With the economy on the upswing, many firms are feeling flush, but current success may mask hidden financial danger. Do not let the economic upswing mask hidden threats to your firm's longevity. Four financial threats in particular could jeopardize your firm's financial future:

  • Excessive Long-Term Debt

    It is not unusual for firms to make investments in areas like technology and expanding office space. However, if the investment leads to excessive borrowing, the financing leads to higher fixed costs. If debt undermines the bottom line, it may be a challenge for the firm to cover expenses or reward talent. Furthermore, if your firm's long-term debt exceeds its assets and cash on hand, then you have borrowed against future partner earnings. This can lead to long-term financial constraints that limit the firm's ability to bring in new talent and may even prompt valued partners to start looking to the exits.

  • Unfunded Retirement Obligations

    Established firms are often plagued by unfunded retirement obligations dating back years. These plans divert profits away from current partners. If more than 1% or 2% of your current revenues are flowing to inactive partners, these payments are likely causing undue cash flow constraints. Well-structured retirement payments can play a key role in succession planning. However, unless they are thoughtfully constructed, these obligations can negatively impact partner retention. /

  • Unwarranted Compensation Guarantees

    Many firms offer large, guaranteed salaries to lateral hires, typically to those regarded as rainmakers. However, the urge to expand should not overshadow the need for every attorney to meet performance metrics. Firms painstakingly develop the incentive structure in their compensation schemes—guarantees can undermine this effort. A firm is often rewarded for discovering talent and providing space for that talent to grow. However, the guarantees cannot undermine the expected return on investment. The firm and the lateral hire should have a clear understanding of how the firm will get a return on its investment. Guaranteed salaries eat into profitability and can potentially breed resentment among colleagues. This can push existing talent to seek a similar deal somewhere else.

  • Injudicious Expansion

    For law firms, growth is frequently seen as the ultimate hallmark of success. In fact, some firms seem to expand only for expansion's sake. However, not all expansion is healthy and expansion without a strategy has financial repercussions. New offices may seem great, but they must generate enough additional revenue to justify its cost. Additionally, acquisitions and mergers require investments to integrate separate firm systems and cultures. It is unknown if the combined firm can produce enough synergy to justify the expense. Expansion will always require additional investment in the short term. It is essential that the expansion is underwritten by a reasonable plan to realize a return on investment. Otherwise, expansion only reduces profits and may increase debts. This may leave your firm without the financial agility it may need to capitalize on unexpected opportunities.

Knowledge is Half the Battle

Threat awareness is the first step in securing your firm's future. Once the threats to your firm are identified, your financial advisors can help you develop a strategy to avoid or overcome them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.