Hiring vs. Paying Off Debt: Strategic Investment Decisions for Law Firm Growth

Alright, here's the thing. This is an opportunity for you to not just be the owner, but be an investor. An owner asks, what is this going to cost me? An investor asks, what is this going to unlock for my future?

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Hi everyone. Welcome back to The Law Firm Owner Podcast. I'm Melissa Shanahan, and today I am talking to those of you who feel like you need to hire, but the cash just isn't there. So, we're going to dig into this concept of debt and strategic investments, and I think many of you will find this probably applies to you.

I hear often from law firm owners that they have the work to be done. They know they need to hire, but they don't have the revenue to do it. And when I dig in more with owners, the question becomes, where's the revenue going? And so we look at the expenses, and the expenses aren't bad. And so then it's like, okay, where is the money going? Towards debt. So they're paying out of the profit of the business towards debt. Maybe it's a line of credit, maybe it's credit cards, but they're paying out of that, and so they don't feel like they have a lot left over. And they feel like a bit of a slave to the debt.

What I help people do is the math on all of this, to figure out what's possible, what feels like a smart risk. Everything with business ownership, there's always risks and you have to weigh out risk versus reward. So I'll do the math with people to help them figure out what makes the most sense.

First, let's talk about the mental misfire that we can have around the subject of debt. Debt can feel heavy. In many cases, people feel shame around debt. They have more than what they want to have. And when you are trying to evaluate how to fix some of the problems you're having in the business, it can feel irresponsible at face value to go spend more money when you've got this debt to take care of.

I had someone recently tell me, I have the work. I know I need another paralegal. And yet, I don't have the cash for it. And so when we dug into his specific numbers, what we found was that actually, there was cash. There was plenty of profit left over. So, as I referenced a little bit earlier, we take a look at, okay, some of this is going towards debt, and he's funneling a lot towards debt. So he's ending up with very little cash left in the bank because of what he's using from the profit to go towards debt. And that feels like the responsible thing to do. And because he's doing that, he feels like he doesn't have any options to get any help because he can't afford it, because he's putting all the money towards the debt.

Now, his expenses, that margin was healthy in terms of overhead expenses. His revenue was really great. It's up this year. He is taking home the amount of money he wants to take home. Maybe he would want more, but he's taking home enough to be stable. And so when I asked him what his people cost percentage was—and people cost percentage is the amount of revenue that goes towards paying the people to do the work in the firm—and his people cost percentage was 13%.

Well, that told me everything I needed to know. People cost percentage, there is a golden standard out there of should be about 33%. That's not true for every firm, but it's a standard that's out there. And it's an interesting one to pit yourself against with where you currently are to see, I'm pretty far off of that, or I'm under that, I'm over that, I'm close to that, I'm far from that. It's an interesting standard because it is, it tends to be, for many firms, a healthy benchmark. That may not be true for your firm. It depends on the type of law. Immigration tends to have a really hard time getting that low. They usually have a little bit higher people cost. But most people when I meet them, majority, are somewhere between 40 and 60%.

Now, I know for sure when I look at a business, 60% is too high. That usually leads to flags for me on what's not going well or going right with the team or with the output, the work that's being done. And it's not hard to spot what to address when the people cost is too high. When the people cost is too low, the immediate thing that tells me is that there's a capacity issue.

That there is no way that the work that's coming in can be handled by the team. Now, of course, there are exceptions to every rule, but generally speaking, that's a flag. If I wasn't able to talk to this person and I only saw their numbers on a spreadsheet, and I saw that 13%, I would have guessed that they feel overworked. There's too much work going around and not enough people doing the work.

So again, your people cost percentage is really important when you are looking at, if you're thinking you need to hire but you can't afford it, that's how you feel, you have to look at the people cost percentage. And if it's low, yes, you're right, you need to hire, and you need to figure out a strategic way to make that possible for yourself. If you're on the flip side and you look at your people cost and it's too high, it's like 50, 60% of revenue is going towards people, and you feel like you need to hire more but you can't because your money's tied up in this expense, then that's good to know because then you can say, wait a minute. I technically shouldn't have to spend more on people.

So what is going on that the team that I have is not able to bring in the revenue that's going on? Are your producers not meeting requirements? Where are the bottlenecks? Where are the inefficiencies? Where are things just going wrong? I know from your seat as an owner, you have hunches about what might need to be improved. It's your job to go dig in and test your assumptions, get the facts, not feelings, and see if you are if you're actually right. And if you're right, you need to put in some things to fix what you know is wrong.

Okay, some benchmarks that can be a guide for strategic investments that you might make in the firm. One, we talked about was people cost. Knowing what that number is will give you an immediate read on if something's up there or not. The second is a net profit threshold. You as the owner get to decide, what is your threshold for profit margin? And it's all relative. I get questions all the time like, what's a healthy profit margin? I see people all over the place, but the healthiest firms I work with are anywhere from 30 to up to 60% profit margin. 60 is rare, but it happens.

And there are reasons for that. Maybe that's a whole other episode. So I would say 30 to 50% is healthy, really healthy. Now, you may be at 2%. You may be in the red. So I'm not asking you to jump yourself to 30, but having a target for yourself that makes sense, that is moving in the right direction in terms of profit margin is really important.

And the last one is the overhead expenses. So we have people cost and overhead. Overhead is your total expenses minus people cost. And that what's left is what we call and what many people in this sphere call overhead. The overhead should also be about a third. Now, oftentimes these days, it's less for firms because they're not renting physical spaces, there's a lot more virtual firms. So sometimes overhead is a lot less than 33% of revenue. But it's still a standard that exists out there. Technically, if you have a third people cost and a third overhead, that would mean you have a third profit.

So that is a bit of a some benchmarks that you do not need to be in line with a third, a third, a third. But you do need to know that those benchmarks exist out there, and knowing where you fall for each and deciding what is okay with you and what you intuitively want to bump up or down is really important.

Alright, here's the thing. This is an opportunity for you to not just be the owner, but be an investor. An owner asks what is this going to cost me. An investor asks, what is this going to unlock for my future? And being able to do that is very important in moments like the one I shared where I talked to the member about their situation where they didn't feel like they could hire because the cash flow, but yet they needed help with work.

Now, let's say hiring a $4,000 a month paralegal takes a bunch of work off of your plate, allows you to bill more hours or do more billable work, even if you're flat fee, contingency, whatever, land more clients, deliver better service. That's not debt. That's leverage. So giving yourself that will unlock something for your future.

Now, you may decide to slow down your debt repayments. You may decide to take less of a draw for a bit. And that could be uncomfortable, but it's strategic. It is enabling you to get to a different place for your future. So that you could get to the place where you could pay down your debt faster and you could take more draws as an example.

You're not spending recklessly. You are building capacity for growth. And here's the beauty of it: you don't have to do this all at once. I always encourage people to hire the low-cost hires first. And if you read Dan Martel's book, 'Buy Back Your Time,' he mentions this as well with the Drip Matrix. There are many experts out there that recommend this, and it's because it gives you the most leverage. The lower the cost of hire, the lower level, typically, the tasks that you shouldn't be doing, you are getting off of your plate. So hiring the low-level tasks first, then allowing that to create some stability, create a bit of a new normal, allow things to get stabilized, and then you can have the next hire. That's a staggered investment. That is paced, it's thoughtful, and it's smart.

Okay, maybe you're sitting there saying, 'Okay, this is me. I do. I have debt. I don't feel like I can pay for anyone to help me or pay for other strategic investments that I want to because I am a slave to this debt. I'm trying to pay it off as fast as I can pay it off.' Well, here is what you do. The first thing you do is go run your numbers. You have to look at those three key numbers, those benchmarks I gave you earlier. You have to know at a minimum what those are.

The second thing is to set thresholds for your profit. Decide what is a non-negotiable for you. And not just profit, but all of those benchmarks. You know, there's a time where, yes, a firm wants to get to 33% people cost, but from where they're sitting now, they're going to have to make an investment that's going to push them above the 33%, but it's strategic, because with that new hire, once they get trained and fully ramped up, then the business's revenue can rise and that means that the people cost, the ratio, will be less. So it'll it will work itself out to be closer to a third of revenue will be spent on people. But you have to sort of push yourself into that zone where it's higher and then it'll level out.

So, being strategic with your thresholds, like we are not going to go over 45% for even for a short period of time, knowing that it's going to come back. 45 is our limit for strategic short-term so that we can get it back to 33% because that hire is going to allow our firm to handle more work, which is more revenue.

Once you run your numbers and once you determine your thresholds, then you want to run the scenario for the key hire you should make. Again, I'm going to recommend that you do the lowest cost tasks. You hire for those first. So if that means an administrative assistant or professional or a legal assistant, then start there so that they're getting the lowest tasks off of your plate or of your team members' plates. And then once there's stabilization with that, then you can consider higher-level hires: paralegals, attorneys, etc.

Now, when you are running these numbers, play it all the way to the end. Are they going to be an employee? So what is their salary? What are the employer taxes likely going to be? You don't have to be exact, just make sure you're doing a good job of ballparking it. What benefits is the company going to pay for them? You need to add in their all-in cost so that you can see how these numbers will play out for the firm. Then you want to play out the revenue side of things. Because of this hire, the revenue should be able to increase by what?

Now, if it's an administrative assistant that's going to be taking a lot off your plate, it does give you more space to do some billable work. So if that's the case, how much more billable work? If you're hourly, how many more hours a week will you be able to bill because of this low-level admin stuff taken off your plate? So you'll get to see and start to forecast, 'Okay, this is the extra revenue that should come in because I'm afforded the space with this hire.' And you'll be able to then see, 'Okay, if the revenue is here and my cost is here, what is the people cost percentage with that in place?'

Run the numbers and see where you're sitting. If it is not for you, but it's going to free up another producer in the firm, it's the same thing. It's evaluating what will be enabled in terms of revenue. What will be your new scenario in terms of revenue? And be conservative with that. But let me just say, when you are considering producers, whether it's yourself or others, there needs to be a minimum expectation, and it needs to be healthy for the firm.

I've done podcast episodes on producer cost and information. You can go back to listen to those, but you need to make sure that's smart. You can't just have somebody come in and hope that they're going to bring in enough. No. They need to walk in knowing some something that they are shooting for, whether it's a goal on hours or on number of files that they're working on, on amount of revenue that's coming in through the door, something. They need a benchmark because you need to consider sort of the minimum threshold that you are okay with this person being employed, and that sets the expectation. And then there can be goals above and beyond that.

But use the conservative number, use the minimum expectation when you are forecasting out. It could be better than that, but you want to be conservative and make sure that you're making a wise decision no matter the scenario you end up in if they are doing just the minimum or if they're going above and beyond. And by minimum, I don't mean their minimum, I mean your minimum.

All right, so once you play that all the way out, it's the same thing. You'll see, 'Okay, this is the extra revenue that we can make with this hire. This is the extra cost that's going to be incurred with this hire. This is a good deal. This is a good bet. This unlocks my future. This unlocks the future of the firm.' And if you can honestly say that once you run the numbers, then you go back and say, 'Okay, this is my profit every month. This is the amount of money I'm taking out of the profit in order to pay towards debt. And it's way above my minimums. I'm going to be a little less aggressive with the debt payments, and I'm going to put this money in as an investment towards this hire so that I can get the firm to a better place and there will be more to go around in terms of money and cash at the end of the day if you do the math all the way out, right? Just like I talked through, there you will know if there's what cash you will have to put towards debt once this hire is in place.

So, this really, I want to bring this back to the initial intention of this episode was to help you understand that debt is just debt. It's not bad, it's not good. It just is what it is. It's sitting there, right? You have to do something about it. But your mentality around it is everything. You don't need to go swinging hot towards the debt all the time. If you're in a position to do that and your firm is great in terms of capacity, you don't need to hire, there's no investments that your firm currently needs right now, then swing hard at the debt.

But if you are in need of something, you are in need of an investment to get yourself to a place that will unlock a future or unlock a new level of stabilization for your firm, do the math and make the call. And figure out what that means towards your debt. Of course, it's going to slow it down, but temporarily, and what does that mean for the bottom line?

I hope this helps you think through for yourself or rethink if you've been holding on to the scenario that's terrible. You're overworked, and maybe you have team members that are as well, but you're cranking so hard towards the debt, it almost just feels like you're in a hurry to make as much money as you can so you can crush the debt as fast as you can crush it. I understand that. But that mentality won't get you out of what you're in. The mentality that will get you out of what you're in is one of not just an owner—that's a very owner mindset—but one of an investor.

When you run the numbers, ask yourselves, will this investment unlock a new future for me and for the firm? And if the answer is yes, see if you can find a way to reduce or slow down towards debt and be able to put towards the hire.

All right, everybody. Thank you for tuning in. I'll see you next week.

Hey, you may not know this, but there's a free guide for a process I teach called Monday Map Friday Wrap. If you go to velocitywork.com, it's all yours. It's about how to plan your time and honor your plans so that week over week, more work that moves the needle is getting done in less time. Go to velocitywork.com to get your free copy.

Thank you for listening to The Law Firm Owner Podcast. If you're ready to get clearer on your vision, data, and mindset, then head over to VelocityWork.com where you can plug in to quarterly Strategic Planning, with accountability and coaching in between. This is the work that creates Velocity.

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