Legal Marketing & PR

The Risk of a Blank Check

By Edward Poll, J.D., M.B.A., CMC

I have warned about the dangers of law firms paying staff salaries and even partnership draws by using their bank lines of credit. In a credit line arrangement, the firm borrows and repays at will up to the amount of the credit line, which the bank regularly reviews and extends, increases or terminates as circumstances warrant.

Such a practice seems simply too risky. If you borrow for payrolls, partner draws and tax payments in anticipation of collecting on accounts receivable and then fail to collect enough to cover the borrowing sufficiently, the result will be a damaged credit rating, not to mention potential civil and potential criminal penalties.

This kind of borrowing is especially an issue at year-end for many law firms, large and small,  one which is generated by accountants’ tax advice to clear out the firm’s cash before December 31 of each year. The problem for many attorneys is that this leaves them little or no reserve to make capital improvements, expand their office or increase the number of attorneys/staff to meet new client needs/demands.

It seems to me that law firms should be able to find a way to accumulate capital, with minimal tax consequences, in order to fund their needs in a down economy without resorting to a credit line. But, lawyers generally don't think this way. A number of years ago, the accounting industry was prepared to fight the legal profession and take us over  until Enron hit. They were confident they would succeed because they could create a capital fund, while lawyers  with a shorter-term vision  always took everything they could from the cash register.

That’s the real issue with using a credit line to pay partnership draws as well as payrolls. Equity partners don't receive payroll, they receive what’s left over (the profits). Too many equity partners think as employees who are entitled to a paycheck, rather than as owners. I disagree with this philosophy.

In a down economy, firms will have to “knock on wood” and hope for quick collection of accounts receivable if they begin the year by having little cash on hand, borrowing to meet immediate needs, and hoping the receivables do come in like they have before. If there’s a miscalculation at a time when even large law firms run into financial and economic difficulty, banks may be reluctant to give credit to any law firm customer, especially ones that view a line of credit as a blank check to tide them over.

Full post as published by Law Biz Blog on December 09, 2008 (boomark / email).