Many law firms offer to work on a contingency basis for their clients. Working on contingency means the law firm will wait until they settle the case to collect a percentage of the award. This fee structure relieves the client of needing to pay fees during the lawsuit and helps attract more business.
Still, this can burden law firms. After all, the lawyers still need to finance the case. Some lawsuits take several months or years to settle. Also, savvy lawyers will choose clients with cases they believe they will win, but they can never be sure. Thus, law firms face an unpredictable payment cycle, which makes it hard to manage cash flow.
Thus, legal firms must often secure outside financing before accepting new clients. Yet, they face problems qualifying for loans that differ from typical businesses. Specialty legal lenders may provide law firms with a flexible, fast option that better suits their unique business model.
Find out how specialty legal finance companies differ from banks, how legal loans work, and why they can provide a better solution for legal funding.
Speciality Legal Financing Vs. Banks
Traditionally, law firms turned to banks and other traditional business lenders for funding to manage their cash flow. However, legal firms only sometimes satisfied the typical creditworthiness measures banks had established for other businesses.
Legal clients often found their loans delayed or denied because they didn’t perfectly fit the typical criteria. This issue could delay cases and risk losing clients. To understand the problem, consider the primary differences between law firms and most businesses:
- Cash flow: Banks look for consistent cash flow to measure how well the customer can generate enough income to repay the loans. However, law firms may receive their payments irregularly as their cases close. Attorneys needed lenders that understood their business and flexible terms in case of unexpected delays or appeals.
- Collateral: Banks look at the company’s assets, like real estate or financial accounts, as measures of the loan’s repayment ability. A lawsuit without a 100-percent guarantee of winning did not satisfy loan officers as acceptable collateral. Meanwhile, a law firm’s primary assets may remain in its pipeline of cases for a long time.
- Loan terms: Banks expect repayment by the end of a scheduled loan term. However, law firms rarely control the speed of settling cases. If a suit gets delayed or sent to appeal, the borrower may have to pay penalties or extra fees. This uncertainty made bank loans potentially more expensive for law firms than other businesses.
- Application time: Traditional bank loans for businesses can take several weeks or months to approve. A law firm may not have time to delay accepting a case or filing an active lawsuit. Having to wait could cost money and sometimes, clients.
- Credit scores: Banks look for established businesses with decent credit scores. Many new law firms start as self-funded ventures. The lawyers might have sought credit for the first time when a big case came along. Thus, newer and smaller law firms might not have had the time or a chance to develop excellent credit scores. Banks denied applications because of low credit scores and a lack of collateral.
How Does Specialty Legal Financing Work?
Specialty legal financing offers an alternative funding source tailored to law firms’ demands. These funding sources understand the special lending requirements of the legal profession.
Legal funders also offer more flexible terms. For instance, borrowers can choose from two specialty financing types: recourse and non-recourse funding.
Recourse Legal Financing
Recourse funding works similarly to a typical bank loan. Some finance companies will also offer a line of credit as an alternative to a standard loan. A line of credit may provide several benefits for lawsuits with uncertain settlement dates or expenses.
- A line of credit lets borrowers withdraw the amount they need and make later withdrawals up to their credit limit.
- The firm won’t need to pay interest charges on any money they don’t withdraw. If a case settles rapidly, this can save the law firm money.
- Repayment of the loan should help boost the law firm’s credit score. Better credit scores can lead to future loan offers with lower interest rates.
In contrast to regular lenders, legal financing companies will consider the law firm’s pipeline of cases when qualifying their customers. When cases get delayed or appealed, the recourse funder usually works with their customers to adjust deadlines.
Recourse Legal Financing
Law firms that accept riskier cases might turn to non-recourse funding. The finance company will partner with its customer to assume some risks. If the firm loses and can’t collect money from the case, the non-recourse lender won’t oblige them to repay the loan.
This type of legal loan does come with some disadvantages. For instance, attorneys should expect higher interest rates in exchange for passing on some of the burden or risk.
Non-recourse legal funding compares to buying insurance coverage against the possibility of losing. The loans cost more because they can help mitigate risks. Even so, this funding option may allow firms to consider lawsuits they could not have accepted otherwise.
Why Turn to Specialty Financing for Law Firms?
Lenders specializing in legal funding understand the valuation of firms and cases in a way that other financial institutions may not. This familiarity with the industry lets them determine creditworthiness fairly.
Legal financing companies also know their borrowers can only sometimes predict when cases will close. Law firms also can’t offer a guarantee that they will win and collect their share. These specialty lenders know their customer’s needs and provide flexible terms to satisfy them. Sometimes, they even offer non-recourse loans “on contingency,” just like their customers do for their clients.
Specialty legal financing companies typically offer rapid online application processes and quick funding. Thus, law firms can enjoy working with a lender that gives them flexibility, speed, and a deep understanding of their business model.
This tailored financing gives plaintiff law firms the funding to accept more cases and begin to work on them faster. These benefits let lawyers focus on serving and attracting clients to grow their businesses.