Of all the financing models available to law firms, many find that a line of credit best suits their needs—providing funding for operations and growth and available when you actually need the money, without requiring you to reapply each time you need the funds.
However, repayment terms and conditions can vary greatly between lenders, which means this flexible financing solution could end up being more of a burden than a benefit to your firm if you’re not careful.
Here are 3 key provisions you’ll want to compare and fully understand before signing on the dotted line.
- Repayment Schedule
Maturity dates on financing commitments can differ drastically from lender to lender. Some financiers offer short term loans of six months or less accompanied by a monthly, weekly or even daily repayment schedule. For firms primarily dependent on contingent fee income, such an aggressive timetable doesn’t work well with the ebbs and flows of your practice.
Other financiers, like certain specialty lenders, have more firm-friendly terms—structuring your line to coincide with the average length of a case (i.e. two to six years) and include repayment provisions tied to when you generate fees.
For example, a traditional bank line may require you to make principal and interest payments monthly, whereas a specialty finance line could require interest only payments for a period of time, while requiring mandatory prepayments as legal fees are paid. Some funders will provide a hybrid approach—tailoring the frequency of your payment obligations to your practice’s individual budgetary objectives.
- “Clean-Up” Period
While becoming less common, some lenders demand a “clean-up” provision in their documents. A clean-up requirement generally means that you must pay down your credit line to a zero-dollar balance (or some other specified principal balance) and keep it at zero for specified period of time (e.g. 30 to 90 consecutive days)—usually on an annual basis.
The purpose of the clean-up is to ensure that you aren’t relying too heavily on your line of credit to conduct business or acquiring debt you can’t repay.
Compliance with this type of clause, however, can be difficult (if not impossible) for a business with highly unpredictable revenues, like a contingent fee practice. This is especially true if you use your line to fund case expenses because those expenses tend to arise unexpectedly and compel you to make significant outlays upfront.
On the flip side, specialty lenders often don’t have clean-up requirements, but rather provide renewal options that allow you to hold off making principal payments for a longer period or keep your line of credit open without going through the application process again.
- Prepayment Penalties
Lastly, you may find that you want to pay your line of credit prior to the maturity date, for instance, if a large fee is realized on a settled case. It’s important to be sure your lender won’t tack on any additional fees for doing so. Some lenders charge a prepayment penalty in order to make up for lost interest income on a line of credit that is closed early. If this is the case, early repayment will cost you. Learn more about costly loan provisions here.
What works for one law firm may not work for yours. Be aware of what your firm’s needs are and how those needs can best be met. If any of the repayment terms don’t appear to be a good fit, keep asking questions and investigating other funding sources until you find the best product for your firm.