Improving Management of Hard Disbursements

Improved hard-disbursements management can mean major improvements for firms' financial performance.

In the mid-1990s, the IRS stopped allowing lawyers to deduct as a business expense funds advanced for clients, treating their repayment as income. The agency said such advances should be treated as loans. This policy turned the nation's lawyers into bankers making interest-free loans. Last year, the AmLaw 100 firms alone reportedly advanced more than $4.5 billion in such loans.

Firms typically average about 120 days from the date they pay outside vendors to the date clients repay firms. Most firms lay out the cash and finance these payments on behalf of their clients without charging interest to cover their own cost of funds. Bank borrowings or borrowings from principals as additional capital are needed to pay vendors when firms pay before clients do.

There's a better way, made possible by the availability of outsourced, client-paid borrowing. It begins with adopting a policy like this:

If the firm advances cash or credit on behalf of any client for more than [30 to 45] days, the cost (or 'float') for that loan must be billed to the applicable client to avoid burdening the firm and our other clients with this cost. Clients have three choices in how they wish to handle their hard disbursement obligations: pay the legal matter's invoice in full within [30 to 45] days, provide an evergreen retainer per legal matter, or use an outsourced third-party vendor to finance these costs.

Emphasizing Fairness

The emphasis in this policy is on fairness and client choice. If clients are not responsible for the interest charges their work generates, firms have to raise billing rates, charging all clients more in order to defray expenses and stay competitive for talent. Clients respond with understanding to a plea for fairness, and they appreciate competitive pressures and being given choices as to how to pay for disbursements.

The vast majority of businesses or professions, other than lawyers, charge interest on unpaid balances of longer than 30 to 45 days. Clients are not being asked to pay interest on legal fees, just out-of-pockets.

The overall cost to typical general practice clients that use outsourced third-party vendors is less than 0.25% of their total invoices for the year. Even for IP clients, the cost is less than 1% of the total. Yet the benefits to firms are enormous.

Clients use significantly different levels of hard disbursements for each legal matter, and these charges can be kept separate in their minds. It therefore makes sense to unbundle the costs of funding hard disbursements from billing for related services.

Ending the practice of free financing does not mean that firms need to lower their billing rates. The goal is not to be revenue-neutral to clients, but rather to provide equitable charges to all clients by ending free lending practices.

Partner Capital and Distributions

Implementing outsourced, client-paid borrowing can generate additional capital equivalent to a one-time gross revenue increase of more than 10%. On average at an AmLaw 100 firm, $50,000 to $100,000 of each partner's capital is tied up financing hard disbursements and can be put to other uses as payment is received for receivables outstanding on the conversion date. Of the ways known to increase firms' capitalization relative to their needs, this may be the fastest and least stressful, as it can be accomplished within months of implementation and is the reverse of a capital call.

Partner distributions often have to be limited in their amount or frequency due to cash shortfalls, irrespective of profits. That is, the revenue from accounts receivable is needed to pay down a large percentage of firms' working lines of credit, which is in large part tied up financing hard disbursements. Banks typically require firms to bring their working lines of credit to zero for rest periods each fiscal year. That means they need to use up cash from accounts receivable payments to pay down their working lines of credit. Furthermore, banks often prohibit using borrowings to pay partners. And most firms distribute as much of their profits as possible to partners at the end of the fiscal year, so their cash reserves are low going into the next year. Therefore, cash shortages do occur. Conversion to a new approach frees up the cash.

Simplicity and Flexibility

Prior to adopting such a policy, law firm managers should ask their bankers to bifurcate their working line of credit. A separate working line of credit should be established for payment of clients' hard disbursements, still collateralized by the firm's overall accounts receivable. The bank need not require this line of credit to have an annual rest period, as it is not supporting the payment of partner distributions.

The software and services of outsourced third-party vendors make implementation simple and easy. Firms do not have to develop new infrastructures. One approach uses innovative software employing patented methods and ensures that charges to clients are precisely reconciled against actual interest costs. The software will integrate with most firms' time-and-billing systems to keep track of costs billed to clients. The service calculates interest due, matter by matter, for clients that have adopted the service, and further reconciles the amount due when payments are made early or late. The software ensures that firms are merely passing along actual interest charges and not making any profit on such disbursement charges. If clients pay early, they are refunded the unused interest cost. This is fair to clients, as they pay just for financing they choose to use. Another, older approach is slightly less precise and is based on clients agreeing to a payment timetable and set service fee that is passed along by the firms.

When outsourced third-party vendors can integrate these costs directly into firms' time-and-billing systems, there are virtually no additional efforts by firms and none by their clients in monthly billing and payment operations. Clients experience just an extra-itemized disbursement charge on their invoices; this is little different from paying for soft disbursement costs such as photocopies and postage.

Two outsourced third-party vendors that support this approach offer clients the flexibility to decide whether they want to use their own money or their firms' credit facility for payment of hard disbursements on each legal matter. That is, they can use their own cash or own line of credit or a firm's outsourced vendor. If they choose the latter, clients can decide whether they will commit to paying invoices on a 30-, 60-, 90-day or other basis, setting the finance terms.

In contrast to the simplicity of outsourcing, most other approaches to reducing hard disbursement burdens on firms require significant administrative effort on behalf of both clients and firms. For example, some firms might try to calculate and add interest expenses manually or through legacy spreadsheet programs. This creates a need for an additional process outside of their time and billing systems. Also, if they prebill interest costs to eliminate sending bills for hard disbursement costs after invoices for services have been sent (due to vendor billing cycles), extensive reconciliation is required, as the American Bar Association's ethics guidelines frown on lawyers making profits on disbursements.

Conclusion

The use of software and outsourcing services to manage and fully recover hard disbursement expenses and firms' capital should become an industry standard, similar to the use of systems for soft disbursement cost recovery. It provides a threefold (profit, cash and capital) benefit to firms, and is the only solution that does so without any extra administrative burden on clients.

Steven J. Henry is a partner at Boston-based Wolf Greenfield, an intellectual property firm. He served as managing partner when the firm adopted an outsourced financing approach for hard disbursements.

Improved hard-disbursements management can mean major improvements for firms' financial performance.

In the mid-1990s, the IRS stopped allowing lawyers to deduct as a business expense funds advanced for clients, treating their repayment as income. The agency said such advances should be treated as loans. This policy turned the nation's lawyers into bankers making interest-free loans. Last year, the AmLaw 100 firms alone reportedly advanced more than $4.5 billion in such loans.

Firms typically average about 120 days from the date they pay outside vendors to the date clients repay firms. Most firms lay out the cash and finance these payments on behalf of their clients without charging interest to cover their own cost of funds. Bank borrowings or borrowings from principals as additional capital are needed to pay vendors when firms pay before clients do.

There's a better way, made possible by the availability of outsourced, client-paid borrowing. It begins with adopting a policy like this:

If the firm advances cash or credit on behalf of any client for more than [30 to 45] days, the cost (or 'float') for that loan must be billed to the applicable client to avoid burdening the firm and our other clients with this cost. Clients have three choices in how they wish to handle their hard disbursement obligations: pay the legal matter's invoice in full within [30 to 45] days, provide an evergreen retainer per legal matter, or use an outsourced third-party vendor to finance these costs.

Emphasizing Fairness

The emphasis in this policy is on fairness and client choice. If clients are not responsible for the interest charges their work generates, firms have to raise billing rates, charging all clients more in order to defray expenses and stay competitive for talent. Clients respond with understanding to a plea for fairness, and they appreciate competitive pressures and being given choices as to how to pay for disbursements.

The vast majority of businesses or professions, other than lawyers, charge interest on unpaid balances of longer than 30 to 45 days. Clients are not being asked to pay interest on legal fees, just out-of-pockets.

The overall cost to typical general practice clients that use outsourced third-party vendors is less than 0.25% of their total invoices for the year. Even for IP clients, the cost is less than 1% of the total. Yet the benefits to firms are enormous.

Clients use significantly different levels of hard disbursements for each legal matter, and these charges can be kept separate in their minds. It therefore makes sense to unbundle the costs of funding hard disbursements from billing for related services.

Ending the practice of free financing does not mean that firms need to lower their billing rates. The goal is not to be revenue-neutral to clients, but rather to provide equitable charges to all clients by ending free lending practices.

Partner Capital and Distributions

Implementing outsourced, client-paid borrowing can generate additional capital equivalent to a one-time gross revenue increase of more than 10%. On average at an AmLaw 100 firm, $50,000 to $100,000 of each partner's capital is tied up financing hard disbursements and can be put to other uses as payment is received for receivables outstanding on the conversion date. Of the ways known to increase firms' capitalization relative to their needs, this may be the fastest and least stressful, as it can be accomplished within months of implementation and is the reverse of a capital call.

Partner distributions often have to be limited in their amount or frequency due to cash shortfalls, irrespective of profits. That is, the revenue from accounts receivable is needed to pay down a large percentage of firms' working lines of credit, which is in large part tied up financing hard disbursements. Banks typically require firms to bring their working lines of credit to zero for rest periods each fiscal year. That means they need to use up cash from accounts receivable payments to pay down their working lines of credit. Furthermore, banks often prohibit using borrowings to pay partners. And most firms distribute as much of their profits as possible to partners at the end of the fiscal year, so their cash reserves are low going into the next year. Therefore, cash shortages do occur. Conversion to a new approach frees up the cash.

Simplicity and Flexibility

Prior to adopting such a policy, law firm managers should ask their bankers to bifurcate their working line of credit. A separate working line of credit should be established for payment of clients' hard disbursements, still collateralized by the firm's overall accounts receivable. The bank need not require this line of credit to have an annual rest period, as it is not supporting the payment of partner distributions.

The software and services of outsourced third-party vendors make implementation simple and easy. Firms do not have to develop new infrastructures. One approach uses innovative software employing patented methods and ensures that charges to clients are precisely reconciled against actual interest costs. The software will integrate with most firms' time-and-billing systems to keep track of costs billed to clients. The service calculates interest due, matter by matter, for clients that have adopted the service, and further reconciles the amount due when payments are made early or late. The software ensures that firms are merely passing along actual interest charges and not making any profit on such disbursement charges. If clients pay early, they are refunded the unused interest cost. This is fair to clients, as they pay just for financing they choose to use. Another, older approach is slightly less precise and is based on clients agreeing to a payment timetable and set service fee that is passed along by the firms.

When outsourced third-party vendors can integrate these costs directly into firms' time-and-billing systems, there are virtually no additional efforts by firms and none by their clients in monthly billing and payment operations. Clients experience just an extra-itemized disbursement charge on their invoices; this is little different from paying for soft disbursement costs such as photocopies and postage.

Two outsourced third-party vendors that support this approach offer clients the flexibility to decide whether they want to use their own money or their firms' credit facility for payment of hard disbursements on each legal matter. That is, they can use their own cash or own line of credit or a firm's outsourced vendor. If they choose the latter, clients can decide whether they will commit to paying invoices on a 30-, 60-, 90-day or other basis, setting the finance terms.

In contrast to the simplicity of outsourcing, most other approaches to reducing hard disbursement burdens on firms require significant administrative effort on behalf of both clients and firms. For example, some firms might try to calculate and add interest expenses manually or through legacy spreadsheet programs. This creates a need for an additional process outside of their time and billing systems. Also, if they prebill interest costs to eliminate sending bills for hard disbursement costs after invoices for services have been sent (due to vendor billing cycles), extensive reconciliation is required, as the American Bar Association's ethics guidelines frown on lawyers making profits on disbursements.

Conclusion

The use of software and outsourcing services to manage and fully recover hard disbursement expenses and firms' capital should become an industry standard, similar to the use of systems for soft disbursement cost recovery. It provides a threefold (profit, cash and capital) benefit to firms, and is the only solution that does so without any extra administrative burden on clients.

Steven J. Henry is a partner at Boston-based Wolf Greenfield, an intellectual property firm. He served as managing partner when the firm adopted an outsourced financing approach for hard disbursements.