he knew what his costs were and so he started with those. Then, he inserted what revenues he needed to match the expenses, plus a profit for himself. If he thought the revenues looked do-able, he left it alone; if he thought the revenues needed exceeded what he realistically expected to be able to do, he would go back and adjust the expenses first and then adjust the revenues … until he brought both in line with his expectation of reality. Remember, this is a guide only … and needs to be reviewed monthly, not put in a drawer and forgotten. What item(s) or category(ies) of expenses do lawyers typically forget or underestimate? Many people underestimate the amount of the staff expense. Even if they get the number correct for secretaries and others, they most frequently forget to add another 25 percent(sometimes more) for taxes and related benefits costs. � How do you approach budgeting if you’re fresh out of law school? Or, for that matter, if you’ve been with a large firm and had no involvement in finances? Lawyers are bright people; this is not rocket science. The problem with most lawyers is their lack of patience for this subject; that’s not what we’ve been trained to do and we don’t want to create a strategic plan, a budget or think like a business person. We want to get out into the judicial trenches and perform those tasks we were trained to do. Whether you’re coming out from law school or the womb of a large firm, you must think about what you want your future to look like. And doing that will go a long way to completing this process. If you need assistance, hire a law firm management consultant, an accountant, an executive director or other person who has worked in this capacity with law firms in the past. � What should a business plan look like? Obviously, I’m biased. I mentioned the format above that I recommend in order to keep the process simple, direct and most useful. To get a better look at what I believe is the appropriate format of the business/strategic plan, look at my book, “The Profitable Law Office Handbook: Attorneys’ Guide to Successful Business Planning.” � Should you set your billing rate based upon your budget, or something else? Does it matter? Your billing rate will most probably be controlled by the marketplace in your local geographic community. But, you can also be creative and use alternative billing methods. One key here, I believe, is to know what your client’s budget for legal services is. Irrespective of your set fee, if your client can’t pay it, you are working pro bono. And, on the other hand, if you save your client, say $500,000, your fee should most probably be more than $175, even you worked only one hour on his/her matter. � Should you pay your creditors first? This may be an ethical issue more than a practical issue. For my part, I believe my creditors/suppliers, as well as my clients, have made my success, and I owe it to them to make sure their bills get paid before I do … . Having said that, if you are successful, there should always be enough left over to pay yourself also. Many times, this comes down to a matter of timing … and there, always, pay your staff and your creditors first. The long-term discipline and benefits to you will far outweigh a momentary inconvenience. To the participants of this seminar, if you have any questions about creating your own budget or plan, feel free to call me. Ed Poll “Your Practical Guide to Profit” http://www.lawbiz.com (800) 837-5880 CAROL SEELIG, SMALL LAW FIRM CENTER ASSOCIATION OF THE BAR OF THE CITY OF NEW YORK, NEW YORK Setting fees is always challenging — particularly at the beginning. After you have worked out your financial plan, which I, too, encourage you to do, I suggest you pick what you think is a reasonable hourly rate and divide it into the revenue projection you have. This will tell you how many hours it will take you to produce that revenue at that rate. The number of hours may require more than 24 hours in a day or if you are lucky you’ll find you could vacation half of the year. Most people will be some place in the middle. While I agree that a small-firm attorney’s hourly rate should be less than that of the large firm in town, I also believe that a small-firm attorney or solo should bill at the rate comparable to his/her expertise. If you are an expert at something, e.g., applying for SBA loans because you worked at the SBA and developed certain skills, then I believe you can charge a higher rate because in all likelihood you will be more efficient and perhaps produce a lower aggregate bill than your competitor who has a lower rate but not as much experience. If you are charging a higher rate because of your special knowledge or experience, then you must let the client know what the knowledge base or experience is so that they understand why you are charging more. While I hate to be sexist, I find that women (more often then men) charge an hourly rate that is lower than the one required to be competitive. I’m also a firm believer in flat fees. I know clients like it better and it helps you to improve your efficiency. You may lose money on the first few transactions but consider those as marketing loss leaders. This belief in fixed fees is based on the assumption that you will have repetitive products that can build on your earlier projects. ARTHUR BEHIEL, PATENT ATTORNEY, PLEASANTON, CALIF. I have only one comment, and that relates to flat fees. I was working for one client writing patents for a fixed fee. I expected to lose on some cases and win on others. After a stunning series of difficult cases, I discovered that the client never assigned simple cases for fixed fees because she couldn’t see paying so much for them; instead, she assigned simple cases to attorneys who billed by the hour. I was therefore only doing average and complex cases for an average fee. I switched to hourly, and concluded that fixed-fee work may not make sense if your client retains both fixed-fee and hourly attorneys.

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