I’ve been writing these posts for thirteen years and a fair share of them have been about clients owing money to your law firm.
I’ve written about better client agreements, billing more frequently, refreshing trust account balances, delegating the process, cajoling clients to pay, fixed fees, collections, dunning notices, and more.
Despite all of my posts, I continue to talk to many lawyers who suffer from a receivables problem.
The lawyer does the work, the lawyer bills for the work, the client fails to pay the bill, the lawyer quite often does more work, the client still doesn’t pay. The lawyer does it again and then again and then again. And the lawyer is upset when the bookkeeper mentions the huge unpaid balance.
Predicting profitability is easy if you know where to look
My eye is drawn to three places when I look at a profit and loss statement.
First, I look at revenues at the top of page one. When the money is flowing in the door, we’ve got something that’s going to work. It might not be working yet, but if we have money, we can use it to fix things. We can solve the too-busy problem, we can fix the lack-of-quality-clients problem, and we can fix the employee-turnover problem. Revenues give us the fuel we need to power the machine.
Second, I look at payroll numbers as a percentage of those revenues. When the payroll exceeds 45% of revenues we’re in trouble. The odds are good that we’re going to have to make some major changes because we’re paying too much and getting too little work in return. That’s a tough problem to fix without firing everyone and starting fresh. It’s difficult to convince anyone that they’re getting paid too much.
Finally, I flip over to the balance statement on page two and look at outstanding receivables. Quite often that number explains the problems on page one. The revenues are too low because we’re not collecting for the work we’re doing, which also explains why the payroll is too high. We’ve got a team of employees who are are doing work that no one is paying for.
I didn’t go to business school, but my lemonade-stand education taught me that working for free isn’t a good plan.
My wife may have a gambling addiction
Many years ago, Lisa and I went to St. Martin for an American Bar Association meeting. I had been a lawyer for a year and had no money. Lisa was in graduate school and had even less.
Dinner each night cost us about $100 and I was freaking out about our increasing credit card balance.
My solution? A timeshare tour, offering a coupon for a free meal plus a t-shirt and $25 in quarters for the slot machine.
We ate the free dinner, and then Lisa fed the roll of 100 quarters into the slot machine, one at a time.
She lost 100 times in a row.
The three bars never matched up, not once. I’m not even sure that’s mathematically possible, but it’s true: she never won even a single quarter.
Her response? She wanted more quarters. I had to drag her out of the casino.
I can’t understand my wife, but I can understand some lawyers who keep extending credit.
They’re not actually losing 100 times in a row–it’s more like 95 times in a row. They get intermittent reinforcement, because some clients actually pay their bills. Intermittent reinforcement is addictive.
But extending credit to most clients is just like putting money in the slot machine; over time, you lose.
P.S. Lisa documents our six years of full-time travel in her weekly newsletter. Don’t count on any casino stories though–she has never been back in another since the loss of all those quarters.
What has two thumbs, a closet full of suits, and lots of receivables?
You are not alone. The biggest “asset” of most law firms is the list of receivables.
Receivables are also the biggest topic of concern, anxiety, and “lies.”
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I don’t think lawyers plan to lie about receivables. But when I ask questions like what’s your hourly rate, how many hours are you billing, what’s your lifetime client value, the answers aren’t quite grounded in reality. Billing clients who don’t pay is a hobby, not a business.
You might as well tell people your hourly rate is $1m/hr, because if you don’t collect, what’s the point?
Law firm bookkeepers have to invent new terminology, like “realization rate,” to turn those “facts” back into words that carry meaning.
The lawyer answers I get always assume the receivables will be paid off in full. They’re won’t be.
And the really big lie is the slightly superior “Oh, we collect 97%.” Funny–all too often, the balance sheet shows otherwise. I’ve stopped believing lawyers’ comments about their collection of receivables. These comments fall into the same category as discussions of the fish they caught last week, or penis size. Collection effectiveness gets exaggerated.
Why do we do this to ourselves?
There are lots of reasons lawyers put themselves in this position.
1. We’re reluctant money talkers
We don’t like talking about money. Mom told us to avoid money, politics, and religion as topics of conversation. How about we send the invoices to mom?
Money talk is uncomfortable for many of us. It’s awkward. The client is upset and wants help. We want our money first. It puts us in a position adverse to the client in some instances.
It’s incredibly easy to tell the client we’ll email an agreement, and then bill them periodically. It allows us to avoids awkward conversations, but it’s a super quick way to grow our receivables. Being comfortable almost always comes at a cost.
2. It’s not done that way
I told the lawyer “we pay ‘net 60’ so just invoice us” and he nodded like what I’d said made sense. I learned that trick from a great business owner friend of mine. He explained that the payment terms are just as important as the price, and that he never paid for anything in advance.
I was a little stunned when the lawyer let me dictate my own payment terms, but he never challenged my suggestion. I owed that lawyer thousands of dollars, and I paid the bill, but he put himself in a very vulnerable position. I’m not above renegotiating the fee after I owe the money and have more control. In retrospect, I probably should have hired a different lawyer after realizing how easily I’d manipulated that first one.
Your business, your terms. You get to decide how it’s done. Does that mean that sometimes you’ll lose a client because you won’t accept their terms? Yep, but you’ll also miss out on not having to collect your receivables.
3. We trust people
I default to trust; it’s my nature. Thankfully it usually only leads to getting ripped off when I’m a tourist in Istanbul. (I love Istanbul, but I’m pretty ambivalent about the taxi drivers and shoe shine guys. Ask me some time and I’ll tell you the embarrassing details.)
Lawyers are taught that lying is bad. Professors try to drill that into us when we’re in law school. We learn not to lie, so we assume others have the same mindset. We trust people despite the fact that we’re always imagining ways in which deals can sour and our clients can get screwed.
We assume a client who promises to pay will do so. We’re wrong. The risk inherent in business is present in our businesses, too. People don’t always do what they promise. I hate to say it, but trusting people to pay their legal bills isn’t always smart.
4. We don’t send bills, then we feel guilty about not billing
Small firms are notorious for not sending bills. I met with a lawyer recently who hadn’t sent out invoices in three months. When she finally ran the bills, she was owed lots of money by quite a few clients. The clients were surprised by the high balances. She’d been busy racking up the hours while she wasn’t busy sending out bills.
The surprised clients weren’t prepared to pay their unexpectedly high bills and asked for more time. She rolled over. Then more time passed, and the likelihood of collection diminished.
Her neglect of the billing process created the problem, then she felt bad because she believed she’d created the problem when she did send the bills, so she further extended credit. She created a vicious cycle of non-payment.
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At the same time, each hour that she worked but didn’t collect on weakened her position with her clients.
A friend of mine who dabbles in real estate investment and has a much higher comfort threshold for being in debt once told me “If you owe the bank a little money, it’s your problem. If you owe the bank a lot of money, it’s their problem.”
The more your client owes, the more leverage they have over you. And our solution is often to let them increase their balance.
5. We believe we’re a good judge of character
Many of us are proud of explaining how good we are at judging the character of others. Maybe we are, in fact, good at it. But, apparently having good character doesn’t always involve paying the lawyer’s invoice in full.
A better way to judge character is to require a wire transfer straight into your operating account. When the money is deposited, you can complete your character assessment. Until the bank emails the confirmation, you ought to withhold judgment.
6. We convince ourselves we’re pricing in some defaults
You can price in defaults by raising your price, or you can compete on price. You can’t do both. But I talk to lawyers all the time who explain to me that they charge rates comparable to the market, while simultaneously explaining that they also price in some defaults.
Let me help you with this: your competition isn’t pricing in defaults. They are eating defaults.
You are matching their prices while simultaneously not getting paid. Big mistake.
7. We feel worth less because we haven’t served them well
This is the classic scenario. We start the case with a deposit into the trust account. We bill against the deposit until the funds are depleted.
Our bookkeeper sends a request for a deposit into the trust account. We keep working and billing against the now-zero trust account balance. But most of what we’re doing is trivial. It all has to be done, but it doesn’t do much to move the case forward. We’re talking with opposing counsel, or checking on the case status, or answering a quick call from the client. The outstanding balance increases, but the case isn’t rapidly progressing.
The bookkeeper asks us to call the client about the empty trust account. We put it off because we haven’t made any progress on the case. The minutia continues, the client’s balance grows, and we don’t ask for the money.
Then something big happens–a trial, or mediation, or some big transaction–and we roll through it because we’re already owed money and we don’t want to jeopardize that balance.
And the big thing turns out poorly. The client had bad facts or the deal fell through or things didn’t work out well for some other reason. The client now has a huge outstanding balance, but isn’t happy with the outcome. What do you do now? There are no good options.
The only real solution
The only solution is to stop extending credit. You just stop.
Unfortunately, some will never stop. Others will ease into it by stepping forward in phases. Some will go cold turkey and simply stop right now.
It’s your call, since it’s your money–well, it’s not really money because it so often doesn’t get collected, but you get the idea.
I push lawyers to go cold turkey, and they explain that their client base doesn’t have the funds to place a deposit into the lawyer’s trust account.
Do you know what I call a client without the funds to pay in advance for my services? That’s somebody else’s client.
I get it, though–you want that client even if they won’t pay everything they owe. Look, if you’re going to give away your time, I’d suggest giving it to your marketing effort, in order to attract clients who can pay in full. Marketing has a compounding effect that grows your business. Writing off receivables isn’t a growth activity. Marketing is.
If you’re going to take on pro-bono cases, it should be for work you choose because it gives you some emotional and spiritual fulfillment, not work where you just got stiffed on the bill.
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I’ve been writing on this particular issue for more than a decade. Some of those receivables have gone unpaid for longer than I’ve been writing. You know that’s true.
The question is–have you had enough? Are you done? Are you ready to get paid? If so, then you know what to do.