The Business Of Law


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Financial information you must know about your firm
1. Annual Profit and Loss Statement
2. Annual Budget and how it compares to your Profit and Loss Statement
3. Cost to produce each file
4. Your Realization Rate on a global and file by file and practice area basis
5. How your compensation system works for or against your business plan
6. Your time on each file, updated on a real time or continual basis
7. Your disbursements on each file, on a real-time or continual basis
8. Your budget for each file and how costs compare to the budget
9. How your partners and associates are measuring up based on the above criteria
10. What is your overall firm debt and how does it compare to draws, compensation and
11. How is your retirement fund built into your overall office financial plan
12. Does your compensation system reward effort or results

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The Business Of Law

  1. 1. The Business of Law - Internal Controls for a Financially Healthy Law Practice Ronald L. Seigneur Seigneur Gustafson LLP Lakewood, Colorado / 303.980.1111
  2. 2. Table of Contents: The Business of Law - Internal Controls for a Financially Healthy Law Practice 1.  Introduction:................................................................................................................................. 2  2.  Strategic planning ........................................................................................................................ 2  3.  Software for time and billing/accounting/general Ledger ........................................................... 4  4.  Setting and collecting your fees ................................................................................................... 5  5.  Financial information you must know about your firm ............................................................... 5  6.  Alternative Billing Methods ........................................................................................................ 5  7.  Do the Math! ................................................................................................................................ 8  8.  Top 10 Billing Tips ...................................................................................................................... 9  9.  Top 10 Steps to a More Profitable Practice ............................................................................... 10  1. Introduction: The last few years have been tough ones and many law firms along with other businesses were caught in the same downdraft that has humbled the Dow. As a result, some of the highest-flying law firms folded or dissolved, often in a blaze of publicity. Fortunately, signs are present that the economy is perking up again. Surprisingly however, according to the law firm management consultant Hildebrandt International's mid-year report for 2003, many small and mid-size law firms have performed well during the recent slowdown. The strong performers in this category tend to be firms with a well-formed sense of strategic direction and practice focus, as well as a competitive level of profitability and compensation that suits the objectives of most key partners. However, Hildebrandt also reports the increasing level of law firm dissolutions. Hildebrandt believes that these failures all have common themes: 1. Weak management, often with leaders who have lost touch with their partners. 2. High debt levels (sometimes not fully disclosed to partners). 3. A growth plan based on size rather than a well thought out strategy. 4. An eat-what-you-kill compensation system. 5. A lack of core values and institutional loyalty. These firms are now poised to ride the wave as the economy builds steam. In this paper we will explore ways and means to structure your solo or small firm to perform strongly over the next few years. 2. Strategic planning What is strategic planning? Easier to define what it is not – it is not a half-day partner discussion with a facilitator prior to the tee-off times. It is not a statement of "Ends" – ie "We will increase our billings by 35% this year" or "This year we will make a whole lotta money and have a whole lotta fun" etc…
  3. 3. Think Wal-Mart. They have a concept – how to carry on business starting from purchasing, inventory management, store layout, pricing, marketing all the way to sales – which is the final step in the process. In Wal-Mart's case, sales come about as a result of carefully considered decisions – all of which predate the sales decision but explicitly or implicitly support that decision. In their case, strategy is no accident - it is simply the expression of how their business theory is applied in a clear, careful and consistent manner. It is a continuum – from Vision to Consensus to Plan to Execution to Follow-up and Evaluation – and back to consider your Vision and start the process again – aiming to always do it better. Vision: An understanding of what you want to achieve – relative to your market, demographics, your and your staff's skill set, your geographic location, the needs in your market etc. This is a clear understanding of what you can deliver – consistently, effortlessly - with the systems (technological, organizational, personal) that you can establish. This has sometimes been described not as selling what you know but knowing what you have will sell. Consensus: Even if you are a solo, you need to have your staff understand what it is that you are trying to achieve. How many businesses do you know where the staff appear to be at odds with the management – where the underlying message is that the management is out of touch with how the real work is done – or worse, where the staff simply don't care? Some people describe this as the business culture. Clearly communicating your vision is key in this stage.
  4. 4. Plan: Ashley Brilliant said it best: "How can things go according to plan if there never was a plan?" How do you intend on achieving your vision? What steps must be taken to implement your systems? Live and breathe what your proposed clients want, how they want it, when they want it, where they want it etc and take every effort to deliver as promised – or better. Execution: Often strategic plans fail due to unwillingness to put the plan into action – so ask yourself: when and how will you stop doing business as you presently do and start doing things differently? You must start building on your consensus and ensure that no part of your plan is inconsistent – i.e. working against – your plan? Also ask yourself – how are you distinguishing yourself from your competition – how are you telling your proposed clients why you are different and why they should seek you out. Follow-up: If you happen to be diagnosed with high blood pressure – your MD will give you suggestions to reduce your blood pressure – often with drugs, diet and lifestyle changes – and will schedule a follow-up visit to determine the effectiveness of the plan. In your case, you need to set a time limit and evaluative systems in place to determine if your new course is taking you closer or further from your desired objective. Evaluation: While this is the last step in the process, it is really just another beginning – because here you stop – look at what you have done and determine if your vision, your system(s) or your implementation need adjustment. Writers on business processes state that successive incremental improvements have resulted in the greatest gains in productivity in recent history. Having a passion for your vision and using this to continually drive your plan – with reasonable adjustments along the way where you can see the need – is the key to getting better and better and getting closer and closer to the type of clients and practice that you desire. 3. Software for time and billing/accounting/general Ledger There are several options available to you to automate your time and billing process and track the information that you require. Here are several of the more popular options: 1. Amicus Attorney, PCLaw: Amicus Attorney is a practice management package – and PCLaw is accounting software. PCLaw will provide you with the general, trust and billing systems that you need in your practice. Amicus Attorney will provide you with a time keeping interface that is integrated with PCLaw – allowing you to manage your practice in a way that is consistent with how a lawyer works – while allowing the necessary billable time entries to be records in Amicus Attorney on a real-time basis and shipped over to PCLaw via a software link. This allows the accounting software to record the information it needs to record not only to keep you out of ethical trouble but to run your practice from a financial standpoint. 2. Time Matters, PCLaw: Time Matters is practice management software similar to Amicus Attorney with a different user interface – but it is functionally similar. You can achieve similar results with TM/PCLaw as with the Amicus Attorney/PCLaw combination. Time Matters has recently introduced Billing Matters – which provides a greater ability to track billing rates/files and is stated to rival Time Slips. 3. Time Slips, PCLaw: Time Slips is a heavy-duty billing package – allowing you to maintain multiple billing rates, billing methods etc on different files. PCLaw will maintain your financial records as discussed. If you wish to implement a diverse range
  5. 5. of billing methods and be able to track your information – this may be an option for you. This combination can also be implemented with Amicus Attorney. 4. Practice Master/Tabs III: Again we have a practice management package combined with an accounting system – the advantage here is that STI is the developer of both and as such, the 'tie-in' between these two packages is closer than most other combos. 5. ProLaw: This unique package combines both practice management and accounting software in one package – hence their claims to be both a front office and back office combination. They have recently introduced ProLaw Ready – which aims at more the solo and small firm market. 4. Setting and collecting your fees 1. Are your fees based on an hourly rate, fixed fee or modified system? 2. Do you have a written fee agreement that clearly sets forth how you intend on billing, how often you intend on billing and what the expectations are on your client in terms of payment of those bills in relation to performance of any future work? 3. Do you know the gross and net profit margin on your files? 4. Do you have a system in place that tracks overdue accounts and calls for set action based on the age of the account? 5. Once an account is over Y days old, do you send letters to clients notifying them that you are suspending work on their file unless and until all outstanding accounts are paid – and you will cease to be their attorney if the account is unpaid after X days (all in accordance with your fee agreement)? 5. Financial information you must know about your firm 1. Annual Profit and Loss Statement 2. Annual Budget and how it compares to your Profit and Loss Statement 3. Cost to produce each file 4. Your Realization Rate on a global and file by file and practice area basis 5. How your compensation system works for or against your business plan 6. Your time on each file, updated on a real time or continual basis 7. Your disbursements on each file, on a real-time or continual basis 8. Your budget for each file and how costs compare to the budget 9. How your partners and associates are measuring up based on the above criteria 10. What is your overall firm debt and how does it compare to draws, compensation and collections 11. How is your retirement fund built into your overall office financial plan 12. Does your compensation system reward effort or results 6. Alternative Billing Methods 1. Billable hour: This is the traditional method of billing a client based on the hours put into the file. What is wrong with this system? To name a few flaws: it does not allow the client any certainty on the cost of a matter at the outset, it fails to build in any incentive for a
  6. 6. lawyer to increase his/her efficiency (since being more efficient only means that you are billing fewer hours for the same result) and encourages senior lawyers to horde work. 2. Flat Fee: This method at least allows the client certainty on the cost of a legal matter or an agreed upon step on the file. It can be used for great effectiveness by a lawyer willing to examine the true costs of producing a file – being your overhead, all soft and hard costs and all hidden and direct costs. If you set your flat fee higher than the total average cost of doing a certain type of file – and design your fee agreement accordingly with appropriate safety valves if the client or the matter strays too far off the mean – then you are assured of making money over the long haul. Moreover, all benefits of productivity gains fall into your pocket and not the client's. 3. Contingency Agreements: Personal injury lawyers have used these to great effectiveness for years in different jurisdictions. They must be used relative to any ethical limitations in your jurisdiction. The criteria for success here is client screening and file selection – care here pays off in the long term. Poor client selection can result in losses and financial drains on the firm (remember A Legal Action?). 4. Incentive Systems: How do you effectively rejig the dynamics between a client and a law firm, when that relationship is largely a legal one and therefore driven by legal considerations? Jeffrey W. Carr, Vice-President, General Counsel & Secretary for FMC Technologies, Inc. believes he has a solution – by reworking the lawyer-client relationship and bringing the law firm's interests into alignment with the goals and economics of the client. FMC has a patent pending on their system, called the ACES™Model – for Alliance Counsel Engagement System. Here is an overview of their system by way of illustration: What does ACES comprise? There are four parts:. · Aces (Litigation and Project Base Case) is designed for litigation matters or engagements in which there is a definable outcome and time is of the essence. The system is designed to reward the outside law firm for efficiency and for achieving the client's success objectives. · Aces LT is for longer-term retainers without a task-specific objective where the primary objective is high-quality service in a specific area or over several objectives. · Aces² (Aces for Aces) is for casesin which multiple law firms are involved or for multiple cases of a similar type. · Inside Aces is a teamwork-based bonus system for in-house counsel. What do all four parts share in common? An economic incentive for the lawyer or law firm to meet or exceed stated criteria for success by placing 20-25% of billings in a “success bucket.” If the matter is resolved according to defined success criteria, the
  7. 7. lawyer or law firm receives the amount in the bucket and in some cases, a defined bonus as well. So what is in the details? Take Aces (Litigation and Project Base Case). This model is used for engagements where the client has a definable outcome and where time is of the essence. The client defines the success criteria. Then the law firm and the client develop a budget – by grouping the major activities on the file into four or five major steps – such as initial pleadings, discovery, mediation/settlement, pre-trial prep and trial. The overall budget breaks down into target budgets for each major step. For each step, while it is below budget, the law firm is paid 75% of its normal hourly rates, with 25% of the hourly billings being placed in the success bucket as a form of contingency. If the budget for a step is exceeded, the proportion of payment to the bucket is reversed for that step (that is, the law firm receives 25% of its hourly billings, with 75% placed in the success bucket). If the success criteria are met for the file, the law firm will recover the amount placed into the success bucket; if not, that amount is forfeited. If the success criteria are met for the file overall, a bonus is paid to the law firm. The bonus consists of the amount in the bucket plus a multiplier. The multiplier declines as the file progresses – hence the incentive for early resolution. Initially the multiplier is 100% (the file's early stages before substantial expenses have been incurred), then 50% (before trial) and 25% (trial). If rapid resolution is not a success criterion, then the multiplier can be kept constant for the file. A second-level bonus (or penalty) then comes into play. 1% is added to the bucket multiplier for each 1% of the saving for the total matter budget (i.e., if only 40% of the file budget was expended, then the law firm would be entitled to a further 60% bonus points added to the multiplier.) However, if the total budget was exceeded, then there is a point-for-point penalty, reducing the bucket multiplier by 1% for each percentage point of total matter overage. Note that this system can be adapted to time-sensitive transactional matters also – the stages being initial discussion, buyer’s selection, due diligence, contract execution and closing. For retainers that are not time sensitive or longer-term retainers, Aces LT comes into play. In this case, a 20% bonus is based on a report card provided by the client to the law firm on a periodic basis. The evaluation criteria are agreed upon with the firm and are based on such matters as: quality, practicality of advice, reflection of business objective, communication, knowledge leveraging and sharing, timeliness, and efficiency. The 'grades' are Acceptable, Outstanding, and Exceptional. The Aces2 (Aces for Aces) model adapts this system to situations involving multiple law firms or similar cases or projects. Finally, the Inside Aces model provides a bonus incentive to in-house counsel by incorporating a 0-20% bonus of base salary based on a “report card,” graded on the same basis as Aces LT. What are the advantages of this system for the lawyer or law firm?: · There is explicit discussion and agreement on the desired outcome on the file and the time scale for its completion.
  8. 8. · The bonus or success criteria are agreed to up-front. · The law firm is brought into the economic equation – thereby focusing the lawyer's attention on not just the legal outcome of the file but also on the timing and financial outcomes. This gives the lawyer an incentive to achieve successful outcomes on each. · Rapid payment of the law firm accounts is assured. (denise – why not mention the e- billing component?) · Teamwork and collaboration are encouraged between the law firm and the client. · The law firm has incentives to examine the total costs of the file and to take an active interest in driving down, not only third-party costs, but internal costs as well to keep the file on budget. In this model, the very fact of establishing a budget for a file is instructive –as it forces the law firm to explicitly face the issue of their own costs of handling the file. · The law firm explicitly knows the bonus to which it may be entitled, over and above its billable hourly rates and it can see how action or cost reduction will affect the equation · By accepting an Aces engagement and completing it successfully, a law firm shows it is entitled to be on the client's dance card for future engagements by the most basic of marketing criteria – doing a good job as judged from the perspective of the client. 5. Combo Systems: There is nothing preventing lawyers and their clients from sitting down and designing a billing system that combines different components of the traditional billing systems (always with an eye on your ethical limitations, of course). 7. Do the Math! There are several ratios to look at in determining if your practice is 'on the money'1 1. Lawyers income / collected billings = 55 to 60%. This tells you if your income is in balance to your billings. 2. Lag time on collection of accounts. A 105 day 'lag' is typical – too long and you have a collection problem on your hands – indicating that your cash flow is going to be negatively impacted. 3. Actual vs. budgeted costs. If your actual costs are running higher than your budget, you are not living within the financial constraints that you have anticipated. Increasing revenues is the longer-term objective, but due to the 'cash flow lag' in #2 – you should cut costs immediately to forestall a cash flow problem. 1 Based on James D. Cotterman's Capitalization, Debt and Taxes, Report to Legal Management, June 2000 and adapted from a paper Managing the Finances of your Practice by David J. Bilinsky and Dan Pinnington, 2003.
  9. 9. 4. Is your WIP increasing or decreasing? WIP over 180 days / Total WIP = 20 to 40%. If your WIP is increasing – investigate why. Contingency files may pay off in time, but they can jeopardize your cash flow. 5. What are your unbilled disbursements? Total debt / net fixed assets = 50 to 80%. Since disbursements are loans to your clients, unbilled disbursements represent funds that are unavailable for your use. 6. What are your Receivables / Annual billings? 15% is high – 5% is acceptable. By acting quickly and preventing receivables from piling up you are preventing cash flow problems. Increasing receivables is a sign of poor client or file selection. 7. What is your realization rate? Realization rate = Collected billings / Total billings. A low realization rate is a sign that a lawyer is using resources of the firm inefficiently and is unable to collect for work rendered. 8. What are your unbilled fees and disbursements broken down separately by lawyer, client and area of law? By looking at these from different perspectives, you can see where the trouble spots lie and whether action should be taken to correct problems before they cause cash flow problems. 9. What are your daily time summaries broken down by billable time, firm administration, education, pro bono, vacation etc? Are you or someone in your firm not being as attentive to business as they should? Does this indicate problems that are affecting their profession? Here is a quick way to determine how many hours you should be billing a day: Take your desired income – say $150,000 a year. Collected billings should be roughly twice this - $300,000. Factor in bad debts at 10 %. This indicates that you should be billing approximately $330,000 a year. There are approximately 231 working days/ year. This indicates that you should be billing at least $1,400 / day to meet your income goals. ($330,000/321). If you bill at $250 / hour, then you must log 5.6 billable hours/day. 10. What are your client trust account balances? Are there funds in trust that can be applied against billed accounts or accounts that you can render? Are there files or clients that are approaching the exhaustion of their retainers or funds in trust? Do you need to write to your clients and request a refreshment of their retainers? These are a sample of the financial reports that you can investigate in terms of determining if your practice is running on all cylinders. 8. Top 10 Billing Tips 1. Strive for real time billing for improved realization by generating invoices on lengthy matters as the work proceeds or immediately upon completion for shorter projects 2. Efficient recovery of client cost advances is predicated on how the costs are captured and posted to the clients billing worksheet. Consider automated collection devices for photocopies and long distance telephone. 3. Detailed billing statements will often give the client a better understanding of the value of the efforts provided on their behalf. For example, include a “re:” entry whenever entering time for telephone conferences or interoffice conferences, etc. 4. Establish an understanding with clients that they will be billed for email and Internet time when appropriate. 5. Give each new client an orientation as to the methods the firm will use to invoice for professional fees and costs to eliminate questions. Often this step can be accomplished by someone other than the attorney working with the client.
  10. 10. 6. Monitor compliance with contemporaneous timekeeping by all timekeepers to minimize the potential for time not being captured. 7. Coach timekeepers on how best to record their time entries to strive for consistency between individuals. 8. Use a time and billing package that allows time entries that will not be billed to still be reflected on the invoice with an indication of “No Charge” to allow the client to see the value of time incurred for which they are not charged. 9. When billing one client for multiple matters, determine if all matter bills should be sent to the same place/person for approval and payment. 10. Insure all office staff are properly trained to know when they should enter time on given matters for chargeable efforts, such as collating reports, delivery of documents, research assignments and the like. 9. Top 10 Steps to a More Profitable Practice 1. Determine your overall Profit and Loss for last year 2. Compare your Profit and Loss against your forecasted Budget 3. Find out your Profit or Loss on a File by File, Client by Client and Practice Area by Practice Area basis for the last year 4. Select your 5 most profitable and least profitable Files, Clients and Practice Areas 5. Set your Strategic Direction and Vision to pursue the most profitable Files, clients and Practice Areas and drop the 5 least profitable ones 6. Set up your annual Budget – targeting your Annual Income after expenses, your total expenses and your target gross income 7. Determine if alternative billing arrangements can be used to your advantage and structure your systems accordingly 8. Tweak your Compensation/Measurement System so that it supports your strategic plan (and isn't eat what you kill….) 9. Be ruthless on dropping clients and files that do not meet their financial obligations on a continual basis (according to your new written fee agreement) 10. Bill – regularly and often.
  11. 11. Ronald L. Seigneur holds a B.A. in Hotel, Restaurant, and Institutional Management from Michigan State University and an M.B.A. in Corporate Policy and Finance from the University of Michigan. Ron is a Partner of Seigneur Gustafson LLP CPAs, where he is responsible for a wide range of tax planning & compliance services, financial reporting, management consulting, and litigation support & business valuation services. Ron has over 25 years of public accounting experience serving a wide range of closely held businesses, non-profit organizations, and individuals. Ron holds the Accredited in Business Valuation (ABV) designation from the American Institute of Certified Public Accountants (AICPA) and is also a Certified Valuation Analyst from the National Association of Certified Valuation Analysts (NACVA). He is a past chair of the AICPA ABV credential committee and past treasurer on the Colorado Society of CPAs Board of Directors. Ron has been qualified and provided testimony as an expert witness in several jurisdictions on a wide range of issues ranging from complex business valuations, forensic investigations, and various forms of economic damages. Ron has served appointments as trustee, mediator, arbitrator, and special master of the court. He is co-author of the 1300+ page treatise on business appraisal titled Financial Valuations: Applications and Models, published in 2006 by John Wiley & Sons. Ron was inducted as a Fellow of the College of Law Practice Management in 2002 and was inducted into the AICPA Business Valuation Hall of Fame in November 2006. Ron has worked as a radio disk jockey, played guitar in a rock and roll band and has prepared meals for Elvis Presley, Muhammad Ali, and the Rolling Stones in a prior occupation. He has been an adjunct professor at the University of Denver College of Law for over 15 years, where he teaches finance, leadership and management classes and is an author and lead instructor for the Association of Legal Administration's highly acclaimed Essential Competencies training program. Ron is recognized nationally as a discussion leader and author on business valuation science, leadership, and management topics and has been a featured speaker at several national conferences, as well as state bar associations, and the Environmental Protection Agency. Business Services Include: Business Counselors & Advisors to Closely Held Businesses, Tax Exempt Organizations and Professional Practitioners. Some examples of our capabilities include: Income Tax Planning & Compliance (Individual, Corporation, Partnership, Tax-exempt, LLC, Estate, Gift and Trust – we continually invest in state of the art software and advanced training in support of 1,200+ satisfied clients served annually) Business Valuations, Forensic & Fraud Analysis & Economic Damages (work with experienced CPAs Accredited by the AICPA & NACVA in Business Valuation). Financial reporting, including audit, review and compiled financial statements. Special purpose audits and tracing assignments. Implementation and training on QuickBooks and Peachtree accounting software. Strategic Planning, Succession & Transition Planning, and Retreat Facilitation Services (Do it right, but more importantly, do it!) Seigneur Gustafson LLP CPAs is recognized for their service and support to a wide range of individuals and businesses, including high net worth taxpayers, real estate development and management, hospitality and food service, manufacturing, professional service providers, transportation & distribution, oil & gas, retail, non profit organizations and to other select clients of high integrity and their professional advisors. Contact Information: Seigneur Gustafson LLP CPAs; 300 Union Boulevard, Suite 600; Lakewood, Colorado 80228 voice: 303.980.1111; fax; 303.308.6969; email: ◙ / (c) 2007 Ronald L. Seigneur. All rights reserved.