Hourly-billing law firms usually borrow on a bank line secured by their fee receivables and sometimes their unbilled time, with the partners guaranteeing it. Banks lend against billed fees that are current, exclude old or disputed invoices, and set covenants on partner distributions and an annual clean-up. Client trust funds are never collateral. Contingency practices are a different credit: their fees arrive only when cases resolve, so banks lend to them less often and specialist lenders underwrite the case portfolio instead. The most common trouble is a line that funds partner draws rather than working capital.
- Hourly and flat-fee firms
- Bank line against billed fees, sometimes unbilled time; partners guarantee
- Contingency firms
- Specialist lenders underwrite the case portfolio; bank lines are less common
- Never collateral
- Client trust account funds and retainers not yet earned
- Cash pattern
- Collections bunch toward year-end; draws, payroll and rent run all year
- Key covenants
- Annual clean-up, limits on distributions, notice of partner departures
Two kinds of firm, two kinds of credit
Lenders do not see "law firms". They see a way of getting paid, and a law firm's fee model decides what it can borrow against far more than its size or its practice area does.
| Fee model | When cash arrives | What a lender can lend against | Who usually lends |
|---|---|---|---|
| Hourly business and commercial work | Monthly bills, paid on the client's schedule; much collected near year-end | Billed fees, and sometimes unbilled time | Banks, many with a professional-practice group |
| Insurance defense | Hourly bills to insurers under billing guidelines, often reduced on review | Billed fees, net of the reductions insurers typically make | Banks |
| Flat-fee and transactional work | At closing or on completion of each matter | Billed fees; little unbilled time to speak of | Banks, on cash flow |
| Contingency plaintiff work | Only when a case settles or a judgment is paid, often years after it is taken on | The portfolio of open cases, and the firm's record of resolving them | Specialist lenders; some banks for established firms with long fee histories |
Most firms mix models, and a lender will ask for the split. A general practice whose hourly work covers overhead while a few contingency cases supply the upside can get a bank line sized on the hourly side. A firm whose overhead depends on contingency fees usually cannot.
The hourly firm's cash year
Lawyers record time, which sits as unbilled work until the monthly bill goes out. Some of it is written down before billing, and some of what is billed is never collected. The ratio of what the firm collects to what its lawyers' time was worth at standard rates, its realization, is the number a lender cares about most, because it shows how much of the unbilled time will ever become cash.
Most small and midsize firms are partnerships or professional companies whose owners pay tax on the firm's profit as it is earned, and many keep their tax books on a cash basis. Firms therefore work hard to collect before the year ends and distribute nearly all of their profit to partners. January starts with little cash in the bank. Partner draws, associate salaries, rent and last year's bonuses all come due while this year's fees are still being worked and billed.
That is the shape a law firm line is built for: it rises through the first part of the year and is repaid from year-end collections. It is also why banks ask law firms, more than most borrowers, for an annual clean-up, a stretch when the balance must sit at zero. A firm that cannot clean up its line is borrowing to pay its partners, and the bank knows it. On reading cash-basis statements, see cash vs accrual financials.
What a bank lends against, and what it cannot touch
A bank line to a law firm is usually sized in one of two ways. Smaller or newer firms get a cash-flow line, sized to earnings and tested for debt service coverage, where conventional banks commonly look for at least 1.25x. Established firms often get a formula line: an advance against billed fees that are current, plus, at some banks, a lower advance against unbilled time for firms with a strong realization history. Billed fees drop out as they age, commonly once they are more than 90 days past invoice, and so does unbilled time that has sat too long without being billed.
Some things are off the table whatever the lender's appetite:
- Client trust accounts. Money held in trust belongs to clients. It cannot be pledged, swept or set off by the firm's lender, and a lender will want it held in accounts clearly kept apart from the operating account.
- Retainers not yet earned. An advance fee deposit is the client's money until the work is done, and a lender treats it that way.
- A share of the fees. Professional conduct rules restrict lawyers from sharing legal fees with people who are not lawyers. Lenders are paid interest on a loan to the firm, not a percentage of a case or a matter.
Guarantees follow the partnership. Banks usually ask each equity partner to guarantee the line, sometimes only for a share of it in proportion to ownership rather than the whole amount (compare limited and unlimited guarantees); see personal guarantees on a line of credit. Some banks also lend partners money personally to fund their capital contributions to the firm, which ties each partner's personal credit to the firm's.
Contingency practices
A contingency firm spends heavily long before it is paid. It pays for experts, depositions, medical records, filing fees and trial preparation on each case, and often for advertising to bring cases in. Its fee arrives only when a case resolves, and the timing is set by courts, defendants and insurers, not by the firm.
Banks that lend to contingency firms look for a long record of fees actually collected, from many cases, and lend on that cash flow rather than on any single case. More often, contingency firms borrow from specialist lenders who underwrite the case portfolio itself: case types, how far each has progressed, the defendants and their insurance, and the firm's history of resolving similar cases. That lending costs more than a bank line and is usually structured as a loan to the firm, repaid from fees across the portfolio rather than tied to the outcome of one case.
A single large fee expected next quarter is not a repayment plan a lender will accept. Lenders lend against the firm's record across many cases, not the one it is proudest of.
Covenants and reporting
Beyond the clean-up, the covenants on a law firm line center on the partners, because they are the firm's cash flow and its collateral walks out the door with them. The general catalogue is in the covenants on a line of credit.
- Limits on distributions and draws while the line is drawn, or if coverage slips; see restricted payments.
- A minimum level of partner capital kept in the firm.
- Notice to the bank when an equity partner leaves, and in some agreements the right to reduce the line, or treat it as an event of default, when a named partner does.
- A monthly or quarterly aging of billed and unbilled fees by client, and a realization report.
- Annual financial statements and the firm's and partners' tax returns.
- Operating accounts at the lending bank, with trust accounts kept separate.
What trips law firms up
- The line that funds draws. Partners draw monthly while collections lag, and the line carries the difference. By December it has not come down, and the renewal becomes a negotiation.
- A rainmaker leaves. Clients tend to follow the lawyer. A partner who controls a large share of billings and leaves with them can reduce the borrowing base and the firm's cash flow in the same month.
- Aged unbilled time. Time that sits unbilled for months is rarely collected in full. Lenders stop counting it long before the firm writes it off.
- Cash-basis books that hide obligations. Unpaid bonuses, deferred compensation owed to retired partners and lease obligations may not appear on a cash-basis balance sheet. A lender will ask, and a surprise late in the process costs credibility.
- Retired-partner payments. Buyout and retirement payments to former partners are debt-like, count in coverage and usually must be subordinated to the bank under a subordination agreement.
- An office move or lateral hire funded from the line. A build-out or a guaranteed compensation package is a multi-year commitment and belongs on term debt.
The documents follow Transparent's line of credit checklist: an AR aging by client with days outstanding, the AP aging, the balance sheet, the P&L and a year-to-date P&L through last month-end, and a debt schedule showing existing liens and any retired-partner obligations, plus bank statements and two to three years of business tax returns where available. For a law firm, add an aging of unbilled time and a realization report by partner. Transparent's book of 1,800+ lenders includes 235 that write asset-based lending and lines. Accounting firms share much of this pattern; see lines of credit for accounting firms. Firms merging or buying a practice should also read financing a law firm acquisition.
Common questions
- Can a law firm borrow against unbilled time?
- Some banks lend a lower advance against unbilled time for established firms with a strong realization history, and stop counting it once it has sat unbilled too long. Most lines are built mainly on billed fees that are current.
- Can our lender take money from the client trust account?
- No. Trust funds belong to the firm's clients, not the firm, and cannot be pledged, swept or set off. Lenders expect trust accounts to be kept clearly separate from operating accounts.
- Can a contingency fee firm get a bank line of credit?
- Established firms with a long record of fees collected across many cases sometimes can, sized on that history. More often, contingency firms borrow from specialist lenders who underwrite the case portfolio, at a higher cost than a bank line.
- Does every partner have to guarantee the line?
- Banks usually ask each equity partner to guarantee, sometimes only for a share in proportion to ownership rather than the whole line. Non-equity partners and associates are generally not asked.
- Why does the bank want the line paid to zero each year?
- Because law firms collect heavily at year-end and distribute nearly everything. A line that cannot be cleaned up after the year-end collections is funding the partners, not the firm's working capital.