Law Firm Capitalization
Law firms usually generate money using client billing, borrowing from banks and requiring partners to make capital contribution. Because partner contributions generally fund the firm's working capital - or money needed for the daily operation of the firm - this source is especially important to the firm's success.
Working Capital
Every firm's capitalization structure is different; working capital needs to be able to cover cash flow requirements of the firm's billing and collection cycle. It should also be enough to provide cushion for unexpected expense and partner draws during slow months or other periods of shortfalls. This money should be sufficient to fund some of the firm's growth and expansion plans, including the cost of adding new associates.
The firm's capitalization and the amount of partner's contribution depends on the size of the firm, the liquidity of cash flow (how quickly clients pay their bills) and how frequently the firm uses its bank line of credit.
Signs of Capitalization
Under-capitalized firms can hinder both daily operations and long-term growth plans. Some of the warning signs are:
Increased borrowing on short-term bank loans
Aging accounts receivable
Reduced partner distributions, and
Less than two months of a working capital reserve
Possible solutions
Re-evaluate and increase your partners' capital contribution
Examine the working capital needs annually
Examine significant changes in hiring or a rise in client costs advanced
