Retiring from a professional services firm can happen for a variety of reasons. Being paid out on departure may not always be simple or straightforward and may not be possible in the timescale one hopes for.
LLP funding and capital requirements
Most professional firms are LLPs or traditional partnerships. They require a level of funding to provide working capital for the business.
Funding in professional firms is usually a mix of:
Traditional bank finance
Asset-based finance
Partner funding
The levels funding in each area will depend on the needs of individual firms.
Role of partner contributions
The amount of partner funding will normally be set by the firm, usually to contribute an amount towards the level of working capital required. At any stage, a partner will need to be able to draw an element of profits (usually monthly) to cover living costs and on retirement will need to be confident that the firm can repay the capital account and pay-out any undrawn profits. The extent to which the firm can do this will mainly be determined by the level of lock-up in the business. Lock-up is the term used to describe the combined value of unbilled work-in-progress (WIP) and unpaid fees. It is often expressed as a number of days.
Calculating lock-up
The example below shows how lock-up is calculated and the effect that changes in lock-up can have on the available cash for the business.
Turnover £7.5m
WIP £625k
Debtors £1.25m
Total lock-up £1.875m
Lock-up days 91 days (Total lock-up/annual turnover x 365)
Whilst there can always be an argument as to the financing required for lock-up - the fact that WIP and debtors should include a mark-up, and lock up could be netted against certain creditors - it is true that in this example there is a funding requirement of up to £1.875m for amounts due to the firm at that point.
Measuring unbilled work and unpaid fees
Using the above example if the lockup was as high as 120 days the lock-up value would be c £2.4m, whilst if it could be reduced to c60 days the value would fall to c £1.2m. (A movement of one day in accounts for around £20k in potentially available cash or c £140k for a movement of lock-up by one week.) In the example given, reducing the lock-up by two weeks could free up c £280k of cash - perhaps enough to help towards a timely pay-out of capital.
The numbers here illustrate the effect of strong lock-up management, and for retiring partners to be aware of the impact of lock-up movement on the potential for releasing cash to them. Put simply, the higher the level of lock-up the more cash (capital) is required by the business, and the less is available for pay-out.
Manage your lock-up
Some firms will run by partner portfolio and some by department, and will therefore have differing ways of managing their lock-up. The overarching principle however is that the lower the level of lock-up the more cash available to the business for future planning including paying out retiring partners.
Partners need to be thinking about lock-up management all the time, not just as they head for retirement. Some key pointers to help are as follows:
Always be aware of where the conversion of lock-up to cash issues are
Ensure that the value of WIP is convertible to bills
Resolve queries on bills promptly. If there is a minor query on a fee note the client probably won’t pay the full amount of the bill
Where possible agree that bills can be raised ‘on account’ as the work in undertaken. Professionals are usually more concerned about raising interim fees than clients are at receiving them
Don’t work with clients who are habitually slow payers
Be confident in stopping work if bills are not paid within agreed timescales
Some types of work do not lend themselves to interim billing, but most do.
In smaller firms it easier to influence the lock-up position than in much larger firms. However, the principles for calculating the lock-up are the same.
Take some time to the consider the liquidity of your firm and the influence you can have to help smooth the way for a prompt and orderly repayment of amounts that are due to you.
If you would like advice and support around managing your lock-up, please get in touch. Call 0808 144 54575 or email help@armstrongwatson.co.uk.
