In our new legal industry research, one partner at an AmLaw 100 firm comments that uncertainty caused by the pandemic has led to “concern about what collections will look like in the fourth quarter.” That view is echoed by 78% of law firm lawyers, who identify the need to monetize legal receivables as a top business challenge.
It is unsurprising that the pandemic has stoked collection fears, as law firms have long taken steep discounts to get cash in the door. A recent study commissioned by LSQ found that 57% of law firms would be willing to discount their bills for faster payments. This comes in addition to Thompson Reuters’s annual legal market research, which shows that realization rates have fallen to roughly 89% in 2019—before the pandemic—from over 94% in 2007.
Law firms have access to new and improved tools to manage cash flow, but those tools remain poorly understood. As firms navigate the downturn, they will need to make use of all available collection mechanisms to maximize revenue and manage cash flow effectively. It is imperative that law firm leaders educate themselves about year-end receivable financing.
Hitting revenue targets: A top concern
AmLaw and Global 100 law firms are all too aware of the importance of hitting revenue targets. Annual revenue and its impact on rankings have a cascade effect on recruiting, partner retention, and compensation.
Unfortunately, our 2020 Legal Finance Report reveals that clients expect to seek pricing discounts to mitigate recession impacts: 59% of in-house lawyers say their companies are likely to push for pricing discounts, and lawyers at large companies, those with revenue over $1 billion, are 12% more likely to agree. This could have a significant negative impact on firm revenue amid stiff competition and challenging market conditions.
Getting clients to make timely bill payments isn’t a new problem, but historically law firms have had limited and problematic options to speed up collections.
Offering client discounts is the typical solution, but it has led to moral hazard and depressed realization. While they incentivize payment, discounts often create a long-term cycle of delay-for-discount behavior.
Traditional financing products, such as factoring and bank loans, don’t necessarily offer relief, either. Loans and similar arrangements cannot be treated as revenue and thus cannot serve as a substitute for fee income when it comes to partner distributions.
These options are of the “last resort” variety, particularly given the availability of new collection mechanisms.
New tools for managing receivables
Law firms now have the option of accelerating or monetizing year-end receivables without using loans, offering client discounts, or resorting to debt collection tools.
These new revenue management tools allow firms to sell sets of client receivables to finance companies, allowing the advance to be booked as revenue. In these arrangements, finance providers offer a one-stop-shop advance against an agreed-upon receivable basket.
These arrangements are true sales with a transfer of title—meaning that that the financier takes the risk if the client never ends up paying—and capital is provided on a non-recourse basis, which means that the agreement is structured as a purchase rather than as a loan, freeing the firm from monthly interest and maturity dates.
Beyond the obvious benefit of creating certainty around cash flow timing, these products offer a range of less obvious benefits:
- Pricing: Finance from specialty providers is priced aggressively, as risk is spread across a wide portfolio of accounts receivable.
- Accounting: Because monetizations are true sales, firms can report the capital as revenue and use it to make partner distributions.
- Client relationships: Finance providers are cognizant of the reputational risks a law firm would face if its clients became aware that bills were being sold at a discount. Finance providers do not act as debt collectors and do not interact with clients. Instead, law firms continue their normal collection process, remitting payments to the finance provider as they are collected.
- Credit: Banks like working with finance providers because they advance cash to the firm, eliminating the need to wait for accounts receivable, with the occasional benefit of boosting a firm’s credit. Perhaps the most important benefit of year-end financing products is that they allow law firms to focus on what matters: Practicing law and winning new business.
Lets firms focus on practicing law
With more than two-thirds of lawyers citing competition from new and emerging competitors as a top business challenge, law firm partners must be laser-focused on new and prospective clients. Year-end financing products allow firm partners to do that by simplifying the number and source of eventual payments, creating certainty around cash flows and preserving deep client relationships.
Exactly how the pandemic will ultimately impact year-end collections is unclear, but firms would do well to assess the full range of collection options available to them. As one law firm leader at a Global 100 firm commented: “[Finance] gives…law firms flexibility because they are essentially cash flow machines.” Fortunately, new revenue management tools can help firms create certainty around cash flow, particularly at year-end.
This article was originally published in Bloomberg Law and can be found here.