Funding for PI insurance and tax
Depending on their premises costs, professional indemnity insurance (PII) is often the second largest annual cost for law firms, after salaries. But whereas salary and premises costs are spread throughout the year, PII is paid for annually. That annual payment represents a huge hit to a firm’s cashflow.
Probably 75% to 80% of law firms use PII loans to fund this annual insurance payment. A much smaller proportion of law firms also fund their tax payments in this way.
If your firm has ample cash balances, or is not involved in high risk areas such as conveyancing and so can obtain less costly PI insurance, such a loan may not be necessary.
Law firms use PII loans to spread the cost of this insurance, typically over a period of 12 months. This frees up capital that can then be used for working capital and for developing the practice.
Similarly, firms can spread the burden of tax payments over the whole year, rather than paying it all when the tax falls due.
Importantly, loans of this type tend to be inexpensive when compared with overdraft finance. Also, unlike an overdraft, a PII loan and a tax loan are for a fixed term – so the lender cannot demand immediate repayment (unless the terms of the loan have been breached).
Whereas an overdraft can simply be renewed annually, each PII loan is a new agreement.
The PII loans are set up (but not completed) well in advance, to give the lending organisation time to do its due diligence on the firm.
Often the loan is organised by the firm’s insurance broker, which will anticipate the size of the loan required (in line with the forecast rise or fall in insurance premiums).
At the point where the insurance cover is agreed, and the actual premium for the year is known, the PII loan agreement can then be completed.
Thanks to the use of electronic signatures, this last stage can be done in as little as 24 hours, although most firms take two or three days to review the final documentation and sign it off.
The funds are then made available, ready for payment before the day on which the insurance comes into force (most commonly 1 October still).
In theory, a PII loan can still be set up after the firm has paid the premium. But in reality, any firm with the funds to achieve the PII payment in the first place tends to not need a loan.
Obstacles to getting a loan
Before the pandemic, when the financial performance of law firms was more predictable, lenders were able to proceed based on limited due diligence – especially for law firms that the lender had provided a loan to the previous year.
But Covid changed that. For example, conveyancing went from zero activity at the start of the pandemic to record levels of activity before the Stamp Duty Land Tax (SDLT) holiday ended. Court closures led to a backlog of litigation and long delays in settlements. And the switch to working from home favoured some firms and negatively impacted others.
So, just as the PI insurers had to step up the level of scrutiny for the law firms that they are insuring, the funders of PI insurance have also.
Covid and all the ongoing changes to the legal sector have led lenders to be more cautious.
This is even more a reason to set up the PII loan facility early, based on a realistic forecast of what the insurance premium will be. If you are not a current customer of the lender, allow extra time for Know Your Customer (KYC) checks and, potentially, discussions around security for the funding.
Lastly, if your firm is acquiring or being acquired by another firm, that introduces another layer of complication and potential delay.
Terms of the loan
The terms of a PII (or tax) loan are straightforward.
Although some providers may offer shorter and longer periods, most loans are for 12 months – to match the term of the insurance being paid for. Repayments are by equal monthly instalments.
There will usually be an option to repay the loan early, upon payment of an early repayment charge.
If your firm is switching to a new lender, that lender may well ask for personal guarantees from all the partners/directors. Whereas this is not usually necessary for a firm that is an existing customer. Of course, the requirement for such security will reflect the financial health of the firm seeking the funding.
Getting the best deal
PII loans tend to be via a ‘referred supplier’ of the insurance broker. But it is worth shopping around, as you may well be able to achieve better terms.
PII loans (and tax loans) are no different from any other type of borrowing to the extent that the terms you achieve will reflect the financial health of your firm and the professionalism of your application.
A sloppy application – that necessitates the funder having to ask for additional information – can be expected to lead to worse terms. So too will a late application. Outdated and insufficient financial information is a common problem area.
If your application is rejected and you then must approach a ‘funder of last resort’, you will be deemed higher risk and you can expect to pay higher charges and a higher interest rate.
A holistic approach
When you are thinking about funding, consider all your firm’s funding requirements (plus any related partner funding) and then work out the best package of funding overall.
- Working capital, which is affected by your utilisation rates and lockup period.
- Professional indemnity insurance, which perhaps cannot be funded by cashflow alone.
- Tax and VAT payments, which can create other awkward pinch points in a firm’s cashflow.
- Asset finance, for example cars, computers and furniture, which can be financed over the useful life of the asset.
- Offices and their refurbishment, potentially funded by a commercial mortgage. Unlike most commercial mortgages, which have a term of 15 years, a mortgage for a law firm can be 25 years. The capital and interest payments are often no more expensive than rent payments would have been, although some firms may prefer the flexibility of not owning premises.
- Practising certificates, which can add up for multiple fee-earners (and can be added to the funding requirement when taking a PII loan).
- Practice acquisition, which leads to a consolidation of the funding of both firms.
- Partner buy-ins and exits, and the associated partner capital loans and capital repayments.
Funding for PII and tax top ten
- Use a PII loan to spread out the cost and de-risk your cash flow.
- Shop around for the best terms. Can you improve on what you've been offered?
- Set up the loan facility well in advance of when you'll need it to be actioned.
- If you are a new customer for the lender, allow extra time.
- Provide a full, up-to-date set of financial information on your firm.
- Provide any additional information that is evidence of your firm being low risk.
- Consider whether the cost of practising certificates should be added to your PII loan.
- Use a PII loan and/or a tax loan as part of a holistic finance package for your firm.
- Schedule time to review and sign the loan agreement.
- If you end up with a ‘lender of last resort’, expect to pay more.
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