Taking the Risk of Payment Out of New Client Development
by Barbara Lewis and Dan Otto
(County Bar Update, January 2004, Vol. 24, No. 1)

 

Taking the Risk of Payment Out of New Client Development

 

By Barbara Lewis, M.B.A., Law Practice Management Section Executive Committee, and Dan Otto, M.B.A. Lewis and Otto are partners with Centurion Consulting Group, which provides business consulting for law firms. They can be reached through their Web site at www.centurionconsultinglaw.com. The opinions expressed are their own.

 

Oftentimes attorneys talk about the difficulty in getting clients to pay them. Accounts receivable amounts may be high, and average collection days may stretch into months. If you face this problem, you may want to solve it by developing a risk analysis payment model for prospective clients.

 

First, identify recent problem clients -- those who were write-offs or who have a substantial fee over 180 days in the accounts receivable aging. Analyze various characteristics about each client: Who referred them? Were there co-signators on the engagement letter? Did they immediately negotiate the fees? Did they have a previous attorney for the same matter? Did they have a court date set? Was the total estimated fee high? -- plus numerous other factors. As you analyze the bad debt clients, you should see a pattern emerge around similar characteristics . . . a real eye-opener.

 

Next, identify clients who paid their fees on time. Examine the same dimensions, and you’ll probably find discernable characteristics that differentiate the bad clients from the good clients. Although certain characteristics, such as immediately negotiating fees, are intuitive to recognizing future problems with payment, others are not but have strong predictive power.

 

You can easily develop a scorecard to assess the various characteristics you’ve identified that are common among your non-paying or poor-paying clients. As you conduct the initial interview with a potential client, you can either ask specific questions or obtain a perception about your prospect that will aid in scoring the risk. If you want to get slightly more sophisticated, you can weight the various characteristics so that certain questions are more influential than others and then mechanize the process by developing a computer model that calculates a risk score in the format of a two-dimensional matrix.

 

A relatively high score indicates a higher propensity for the client to default on financial obligations to the attorney. Potential bad debt can be reduced by not accepting clients who score as high risk for problem- or non-payment.

 

The purpose of the methodology is not an acceptance/rejection decision but a risk reduction. Much like the FICO consumer credit rating, which predicts the probability of defaulting on a loan, the payment risk scorecard indicates potential payment problems with clients. A potential client with a high-risk score does not need to be excluded; however, necessary steps such as requiring a higher retainer fee or using a weekly billing cycle need to be employed to mitigate the payment risk.

 

The five keys to the success of your scorecard or risk model are the following: 1) Choose characteristics that can be evaluated pre-engagement; 2) Perform the evaluation on every potential client; 3) Keep a record of the score and the collection outcome for each accepted client; 4) Periodically review the characteristics and weightings; 5) Use a metric such as percent bad debt expense and/or accounts receivable collection days to track improvements in your client selection and your collections.

 

In addition to bad debt reduction, you can also establish collection policies to accelerate cash flow. Establish a benchmark by calculating the amount of time it takes to collect fees. Take the total accounts receivable, divide by the average monthly billing amount, and multiply that number by 30 (days in a month). This figure is the average number of days it takes to collect your accounts receivable. For example, suppose your total accounts receivable is $100,000. Divide that amount by the average monthly billing amount of $10,000, which is 10. Multiply 10 by 30, which results in the collection days number of 300. (If this amount is over 70 days, you are above the national average.)

 

To ensure that clients are willing and able to pay, don’t hesitate to ask for a substantial fee up front. Otherwise, you may end up “loaning” your clients money or performing services pro bono and never being paid.

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