The inherent conflict faced by the leaders of many law firms is that for a law firm to succeed, the practice must be managed as a business by a person that would rather spend more time practicing law. Most lawyers find the administrative and management tasks less exciting and mentally stimulating and, thus, fail to take the necessary steps to protect their firm. Ironically, lawyers often spend a significant portion of their time explaining to their clients that making the right decisions on the front end allows for better results on the back end. Attorneys often face the same challenges, but at times fail to heed their own advice.
Even after obtaining an MBA and spending twenty-five years setting up small and large businesses, I sometimes find I am the worst at focusing on making necessary changes to my firm. At least once a year, each of us should look at our practice and ensure our most valuable resource, our law firm, is protected. Below are some of the most common mistakes that have come through our office and suggestions on how to start treating your law practice as a business.
THE TYPES OF ENTITIES
Most law practices should be operated through some type of entity. If you have not formed a legal entity, do so immediately. The different types of legal entities provide advantages and disadvantages for attorneys. The potential entities include Professional Corporations, Limited Liability Companies, Professional Limited Liability Company, and Limited Liability Partnerships. The main distinctions between the entities rest in liability protection, how taxes are treated, and the entity’s ease of operation.
Professional corporations require adherence to guidelines, including necessitating shareholders, a board of directors, and a management team—all of which must work independently of each other. Creation of the proper paperwork and the bylaws to govern the operation of the corporation, not to mention shareholder meetings and maintaining the annual minutes and reports, requires time and expense. If the entity has a sole owner, the owner must act out each of these roles, but in separate distinct manners, while maintaining the necessary records and notes to prove conformity with the strict formalities. If there are multiple owners, there should be a shareholders’ agreement to handle management and selling of ownership interests.
A corporation provides for a law firm to easily add additional partners and the required autonomy between the owners and management provides a layer of liability protection for the owners. A corporation can be taxed as either a C-Corporation or an S-Corporation. Although tax rates have dropped for C-Corporations, the overall tax rate usually justifies an S-Corporation election.
Limited Liability Companies.
Limited liability companies provide a lot of flexibility with formation, management, and taxation. However, sometimes this flexibility adds cost. Limited Liability Companies can be taxed as a Partnership or a Corporation, but must pay franchise taxes.
The different types of partnerships provide different levels of liability protection—General Partnerships, Limited Liability Partnerships, or Limited Partnerships. The written partnership agreement generally sets forth each of the partners’ responsibilities and obligations. A General Partnership is unincorporated, does not protect its partners from personal liability, and requires very little or no formalities. A General Partnership does not pay franchise taxes. A Limited Liability Partnership (LLP) is similar to a General Partnership but provides some protection for the other partners for one partner’s negligence; and a Limited Partnership (LP) has one partner who is generally responsible for the debt of the firm and the remaining “limited” partners cannot be held personally liable for the debts of the partnership so long as they do not actively participate in management. The general partner is typically an entity which requires its own documentation and tax returns.
Partnerships are commonly inexpensive to set up, and the profits flow directly to the partners. In many law firms, there are incentives for associates to become partners and the fiduciary relationship between the partners is often conducive to positive reinforcement. However, the sometimes “unequal distribution” of power, joint and several liability, profit sharing, and business disputes between partners can create difficulties as well. In each of these partnerships, the partners will record any income on their personal tax returns.
If an attorney fails to set up an entity, a sole proprietorship is unincorporated and requires little to no filing. As the name implies, a sole proprietorship can only have one member and all profits and losses are recorded on the owner’s personal tax return. The owner of a sole proprietorship maintains unlimited liability and can be held 100% liable for the actions of the firm or an employee of the firm.
PICKING THE RIGHT ENTITY FOR YOUR LAW FIRM
The questions require more than a simple “off the cuff” response. These are long term goals and not simply next week or next month’s plans.
- How many owners do you plan to have? Multiple owners now or in the future will require a strong operating agreement under a Limited Liability Company or a strong partnership agreement as a Partnership or corporation, in order to protect your future liability from co-owners.
- How to maximize tax consequences to maximize after-tax profits. If your law firm owns a building or provides other services, do these need to be under a different entity?
- Is your firm preparing and maintaining the proper entity documents and holding the necessary meetings?
- If your firm is set up as a corporation, were the necessary shareholders’ meetings and board of directors’ meetings held? Were annual minutes required? Were shareholders apprised of the annual reports?
- Each Texas entity must file a franchise tax return and a public information report; has your law firm complied with such requirement?
AFTER THE FORMATION OF THE ENTITY
The following is a checklist of items your business, including your law firm, should have for all of its employees.
IS YOUR LAW FIRM’S HUMAN RESOURCES DEPARTMENT COMPLIANT?
- Do you comply with independent contractor/employee and overtime for each employee?
- Do you have I-9s and W-4s for each employee? Are the I-9s completed properly?
- I-9 should be in a separate file from the rest of the employee’s personnel file and available for USCIS only if requested
- Emergency contact information
- Tracking hours, time-off requests, payroll
- Any medical related employee information should be kept separate from the employee’s personnel file
DO YOU HAVE A CURRENT EMPLOYEE HANDBOOK?
The handbook should include the following:
- Family Medical Leave Policy if the law firm has over fifty, full-time employees;
- Equal Employment and Non-Discrimination Policies;
- Workers’ Compensation Policies;
- Expectations for contact with clients and all communications;
- Security, protection of confidential information, and office technology system policies;
- and a signed acknowledgment page
The handbook should be updated annually to ensure compliance with all state and federal law and to create changes to make enforcement easier for you and your firm.
AN UPDATED, EMPLOYMENT POSTER SHOULD BE POSTED DISPLAYING:
- The minimum wage notice,
- The Equal Employment Opportunity is the Law,
- Employee Polygraph Protection Act
- I-9 Anti-Discrimination Notice, and
- USERRA Notice of Rights and Benefits.
OTHER MANAGEMENT ISSUES
Who at your firm has the authority to sign a contract? Who is liable for a law firm contract? Do you know? Are you personally guaranteeing all contracts? Are you aware of all contracts being signed?
Do you have a business plan? To run a law firm like a business requires starting to act like a CEO.
This is the WHY for your law firm. The firm overview should include the firm’s purpose, objectives, and goals for the future and be the core, guiding principle for the law firm’s growth. This section should include the Mission Statement, Philosophy/ Values, and Vision Goals.
The how your law firm is DIFFERENT. The market analysis will help you recognize your firm’s strengths and weaknesses and identify how to differentiate your firm from the other law firms. This section describes your ideal client, takes a closer look at your competition, finds ways to stand out from the crowd, and understand your role in marketing.
Operations is the HOW you are your law firm will run on a daily basis. This section will include a detailed intake process, the billing, and case management system, technology analysis and upgrade plans, and an organization chart including responsibilities.
Your business plan must include a clear plan of revenue and expenses with a goal based on a baseline number of clients required each month to maintain PROFITABILITY. This section should include monthly overhead, projected revenue, profitability, and key performance indicators (the numbers you will monitor each month to ensure you are reaching your goals).
Now instead of later is always the best time to make sure you are running your business properly. James Rosenblatt