Will You Avoid the “Credit Crunch”?

Published November 27, 2007

Lawyers might need a bank loan for any good reason: to finance growth, recover from a disaster, meet unexpected expenses, or purchase new technology. Given that for weeks the daily news headlines have talked about the ongoing “credit crunch,” with bank financing suddenly drying up despite the recent lowering of the Federal Reserve interest rate, should lawyers be worried that they won’t get the credit they need?

The simple answer is, no—not if they created and have maintained a good relationship with their banker. They may face a modestly higher interest rate than they paid before, but they will still be able to get a needed line of credit. Bankers view and understand any law firm as a business, with cash flow, receivables, revenue, and profits. Lawyers should educate their bankers on how their business operates in order to build a relationship of trust. Then, when “crunch” time comes, the foundation you’ve established will be one on which you and your banker can rely.

However, lawyers can and do take foolish steps to jeopardize that foundation. For example, no matter how fast the firm is growing, it is never a good idea to pay staff payroll using a bank loan. If you borrow for payroll and payroll tax funds in anticipation of collecting on accounts receivable and then fail to collect enough to cover payroll and taxes sufficiently, the result can be disastrous. Remember that your clients themselves may be affected by the credit crunch, and may as a result become slow-pay or no-pay clients. The rationale for keeping constantly on top of your collections could not be clearer.

Another potential problem: sole proprietors often consider drawing from a line of credit to pay themselves for the month. Their rationale is that they are not going to go too deeply into debt for such a purpose and they have cash that’s due in at any time. The real issue here pertains to the rationale on which the line of credit was provided. This is a contract issue between you and your bank. However, using a bank line of credit to pay yourself is just as risky as using it to meet the firm payroll, and for the same reason. Too often the anticipated payment or new work doesn’t materialize. Then you have a major problem with the lender…and your line of credit will indeed be jeopardized.

Categorized in:

Audience type: Administrators, Associates, Large Law Firms, Small Law Firms, Sole Practitioners