Starting a Small Law Firm
Or Solo Law Practice
After grinding away for years in the law factory, you come to the desperate conclusion that the only way you are going to maintain your sanity is to go out on your own….
Your law firm decided to downsize and you got caught in the pinch. Now you are having trouble finding another job and you realize that if you don’t start your own practice, you will have to start waiting tables…
You have been passed over for partnership twice and you are beginning to think you are going to be an associate for life…
You cannot bear the thought of going to another partner’s meeting and deal with the politics and petty back biting…
These are just a few of the reasons that propel lawyers into those frightening waters of starting their own law firm. Too often they jump into the venture with little planning and make the startup and the first three years a nightmare of financial uncertainty and organizational hell.
The good news is that the vast majority of lawyers who start a new small practice succeed eventually. Many even exceed the income levels they attained when in large firms. But most lawyers struggle terribly in their first few years out and the financial and emotional strain can have lasting effects on them and their families.
With some careful planning, this stress can be minimized, and in many cases avoided.
Too often attorneys begin a new practice as a desperate reaction to some intolerable condition. This spontaneous thrust into the marketplace leaves them unprepared for the subsequent series of rude awakenings that follow. The most prominent of these are capital requirements and administrative time demands.
Before you start a new firm or solo practice, it is very important to assess your capital resources. More businesses fail because of lack of capital than bad management. It takes a period of two to three years for most small businesses to get to the point where the business is producing enough revenue to cover the business expenses, income taxes and the personal expenses of the owner. This is called turning the corner. Until you turn the corner, you will be drawing on the capital resources you have available to avoid insolvency.
The first assessment to make is whether available cash resources will be sufficient to keep paying the business and personal bills until there are enough client billings to turn the corner. To evaluate this properly, you need to start at home to assess your personal cash needs.
You should reconstruct your spending categorically for the previous year to get an idea of your personal cash needs. If you have a personal accounting program on your home computer, this will be an easy task. If not, go through the checks you wrote last year and create a spreadsheet to log them by expense category (better still, get a personal accounting program and enter the historical data). Then based on the results, create a budget for next year to determine how much cash you will need each month.
Your next task is to create a budget for your business for the next three years. There are two types of costs you need to assess: startup costs and operating costs. Startup costs include costs for furniture and fixtures, office equipment, computers, software, law library, malpractice insurance, deposits, initial inventory of office supplies, telephone equipment, stationery and numerous odds and ends that you will need to open the doors. Generally I have found these expenses run between $25,000 and $50,000 to open a reasonably presentable office with new furnishings from scratch.
There are other alternatives that can greatly reduce startup costs. You can rent fully furnished turn key office space in an executive suite or as a space sharer with a mid sized law firm. Generally this will eliminate the need to buy furniture, phones, and office equipment, but you will still need a computer and the software to run it. These office arrangements present a good image and keep your startup costs down. Remember however, this solution can increase your operating costs substantially. Rent will be much higher per unit space and many things you use will be a la carte.
Another alternative to keep startup costs down is to lease furniture, fixtures, office equipment, etc. Once again, this will get you started with a smaller initial investment, but in the long run, the increase in monthly operating expense will more than cancel the benefit. Remember, most leases have an interest rate of 20% to 25% built into the lease payment. You would probably be better off charging the startup costs on a low interest line of credit at 12% to 14% and revolve it until you have sufficient cash flow to pay off the debt.
Finally, it is possible to create a virtual office and work from home for a while. While I don’t recommend this for the long term, it is possible to make an arrangement with a solo or small firm to pay them a small amount monthly (perhaps $200 per month) to let you use their mailing address, put your name on the door, and use the conference room for client meetings. Your phone and fax will ring at home, but you meet clients at the office. The clients will have no idea that you don’t have an office there.
After you determine your startup costs, you should make a budget of monthly operating expenses. Be very liberal when estimating expenses. That means budget more than you think you will use. It is better to be prepared to pay more and then come in low than the other way around. Some expenses will be paid annually (like insurance, bar dues) but you should spread them over 12 months to get a better estimate of average monthly expenses. Below is a list of common expense categories:
- Accounting Expense
- Answering Service
- Bank Charges
- Bar Dues and Other Organizational Dues
- Continuing Legal Education
- Interest Expense
- Investigators and Process Servers
- Employee Benefits
- Equipment Maintenance
- Law Books and Periodicals
- Marketing Expense
- Office Lease
- Office Supplies
- Online Services
- Staff Salaries
- Social Security and Medicare Matching Expense
- Unemployment Tax
When you finish your budget and have every category you can think of, add another for miscellaneous expenses at $500 to $1,000 per month.
Next you should estimate the gross personal income you need to take home enough money to pay your personal expenses. A good method of doing this is to take your total monthly personal expenses and divide that number by .60 (assumes you will take home 60% of your gross personal income and pay your bills with it). You will probably take home more than that, but let’s err on the side of conservatism. When you add all your business operating expenses together including income taxes, you will know the amount of gross revenues necessary for you to turn the corner. A brief sample is seen below.
Personal Expenses = $6,000
|Monthly Business Operating Expenses||$5,000|
|Estimated Gross Income Needed (6,000/.6)||$10,000|
|Monthly Gross Revenues To Turn The Corner||$15,000|
Now that you know how much money you need to turn the corner, you can estimate what you will need in cash resources to keep your business afloat while you are building your client base. Cash resources come in the following forms:
- Liquid Assets (stocks, bonds, etc.)
- Credit Lines
- Home Equity Lines
- Loans From Relatives
To calculate the minimum amount of resources you should have available do the following:
- Calculate the Annual Gross Revenues needed to turn the corner by multiplying the monthly Gross by 12.
- Add the amount of your estimated start up costs.
- Subtract the amount of your spouse’s gross annual income.
- Subtract the amount of solid commitments you have in business from portable clients (be conservative).
The result is the amount of resources you will need to stay afloat for one year if no additional clients come in. For example:
|Annual Gross Revenues Needed ($15,000 x 12)||$180,000||$180,000|
|Plus Estimated Startup Costs||30,000||210,000|
|Less Spouse’s Gross Income||50,000||160,000|
|Less Portable Business||60,000||100,000|
|Total Resources Needed||——-||100,000|
This is a very conservative estimate because it assumes you will get no new clients for a whole year. and that is highly unlikely Keep in mind however, that it might take two years to turn the corner so it is possible you could use all these resources before the tide turns.
In this example, you should have $100,000 worth of cash resources including savings, liquid assets, credit lines and family cash resources before you start your business. This doesn’t mean you need to keep $100,000 in cash lying around, but only that you need to have the resources available to have cash ready if and when you need it.
If you are currently employed and you own a home, you should apply for the largest home equity line you can get. This allows you to deduct the interest on some of the money you may have to loan yourself. If you wait until after you leave your current job, you may not qualify for the loan because you are self employed. Also, shop around and look for credit cards that offer a lower rate of interest (there are cards that offer interest rates of 12% or lower) and no annual fee. Apply for these cards and when you get them, put them in a drawer for an emergency. I don’t encourage taking on consumer debt, but these cards can save your bacon if you reach nail biting time.
A few months before you leave, you should take your local commercial banker out to lunch to discuss your future. It is important to establish a relationship with him/her. Tell the banker that you are about to go out on your own and that you are interested in getting a line of credit for your new business. If you are solo, it is very difficult to get this unless you have a good relationship with your banker, a very strong personal financial statement and impeccable credit. However, if you present the banker with a well written business plan including three years of financial projections, a detailed description of where the business will come from, a description of your experience and the focus of your practice, you do have a long shot at getting an advanced credit line to cover your startup expenses. The more partners you have, the greater the chance the bank will extend credit because they have more people they can hold personally accountable for the note. This mitigates their risk and makes them more sanguine about getting paid back. Even if you don’t qualify now, this relationship will be good to have down the road and you can revisit the application when your revenues are better.
One of the factors that most surprises lawyers in a new solo or small firm practice is the amount of time they spend on firm administration. Most attorneys who easily billed 150 hours per month in their old law firm find it difficult to get to 100 hours. There is a host of administrative tasks you will now undertake to keep your business going. You will become the billing clerk, the receivables clerk, the payables clerk, the office manager, the bookkeeper, and the payroll clerk, just to mention a few.
In addition to that, you will have to spend far more time engaged in marketing activities. This will mean more time on the telephone on non-billable calls and probably a total of 300 to 500 hours per year.
You should plan on about 800 hours of administrative work per year if you are a solo with no secretary. With a good full time secretary you can cut that down to about 300 hours (remember you have to manage the secretary). This means if you take marketing time into account, it will be very difficult for you to bill over 1400 hours as a solo, even with a full time secretary. The first year is the worst since you are trying to set up your office and marketing your tail off to bring in business. Most solos fail to reach 1000 hours in their first twelve months, even if they have the business to bill. For most solos, I find that a good goal is 100 billable hours per month or 1200 per year. 1400 hours per year is a heavy load as a solo.
It is important to keep this in mind when you are planning your revenues. If you are planning to charge $150.00 per hour and you bill only 1000 hours, your maximum revenues (assuming all the receivables come in) are $150,000. Given our example above, this would not be enough to turn the corner. This would force your price point to at least $180 per hour if 1,000 hours is your target. Naturally, i recommend setting your rate much higher at a rate that is typical of the market.
After you have launched your new practice or small firm there are two key considerations: marketing and efficiency. Initially, the most important is marketing. Most new practices spend an inordinate amount of time setting up the office and very little time marketing. Then four months later they have a finely tuned law office with no clients. Below are some important initial tips to get your marketing started:
- Mail announcements to everyone you know (make sure you include what your practice focus will be).
- Join at least two organizations that can lead you to business.
- Schedule at least three lunches per week with potential referral sources, especially professional friends, like other lawyers and accountants.
On the practice management side, track your financials very carefully. Don’t wait until the year is over to have your accountant tell you where you stand. Set up your finances on your computer using a small business software package like Quickbooks, and track your revenues and expenses assiduously. You should also purchase timekeeping softwre (unless you are in a contingency practice) and diligently record your time. One of the biggest sources of lost revenue for solos is forgetting to record their time. To avoid losing hours, you must record your time as you complete each task. Even doing it at the end of the day will cause you to forget many small fragments that might cost you three or four billable hours per week. That could mean over $1,000 per month in lost revenues.
For solos and small firms, cash flow is vital. That is why it is critical to ask for retainers and keep a close eye on receivables. If clients fall behind, you should immediately call them to get them current. If they don’t respond, you should withdraw from their matters giving proper notice per the requirements of your local bar association.
Starting your own firm can be an exciting adventure or a terrible ordeal. With proper planning and anticipation of what to expect, it can be your ticket to freedom, fulfillment and control of your own destiny. Start out recklessly and you might find your ship dashed on unmarked shoals. So plan your voyage carefully, market effectively, work diligently, and you will create a strong practice that will transport you to a New World of financial and personal freedom.
Copyright © Art Italo, 2015. All Rights Reserved
Other Articles by Art Italo:
The Benefits of Hiring a Consultant
Marketing for the Small Firm and Solo Practitioner
How to Set Your Retainers and Fees
Improve Law Firm Marketing Using Leveraged Networking
Art Italo is a consultant working exclusively with attorneys in the areas of legal marketing, strategic planning, law practice management and success coaching since 1992.
He has developed and refined the concept of Leveraged Networking after over 15,000 hours of individual consultations with attorneys. He has personally consulted with over 500 attorneys in Atlanta and across the U.S. with practices ranging from solo practitioners to partners with major firms. Art has more than 35 years of marketing and management experience and holds an A.B. from Brown University and an M.B.A. from Pace University.
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