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With the economy on the upswing, many firms are feeling flush,
but current success may mask hidden financial danger. Do not let
the economic upswing mask hidden threats to your firm's
longevity. Four financial threats in particular could jeopardize
your firm's financial future:
Excessive Long-Term
Debt
It is not unusual for firms to make investments in areas like
technology and expanding office space. However, if the investment
leads to excessive borrowing, the financing leads to higher fixed
costs. If debt undermines the bottom line, it may be a challenge
for the firm to cover expenses or reward talent. Furthermore, if
your firm's long-term debt exceeds its assets and cash on hand,
then you have borrowed against future partner earnings. This can
lead to long-term financial constraints that limit the firm's
ability to bring in new talent and may even prompt valued partners
to start looking to the exits.
Unfunded Retirement
Obligations
Established firms are often plagued by unfunded retirement
obligations dating back years. These plans divert profits away from
current partners. If more than 1% or 2% of your current revenues
are flowing to inactive partners, these payments are likely causing
undue cash flow constraints. Well-structured retirement payments
can play a key role in succession planning. However, unless they
are thoughtfully constructed, these obligations can negatively
impact partner retention. /
Unwarranted Compensation
Guarantees
Many firms offer large, guaranteed salaries to lateral hires,
typically to those regarded as rainmakers. However, the urge to
expand should not overshadow the need for every attorney to meet
performance metrics. Firms painstakingly develop the incentive
structure in their compensation schemes—guarantees can
undermine this effort. A firm is often rewarded for discovering
talent and providing space for that talent to grow. However, the
guarantees cannot undermine the expected return on investment. The
firm and the lateral hire should have a clear understanding of how
the firm will get a return on its investment. Guaranteed salaries
eat into profitability and can potentially breed resentment among
colleagues. This can push existing talent to seek a similar deal
somewhere else.
Injudicious
Expansion
For law firms, growth is frequently seen as the ultimate
hallmark of success. In fact, some firms seem to expand only for
expansion's sake. However, not all expansion is healthy and
expansion without a strategy has financial repercussions. New
offices may seem great, but they must generate enough additional
revenue to justify its cost. Additionally, acquisitions and mergers
require investments to integrate separate firm systems and
cultures. It is unknown if the combined firm can produce enough
synergy to justify the expense. Expansion will always require
additional investment in the short term. It is essential that the
expansion is underwritten by a reasonable plan to realize a return
on investment. Otherwise, expansion only reduces profits and may
increase debts. This may leave your firm without the financial
agility it may need to capitalize on unexpected opportunities.
Knowledge is Half the Battle
Threat awareness is the first step in securing your firm's
future. Once the threats to your firm are identified, your
financial advisors can help you develop a strategy to avoid or
overcome them.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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