Getting financing for your law firm is a practical way to smooth out uneven cash flow, build your case inventory and boost the overall performance of your practice.
While loans, lines of credit, cash advances and other funding arrangements can greatly benefit your firm, if you’re not careful, certain terms and provisions can also end up costing you substantially more than you anticipated.
If you want to avoid buried charges and better understand the true cost of your financing, watch out for these 4 provisions in your funding agreement.
- Unused Line Fees
Some financing companies charge unused line fees, which means you are paying for the unused capital commitment on your loan facility.
This type of fee is charged to incentivize you to use the full amount of capital available, and if you fail to do so the lender receives fees anyway. Accordingly, if you use less than the maximum committed amount, then the unused line fee can substantially increase the true cost of financing on the amount that you do have outstanding.
- Key takeaway: Always say NO to unused line fees.
- Maintenance Fees
Maintenance fees (also called servicing fees) cover the costs associated with servicing your loan or other financing agreement while your obligations remain outstanding. They can include the finance company’s expenses related to processing your funding requests, collecting payments, maintaining your records, subordinating a lien, issuing a payoff statement, making copies and more.
Those that charge servicing fees typically require payments monthly, quarterly or annually. The fees can be expressed as a percentage or fixed amount and can range in size. Make sure you fully understand what, if any, maintenance fees you’ll be required to pay and how they impact your true cost of funding.
- Key takeaway: Try to cap maintenance fees if you can’t eliminate them entirely.
- Draw Fees
A draw fee occurs each time you make a request for funding. Normally, the fee owed to the finance company pursuant to a draw fee provision is delineated as a percentage of the amount requested. Upon approval of the request, the fee is then deducted and you receive the net proceeds.
If your financing agreement provides for draw fees, you’re left with two not-so-great options—(1) dodge the fees by taking out a large or lump sum payment or (2) avoid interest accrual on amounts you don’t need yet by making a number of draws, but get nicked by draw fees.
- Key takeaway: Draw fees—another NO!
- Prepayment Penalties
Several reasons exist to keep financing in place for the full term, such as maintaining consistent cash flow, having emergency funds and capital availability to grow your practice.
Prepaying your funder, however, isn’t necessarily a bad idea under the right circumstances. For instance, if you can afford to do it and it gives you peace of mind, then it is something to consider—unless of course a steep prepayment penalty exists.
Prepayment penalties are written into funding contracts to compensate finance companies for interest income lost when you pay off your obligations early. Such provisions can vary widely from company to company, be fixed at a percentage or a dollar amount, or fluctuate depending on when the balance is paid off. These penalties discourage early payment which translate into a much more costly financing arrangement to you.
- Key takeaway: Avoid being fined for prepaying at all costs.
Although some funders have fully transparent agreements with no hidden costs or fees, others artfully craft their contracts with provisions that’ll eat away at your profits to increase their own bottom line.
This is by no means a complete list of all things you should look out for in an agreement, however, they’re just a few of the most common fees that appear to be small but can actually add significant cost to your financing. Nevertheless, by reading the fine print and selecting a funding company with clear, unambiguous terms you can prevent unexpected costs that may impede the profitability of your firm.