Invested capital at law firms varies widely and reflects the differing philosophies between firms. The amount invested says something about a law firm’s values, speaks to its fiscal approach and provides commentary about a law firm’s culture. Traditionally, the more capital in a given firm indicated a strong institution with the shared value of fiscal conservatism. Yet not all successful firms view it as vital that its owners make significant cash investments in the firm. For those firms, the adequacy of cash flow and the deferral of most distributions until year-end is viewed as more than adequate capitalization.
Law 360’s recent BigLaw Putting More Cash in Piggy Bank After Firm Failures reports a recent trend among some large law firms to increase permanent capital through a variety of measures, including requiring greater partner buy-in. As Law 360 reported,
“[I]n a recent firm survey, Wells Fargo found that the top 100 U.S. firms by size had 5 percent more permanent capital in the first half of 2014 compared with the same period of 2013.”
Yet the same article acknowledged that the push towards higher capital reserves is not universal and it can be difficult to convince law firm owners to invest more capital despite pressure from lenders and clients.
As a basic matter, a firm that increases its permanent capital has leadership that over-comes the common reticence among lawyers to part with their money. Experience shows that convincing partners to invest more permanent capital can be tough. Success or failure in cajoling ownership to invest more measures ownership’s confidence in their firm and confidence in firm leadership. It can be a telling if the effort is not successful. For that reason, the following facts should be understood prior to making a “capital call.”
The Timing is Never Perfect. Whether a law firm is riding high or struggling, any proposal to raise permanent capital will be met with arguments in opposition. If times are good, management will be met with “we’re fine, we don’t need to raise our capital.” If times are not so good, many owners will balk at investing more money in a firm that soon may be taking on water. There is never a perfect time to raise capital. But if additional capital is appropriate and all other things are equal, leadership should not refrain.
A Capital Raise Must Also Address the Return of Capital. A successful capital raise is not really successful if the capital raised can be quickly and easily redeemed. Most firms increasing capital also couple it with conservative redemption policies. Any firm adding to its permanent capital must not leave the barn door wide open or its “permanent capital” is not very permanent.
Make it Count. While a request to increase capital is never easy, the struggle that goes with the initiative militates in favor of raising an amount that is more than nominal. Inviting blowback for a small increase in permanent capital just is not worth the effort.
Departures May Result. Anytime a firm seeks to increase its permanent capital, fence sitters may decide that have had enough. So before you seek to raise capital, undertake an honest assessment about who might depart and prepare for that possibility. Many times departures are just part of the process.
Gradual is Easier. Many firms increase capital over a number of years instead of demanding that it all be contributed at once. The more a firm can phase in the increase by raising it from yearly distributions over a number of years, the more likely the initiative will be accepted and succeed.
Any program to increase a law firm’s permanent capital will invite controversy. Yet for firms seeking financial strength, as well as improving their standing with their banks and clients, an effort to raise permanent capital can be sound. Have you attempted to raise permanent capital recently? How have you fared?