What Do Banks Look for When Making Loans to New Law Firms?
Guest post by Brian Hall, Senior Vice President and Area Executive, CenterState Bank, N.A.
There are approximately 5,600 FDIC insured banks in the United States, and most of them covet the idea of having law firms as clients, including start-up law firms. Law firms can result in large, stable and low cost sources of deposits. The opportunities to work with the firm’s attorneys regarding their personal and other business financial service needs are attractive to banks. In addition, bankers place high value on developing mutually beneficial referring relationships with attorneys. However, lending to start-up law firms can be challenging for banks due to the reliance on projected, not historical, performance.
The information below describes some important information banks look for when considering loans to start-up law firms.
- The partners will be asked to provide resumes and references to better understand their background, experience, and confirm that they are in good standing with The Florida Bar. If they are leaving a firm, the bank will want to know if there are any trailing.
- Banks will ask partners for current personal financial statements, debt schedules, verification of liquidity, current levels of life and disability insurance, and two or three years of personal tax returns to look at historical income. These, along with the partner’s personal credit scores, are important because typically any loan made to a start-up law firm will require the unlimited, joint and several personal guaranty of the partners.
The Business & Financial Plan
- Like all start-up businesses, the firm will be asked to share its business plan. Bankers will review this carefully and look for information on business strategy, key assumptions, and major risks to be managed/mitigated.
- 24 to 36 month detailed financial/cash flow projections that recognize the timing differences that can occur between outflows and inflows of cash should be part of the plan. Bankers like to see multiple projections that show what happens to cash flow under growth that exceeds, meets, or is below revenue projections.
Capital & Bank Financing
- It is important to have a detailed financial plan that identifies the amount and timing of capital needed to form/operate/grow the new firm, and where this capital is expected to come from.
- Banks want to understand how much capital is being contributed by the partners. Most banks will require partner equity to be contributed, although the amount can vary depending on the details of the new venture.
- Banks need to clearly understand the purpose for any loan requests. Typically these are for: 1) equipment and technology; 2) leasehold improvements; and 3) short term working capital, which sometimes is mistaken, in whole or in part, for what is really a need for more permanent capital.
- Bankers will seek to understand the primary, secondary and tertiary sources of repayment for any type of loan made. Depending on the purpose and amount requested, and other circumstances of the start-up firm, banks might request pledging of personal assets as collateral in addition to unlimited personal guarantees. Ultimately, this is the most important component of the bank’s lending process – how will the loan be repaid?
- All banks have loan policies and guidelines, and the bank will overlay any start-up law firm loan request to determine if there are any policy exceptions. If so, the banker might discuss how to modify the amount, structure or other conditions in order to conform to the bank’s loan policy.
- For requests that may not be able to obtain traditional bank financing, many banks offer U. S. Small Business Administration (SBA) loan programs that may assist new law firms. Partners should inquire about this option during their initial meeting with their bank.
Most banks welcome the chance to work with a new law firm and build a long term relationship. If you are considering starting a new law firm, I encourage you to visit your banker, discuss your new business plans, and ask for their thoughts. The information above should help you understand what your bank will likely be looking for should you need financing.
The above article contains the personal views of the author, and does not necessarily represent the views of CenterState Bank, N.A.
VIEWS AND CONCLUSIONS EXPRESSED IN ARTICLES HEREIN ARE THOSE OF THE AUTHORS AND NOT NECESSARILY THOSE OF FLORIDA BAR STAFF, OFFICIALS, OR BOARD OF GOVERNORS OF THE FLORIDA BAR.