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Financing Techniques for Legal Professionals
Financing Techniques for Legal Professionals
By: Wilmington Trust

You've finally done it. You've hung your own shingle or you've built your law practice into a major firm. Whether you're a one-person show or a partner in a 200-person firm, there will be times when you need to obtain a loan for your legal practice. You may want to buy the building that you're currently renting, purchase new computer equipment, or simply employ a line of credit for working capital. Whatever your financing need, you should be thoroughly prepared when meeting with a financial specialist in order to successfully obtain the right financing options.

The first step is to gather financial information, which the lender will need to begin evaluating your request. Typically, the following information is needed:

When you have this basic information in hand, the lender can then begin to analyze your business and evaluate your financing request. Keep in mind that when considering a business loan to a law firm, the lender must assess the risk of the transaction and evaluate how to protect the bank against that risk. Many variables will be considered, including the size of your firm, your type of specialization, and your business plan or projections. Generally, there is a process that is followed and you must be prepared to answer specific questions about your firm and its financial status. To help in your preparation, following is an example of the typical process a lender follows:

Once you have provided all of this information to the lender, you must decide whether you will personally guarantee the loan you are requesting. Often, the size and the financial information of your firm will be the deciding factors in whether the principals (and often their spouses) will personally guarantee the loan. Larger, more diversified firms generally will not have partners sign personally for the loans, which often results in the loan being given on a non-recourse basis. Generally, larger firms are considered to have strong liquidity, high net-worth, strong current ratios (current assets divided by current liabilities), strong cash flows, and minimal leverage positions. Smaller firms, on the other hand, which do not have the same strengths due to their size, may often be required to provide personal guarantees for the loan. Alternatively, hard collateral, such as liquid assets or real estate equity, covenants monitoring account receivables, or a pledge of assets could be used to guarantee and secure the loan to a smaller firm.

The Debt Service Coverage of your firm is another important factor in determining whether you will be granted a loan. The Debt Service Coverage shows how strongly your firm's cash flow covers its debt service. The higher the coverage ratio, the stronger the cash flow. This ratio is determined by taking the Net Cash Flow available for debt service (which is calculated by adding net profit after tax plus depreciation plus amortization plus interest expense) and dividing it by the Total Debt Service (the annual principal and interest payments to be made).

The lender will also analyze your financial statements using either a cash or modified cash accounting method or an accrual method of accounting. A cash and modified cash statement often provides a better picture of your firm's true cash flow and its ability to service debt. However, a lender may prefer to convert cash-basis statements to the accrual basis. In this case, additional information may be necessary, such as accounts receivable aging (which would be added to current assets and net worth); and accounts payable, accrued expense, and deferred taxes (which would be added to current liabilities and deducted from net worth). These balance sheet adjustments would provide a better picture of how your firm performs.

While this may seem like an exhausting amount of information to provide, keep in mind that a lender must not only evaluate the financial status of your firm, but must also understand the history and nature of your firm to provide the appropriate financing to meet your needs. Each law firm is unique, and different firms will require different types of financing depending on their sizes, specializations, and potential growth. When considering financing for your legal firm, take care to find a lender who will work with you closely to evaluate your firm's financial status and help you secure the right financing for your needs.

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.

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