By Ed Poll
Government has given us a rather unrealistic perception of finances: Americans tend to think that it is impossible to reduce expenses and that the only way to deal with that phenomenon is to increase taxation. Running a law practice, however, is not like running a government. Lawyers can’t just increase taxes to meet expenses. And increasing fees can create hard feelings and fewer clients from which to generate fees. However, lawyers do have options for reducing the expenses—also called overhead—of a law office.
Nevertheless, those options are limited. An attorney could pare down his expenses in a number of areas, but the impact wouldn’t be significant on the practice because the number of dollars relative to the overall expenditures is not large. However, according to law firm consultant Vincent A. Pellerito, marketing, education, labor, and rent readily come to mind as areas in which significant reductions can be made.
There is no magic percentage of revenue that will be either the limit to spend or the most effective level of spending to produce the best results. In a new practice, it may sometimes seem that you are spending a large part of your revenue, and certainly most of your time, marketing for new, additional business. Marketing in this context includes entertainment (e.g., prospective client lunches, bar association meetings to develop your network, etc.); advertising (e.g., yellow pages); new brochures; and similar forms of “spreading the word” about your skills and availability.
Reducing this area of expenditure may be necessary based on a review of your cash flow, but a severe reduction will also reduce your visibility in the community. On the other hand, when your practice and reputation are established, a reduction of marketing expenses may reduce your overhead without harm.
Education is always a tempting category for reduction, but my advice is to never give up on continuing legal and other education. Attending conferences and learning about the latest developments in your area and related areas, including electronic media, is important; this is what will keep you in the forefront of your profession and enable you to represent clients with the requisite skills to keep them coming back for more.
Rent is one of the most significant costs for law firms, and the one most often ignored once the lease is signed. In fact, rent is usually the second-largest expense item for the average law practice; only payroll for staff is larger. A firm may spend as much as 20 percent of its total overhead for occupancy or rent.
If you only think of rent as a fixed obligation with no room for savings, think again. You can save money on rent! There are three aggressive approaches to negotiating your way to lower occupancy costs, even if you can’t or don’t want to relocate to less-expensive lodgings.
- Restructure Your Lease
Market conditions change. Many lawyers are locked into leases that were made during earlier real estate boom times and are probably paying dramatically higher rates than would be the case if they were new tenants today.
One strategy is to try to restructure your existing lease by asking for a lower rent or extending the lease term. Everyone—including your landlord—knows that it’s cheaper to keep an existing customer than it is to get a new one. Landlords generally do not want to see an interruption in rent; they would rather see a reduction than a cessation.
Before you ask for lower rent, check rates in the area. If your current rent is higher than that being paid by other firms, go to the landlord and explain that you cannot remain competitive with other firms if your rent is higher than that of someone down the street.
Remind the landlord that if you stay, he will not have to pay the new-tenant improvement costs that will undoubtedly occur if you leave and a new tenant moves in.
An alternative strategy is to ask for an extension of the lease term at the current rate. Since all rents do eventually go up, you can effectively lower your average annual lease cost by extending the lease term at the existing rental rate.
- Use Lease Audits for Leverage
Many costs are paid for by tenants, including after-hours HVAC (heating, ventilating and air conditioning) and operating-expense “pass-throughs.” In most office leases, the tenant pays a fixed-base-rate sum plus an additional amount usually called an “escalation” or “pass-through.” The extra charge is based on a pro-rata share of the building expenses each year of the lease. Pass-throughs have been a gold mine for landlords, especially in a declining real estate market. When property values and corresponding lease rates decrease, operating expenses in many buildings tend to increase to offset this loss. Your goal is to reduce these pass-through charges.
Most tenants pay without question the operating-expenses statement and pass-throughs that the landlord submits. The tenant never expects the bill to have any discrepancies or errors. On the flip side, landlords seldom review the differences in each tenant’s lease; they simply assess operating expenses based on a tenant’s proportionate share of a building’s occupancy. But according to commercial real estate experts, landlords are frequently inaccurate or overly aggressive in the pass-throughs, knowing that most tenants don’t look closely at these figures. Overcharges can result from arithmetic errors, inaccurate assumptions, expenses not permitted under your lease or as a matter of law, an overstatement of your fair share, failure to credit offsetting revenues or recoveries, an understatement of credits, or inefficient building operations. Experts estimate that these excessive charges can equal $1 to $3 per square foot per year, or more!
A lease audit is an effective way to review, verify, and examine questionable pass-through charges. Auditing the operating expenses of a building may provide enough information to give you a distinct advantage in negotiating new terms and conditions for the balance of the lease term, including lower rent. In fact, depending on the results of such an audit, the landlord may owe youa refund for overcharges previously collected.
- Competition as Leverage
If you’re nearing the end of an existing lease, your negotiating leverage over the landlord is the possibility of your moving out and leaving him with an empty space.
Landlords will do almost anything reasonable to prevent losing a tenant and the resulting cash flow.
One way to strengthen your position is to invite competition among other landlords in the area by letting them know that you are thinking of relocating. Your current landlord will soon learn that you’re in the market for a new location and will likely want to discuss your tenancy.
Labor is the biggie in overhead reduction. Labor is separated into two categories—staff and associate lawyers—and cost-cutting strategies can be applied to both.
Without the labor, you don’t have the expenses. BUT, without the labor, you also can’t get out the work to meet your clients’ needs.
One approach that some firms are taking to limit staff expenditures is to assign each secretary to more than one attorney. In some firms, the goal is to have three attorneys per secretary. One well-trained secretary, coupled with the necessary technology, can produce a substantial amount of work product. And many more attorneys today can type and give a secretary work that is almost in finished form.
Some firms are also outsourcing their temporary associate attorneys’ needs. When your office hits workload peaks, you can hire a “contract attorney” who will work for you on a designated assignment as an independent contractor. In this case, the pricing is set in advance, usually on an hourly basis, but without the fringe benefits for that individual. Another option is to hire a legal research firm; there are now several around the country (e.g., Legal Research Center in Minneapolis, Minnesota). You simply describe the nature of your requirement, and the research company will deliver a finished product prepared by a qualified attorney on its staff.
Most attorneys are concerned, and rightly so, about keeping costs under control and reducing overhead. Spending on the big-ticket items should be judicious: rent (don’t get too fancy), equipment (buy only what will help you make money), and salaries (don’t take home so much that you have to borrow to meet payroll). Government could use a primer on these points.
Ed Poll is an attorney and the founder of LawBiz, a law firm management consulting company. He can be reached at (310) 827-5415.