Partnerships and Access to Capital

The partnership model does not work well for “access to capital”. It is also not good for the partners. Law firms tend to sputter for a few years before they vote to dissolve or rise from the controversy. To the unobservant or hopeful, when the dissolution does occur, it can look like sudden collapse, but the seeds can be seen long before. Poor communication, “Alpha Attorneys”, divergence of vision, lack of spending control, no “bigger picture” thinking - these all set the internal groundwork for dissolution. The warning sign that some or all of the above are at work can be seen in the “cash flow gap”. The wider the gap the more concern there should be.

The cash flow gap is the difference between when your client pays you and you pay your expenses. Converting unbilled time to billed time takes usually around 60 to 70 days and billed time to revenue takes usually 60 to 80 days. Accounts payable turns every 30 to 35 days and employee salary obligation every 14 days. So you have 120 to 150 days to your revenue cycle and an expense cycle of 14 to 35. The gap then is roughly 106 to 115 days. (This is a simple example model; many other factors enter into play here.) Where does the money come from to fill the gap? And what about the “added” expenses caused by the blessing and curse of growth?

The trigger to dissolve ailing partnerships often comes from “debt accountability”. Debt accountability has its roots in a psychological component called “debt tolerance”. People make up partnerships and partnerships take on the “habits” of the people who run them. If your partners are “risk” tolerant people they will tend to finance a growth and cash gap with debt. If they are “risk adverse” people they will tend to fund a growth and cash gap out of equity. To fund out of “debt”, you have to have access to debt capital. To finances out of “equity” you all have to believe your “business” is a vehicle of wealth creation and not just a revenue stream. These are two very different views. Both, in the end, must be “accountable” to the reality of the internal and external mechanisms at work. Grow too fast on debt and you may be easy prey for ill economic winds, client slowdowns or attorney defections. Basically, you grow yourself into bankruptcy. Grow too slow from equity and you may find your market opportunities limited.

Banks, landlords and private equity markets like to have their investment secured. In the case of partnerships, they seek security in the personal assets of the partners. Law partnerships can call themselves LLC, LLP or PC or whatever else they want, but when it comes to “doing the deal”, you can bet your bottom dollar that the landlord or bank is going to have as many signature lines on the documents as they can get, with a clause to blow past any shield. No matter what the structure, “creditors” know that law firms run themselves like “partnerships” and partnerships are inherently fragile. Because of this, “creditors” don’t pay any attention to the LLC, LLP or PC status when it comes to doing the deal. They want their investment secured and they get it. You don’t have to look at the little guys to see this. Consider Perterson Ross or Brobeck. for example. Citibank was Brobeck’s bank. When Brobeck’s line of credit and Brobeck’s partnership infighting both hit the fan together, that was the ball game. These debts follow the partners for years.

Renewal of lease agreements or negotiating lines of credit, etc., all lead to soul-searching on the part of “partners” since they know they will have to lay their personal assets on the line. If the “emotional” aspects of “partner relations” are out of whack then that soul searching quickly turns into new firm shopping, as loyalty slips away. In Brobeck’s case, as best I can research, each partner’s share of the red ink bank debt was around $430,000+/-, on yearly incomes that had peaked at 1 million+/- each. If the partners really understood each other’s motives and goals, could they have fixed what ailed them? I know they could not do it unless they believed in each other's abilities and goals. As I said earlier, “equity” investment means you “all have to believe your “business” is a vehicle for wealth creation and not just a revenue stream.”

Instead, clients become footballs and more often do not follow the attorney at all. The clients jump ship to yet other firms. Employees also begin to be viewed as commodities. Those perceived as strategically important in the shifting sands are reassured behind closed doors. Others are ignored. Mentoring is forgotten, in most cases, as survival mode kicks in. I am happy to say that there are rare examples of partners taking offers with firms because the new firm is willing to take on a larger group of employees. The partner does this not because it is the best package for them personally, but because it is best for the people who relied on them. To those few, I tip my hat with respect.

Even when partners make the choice of a new firm, there will be a certain percentage that will be “loose in the socket” and move one or more times. This shake out is as much about individuals finding themselves as about finding a place to practice. This process can play out for years.

Access to capital and true liability protection can be created under a true corporate structure by an organization that runs like a true corporation. The current corporate structures are more than enough to get the ball rolling in the right direction, but it has to be part of the actual operational structure and strategy, not just a tax structure document. The organization must protect itself from the ill winds of personal habits, goals and self interests.