Opinion: Is Your Law Firm Properly Capitalized?
Asking partners for capital can have ramifications. Lawyers do not have restrictive covenants, so if attorneys are not in total agreement with expansion plans or the amount that each is asked to contribute, they may go elsewhere. In addition, there are tax consequences to making capital contributions: Although partners forego the income they contribute to the working capital fund, they are generally still taxed on the income.
• Add together accounts receivable and work in progress. Then, divide by the amount of debt. The resulting number should be greater than five.
• Total debt should be less than 100 percent of the net book value of your firm's fixed assets.
• Your firm's balance on any line of credit should be zero at year end.
• Owner's equity of cash basis balance sheet should be positive and sufficiently liquid to cover at least two weeks of expenses.
• Your firm should not be in breach of any debt covenants.
There are other questions to consider when relying on partners for working capital:
• What should be the initial capital contribution of an equity partner? Our firm sees amounts ranging from zero to $75,000.
• Should your firm require additional capital contributions from partners, and if so, at what percentage? What will be the maximum amount? This often ranges from zero to ten percent, with a maximum of $300,000 in total.
• Should your firm ask an equal amount of capital from every partner? Should a junior partner contribute as much as a senior partner? This contribution amount is often based on compensation level.