Borrow for BigLaw Partnership Buy-in?

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Odysseus
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Borrow for BigLaw Partnership Buy-in?

Post by Odysseus » Sat Jul 07, 2018 7:11 am

Dear all--I appreciate your consideration of this long post. I'm a junior partner at a large, national law firm that has been around for a long time. As the next level of promotion, I'll become an equity partner and will be asked to contribute a substantial amount of capital (approximately $150,000). That capital would be held by the firm on an interest free basis until I retire or leave the firm partnership (and assuming the firm is solvent at that time, I would receive the capital back then). It's looking like I'll be asked to contribute in January. The way law firms work from a political standpoint you really need to accept that promotion (and make the buy-in) if you are asked to do so. Let's assume for this exercise that I want to go forward with that and take the next step at my firm.

I don't have sufficient assets outside of my 401(k) and IRAs to pay the buy-in in cash (and I don't want to dip into those accounts for those funds). The firm has a financing program in place with a bank. The bank would finance the buy-in over a five year period (at an annual interest rate of around 4%), payable in five annual installments. There is no prepayment penalty.

As an equity partner I would receive approximately 70% of my annual "draw" (my income from my firm) throughout the year and the remaining 30% would be paid to me at the end of the year if my firm hits budget (we have an excellent track record of hitting budget every year, but these are uncertain times in our industry). A portion of the 30% end of year draw would go directly to the bank to satisfy each annual bank payment. The rest would essentially go into my firm's profit sharing plan. It's unclear what my annual draw would be, but let's assume it is $250,000. Accordingly, a portion of my income would be held back by my firm each year (for five years) and paid directly to the bank to pay off the debt.

I have a few questions for which I would appreciate your thoughts and feedback:

1) Do you agree with my approach of not dipping into retirement funds (401(k) and IRAs) (or reducing or eliminating future contributions to those funds) in order to pay cash for all or a portion of the buy-in? Any concerns with borrowing those funds under these circumstances?

2) I save 20% of my gross income for purposes of retirement. During the five year capital contribution pay-down period my thought is that I would: A) Save 20% (for retirement) of the 70% gross amount of the draw that is payable to me throughout the year; and B) Save 20% (for retirement) of the 30% gross amount end of year draw (to the extent that is possible after the bank payments are made). In short, I am not planning on pre-paying that bank debt at the expense of my 20% retirement savings, but I would consider paying down that bank debt if possible with any bonus income, etc.

I am in great appreciation of your thoughts on my above plan. Thanks all.

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Atomic
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Atomic » Sat Jul 07, 2018 10:20 am

The plan seems reasonable. If I understand the risk right, if your firm doesn't make budget you still may need to make the loan payment from other sources. Based on the ratio of debt to income, I don't think the capital buy-in is all that substantial and the up side seems worth it. You may want to adjust your emergency fund or review your other insurance risk to work with this new risk you are taking.

simas
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Re: Borrow for BigLaw Partnership Buy-in?

Post by simas » Sat Jul 07, 2018 10:32 am

1) Yes
2) Yes on trying to keep the same 20% target

overall, cross the bridge when you get to it - IF you are offered then you can respond with 'let me review the details' and go from there, especially since they have a program with the bank to arrange for that.

Nate79
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Nate79 » Sat Jul 07, 2018 10:49 am

What is your financial picture outside of this? Are you debt free and this would be your only new debt? Or are up to your eyeballs in consumer debt, student loans, and a huge mortgage?

Odysseus
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Odysseus » Sat Jul 07, 2018 11:03 am

Thanks for the responses all. You're correct that if the firm doesn't hit budget, I would need to come up with the substantial annual payment for that year on my own. Excellent thought on increasing my emergency fund accordingly.

On the question regarding my overall financial picture, it's generally healthy. My only debt is my mortgage and the payments are comfortable (right around $3,000 per month). Retirement savings are good, but I need to work on my cash emergency fund (it's just a little over $10,000 if you don't include the Roth's). I've been not wanting to divert resources to cash savings, but I think that would be prudent given the added risk.

Thanks all.

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archbish99
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Re: Borrow for BigLaw Partnership Buy-in?

Post by archbish99 » Sat Jul 07, 2018 11:18 am

One option to consider is that, if you believe the firm not making budget is highly unlikely, you could continue to focus on your Roth and 401k savings first. In the event that you need to make a payment out-of-pocket, you have the option of a Roth principal withdrawal or a 401k loan.

Bearing in mind, of course, that failing to make budget could be strongly correlated with downturns in those accounts.
I'm not a financial advisor, I just play one on the Internet.

simas
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Re: Borrow for BigLaw Partnership Buy-in?

Post by simas » Sat Jul 07, 2018 12:32 pm

archbish99 wrote:
Sat Jul 07, 2018 11:18 am
Bearing in mind, of course, that failing to make budget could be strongly correlated with downturns in those accounts.
failing to make budget could also be strongly correlated to downturn in the firm (as in you would have much bigger problems including no income if you would be among 'optimized' in such downturn). Dont waste your time overthinking it, if you 'make it' (if they offer), deal with in then . 'help me understand' works wonders and there is no fear in asking about something that is new to you , as well as taking the time to think it over behind you sign behind something (or anything). firms come, firms go, conditions change, teams change, people leave all the time - be patient, flexible , and deal with it as it comes..

Odysseus
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Odysseus » Sat Jul 07, 2018 2:56 pm

Thanks for the sharing of wisdom all.

smectym
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Re: Borrow for BigLaw Partnership Buy-in?

Post by smectym » Sat Jul 07, 2018 5:23 pm

We went through this. The firm had a "special relationship" with Wells Fargo and facilitated taking out the loan with them. We hesitated, thought about dredging up the cash to avoid the loan--but ended up taking it. We did make sure the loan had no prepayment penalty. It didn't or it was de minimis, can't remember. In any event, our strategy was to prepay the loan as quickly as possible without undue hardship, and that worked well. Had the loan for only a little more than a year. I would avoid letting the loan hang around for many years, as I gather many of my colleagues did. In short, not a big deal to accept the loan if it can be readily prepaid.

Smectym

ivk5
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Re: Borrow for BigLaw Partnership Buy-in?

Post by ivk5 » Sun Jul 08, 2018 1:43 am

You may find that loan terms are quite favorable. In the professional services partnership I’m familiar with, the effective rate on capital loans is (currently) lower than rate you can earn on cash. (Capital loan interest is deductible against K-1 income, including for SE tax purposes I believe.) You’ll need to evaluate whether and how aggressively to prepay when you have all the facts. Of course, prepaying is irreversible while the inverse is not the case. Similar to mortgage prepayment considerations.

Be on guard if you are offered the opportunity to make additional “voluntary” capital contributions on what seem like favorable terms, or to participate in a non-qualified deferred comp plan. These may be useful tax planning tools within a few years of retirement, but in early/mid career the additional exposure to firm risk seems unwise to me. Don’t become a voluntary lender to your partners; the firm can finance its organic/inorganic capital needs in other ways.

Needless to say, if you have been a W2 employee until now, make sure you are on top of estimated tax payments. Also pay attention to tax impacts (opportunities) in the year you cut over if firm has a fiscal year that is different from calendar year.

Bleck
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Bleck » Sun Jul 08, 2018 2:04 am

Most major banks will offer loans to fund capital accounts to big law partners. The terms will really vary. Shop around. Some banks might be party to your firm’s revolving credit or other debt facilities and might have better (or worse) terms depending on what they know about your firm.

Also surprised that you don’t receive interest on the capital.

If you haven’t, I would have a chat with the firm’s CFO and tax director; they have seen it all and can give a lot of background. They might also share a pro forma cash flow schedule and partnership accounting based on other recent new partners for the first three or four years. Cash flow can be really tough on new equity partners in light of capital downpayments, required benefit contributions, additional tax liabilities and potential changes in the cost of benefits. Try to get as much info from the firm as possible.

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JamesSFO
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Re: Borrow for BigLaw Partnership Buy-in?

Post by JamesSFO » Sun Jul 08, 2018 5:01 am

Just one reminder, depending on how your firm works the first ~2-4 years as a junior partner you may make less than you did as a senior associate.

TheAncientOne
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Re: Borrow for BigLaw Partnership Buy-in?

Post by TheAncientOne » Sun Jul 08, 2018 9:13 am

Odysseus, you need to temporarily reduce your tax sheltered contributions to build up your cash position. First to pay off the partnership loan but also to build up your cash reserves and taxable account savings. The usual view here is that you should never give up the one time chance to make 401K contributions in any given year but your partnership is also a valuable long term investment. It's in your best interest to get that loan paid off quickly and to have assets in taxable accounts so you have financial security over the short and medium term.

afan
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Re: Borrow for BigLaw Partnership Buy-in?

Post by afan » Sun Jul 08, 2018 12:00 pm

Don't reduce your tax favored savings to do the buy in. If you pass up a chance to svae this year you never get that opportunity back.

You do not indicate your expected income, base salary or year end bonus. From equity partner at a national firm, it sounds like the $150k will quickly seem like a small amount of money. If that is true, then borrow it and pay back as you planned. Max out your tax advantaged savings. If your income permits you may want to accelerate paying down the loan.

Or not. Itwill depend on what happens with interest rates. Four percent fixed is a very good rate for a personal loan. If interest rates keep going up you may find you can make a higher return on a low risk investment than you are paying in interest on the loan.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

afan
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Re: Borrow for BigLaw Partnership Buy-in?

Post by afan » Sun Jul 08, 2018 12:26 pm

James and Bleck give excellent advice. The people running your firm should be able to walk you through how much this will cost, what your cash flow should be and the tax implications. I have seen associates surprised that their take home went down for a while after they made partner. Long term it was definitely worth it, but they would have been better off if they had known what was coming.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

il0kin
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Re: Borrow for BigLaw Partnership Buy-in?

Post by il0kin » Sun Jul 08, 2018 12:28 pm

What is the long term upside of the $150k? A percentage of total firm profits? How long will it take to recoup your 150k investment and once you recoup it, on an annual basis what could you reasonably expect above and beyond being a W2 employee?

Odysseus
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Re: Borrow for BigLaw Partnership Buy-in?

Post by Odysseus » Sun Jul 08, 2018 12:55 pm

Thanks all for your thoughts on this. The upside of the $150K is difficult to quantify. It allows me to participate proportionately in the profits of the firm for so long as I'm a productive partner. I guess I've always viewed it as something that is necessary in order to maintain my financial earnings (rather than evaluate it as an investment).

I agree that the first five years will be tight until that is paid off. My gut agrees that building up cash reserves would be prudent.

il0kin
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Re: Borrow for BigLaw Partnership Buy-in?

Post by il0kin » Sun Jul 08, 2018 1:16 pm

Odysseus wrote:
Sun Jul 08, 2018 12:55 pm
Thanks all for your thoughts on this. The upside of the $150K is difficult to quantify. It allows me to participate proportionately in the profits of the firm for so long as I'm a productive partner. I guess I've always viewed it as something that is necessary in order to maintain my financial earnings (rather than evaluate it as an investment).

I agree that the first five years will be tight until that is paid off. My gut agrees that building up cash reserves would be prudent.
I think you should ask for written documentation and examples on what you could have expected as a payout at your current productivity level +/- 10% were you to contribute the $150k.

If the 150k nets you 10k per year (unlikely) it'll quite some time to recoup the initial investment. If it nets you an extra 50-100k per year, put in 300k :D

DC3509
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Re: Borrow for BigLaw Partnership Buy-in?

Post by DC3509 » Sun Jul 08, 2018 1:21 pm

OP -- I think only other biglaw attorneys can really appreciate the question. This is not something where you should be getting cute or asking what the upside is, etc. -- you know what the upside is, you become a biglaw equity partner and the right to share in the firm's profits. How about not being fired, or pushed out the door, like a lot of biglaw attorneys? Most attorneys would die for a job at a biglaw firm, let alone equity partnership at a biglaw firm. Don't overthink it. Take out the loan like almost everyone else does, pay it back, and you will be done with it before you know it. This is the typical example of a very "good" form of debt.

mcraepat9
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Re: Borrow for BigLaw Partnership Buy-in?

Post by mcraepat9 » Sun Jul 08, 2018 1:24 pm

DC3509 wrote:
Sun Jul 08, 2018 1:21 pm
OP -- I think only other biglaw attorneys can really appreciate the question. This is not something where you should be getting cute or asking what the upside is, etc. -- you know what the upside is, you become a biglaw equity partner and the right to share in the firm's profits. How about not being fired, or pushed out the door, like a lot of biglaw attorneys? Most attorneys would die for a job at a biglaw firm, let alone equity partnership at a biglaw firm. Don't overthink it. Take out the loan like almost everyone else does, pay it back, and you will be done with it before you know it. This is the typical example of a very "good" form of debt.
This advice is spot on.

Disclosure: I am a newly minted biglaw partner who just ponied up the equity buy-in. Did not hesitate.
Amateur investors are not cool-headed logicians.

HornedToad
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Re: Borrow for BigLaw Partnership Buy-in?

Post by HornedToad » Sun Jul 08, 2018 4:10 pm

I agree with the previous Lawyer's advice.

The only thing that is strange to me, and probably because I'm less familiar with Law firms than other professional services firms is that the buy-in is facilitated by a loan from a bank instead of by the company itself where you just have a lower draw until it's paid off. But I guess they want it to be more strictly separated. In other industries the partnership buy-in is slowly phasing away or at least interest free loans but the supply/demand curve for Big Law probably hasn't hit that point yet.

smectym
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Re: Borrow for BigLaw Partnership Buy-in?

Post by smectym » Sun Jul 08, 2018 4:36 pm

>DC3509 wrote: ↑Sun Jul 08, 2018 1:21 pm
>OP -- I think only other biglaw attorneys can really appreciate the question. This is not something where you should be getting cute or asking what the upside is, etc. -- you know what the upside is, you become a biglaw equity partner and the right to share in the firm's profits. How about not being fired, or pushed out the door, like a lot of biglaw attorneys? Most attorneys would die for a job at a biglaw firm, let alone equity partnership at a biglaw firm. Don't overthink it. Take out the loan like almost everyone else does, pay it back, and you will be done with it before you know it. This is the typical example of a very "good" form of debt.
This advice is spot on.

Disclosure: I am a newly minted biglaw partner who just ponied up the equity buy-in. Did not hesitate.


As a retired biglaw partner: Agree absolutely. The buy-in is just "what's done." The loan from the bank the firm has ties with and suggests you take the loan from is generally the loan you should choose. The capital contribution never accrues interest. My wife just got hers back after over 20 years--the same amount she put in. That's the business model. OP will not score points by getting crafty and trying to reverse engineer the model.

Smectym

mcraepat9
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Re: Borrow for BigLaw Partnership Buy-in?

Post by mcraepat9 » Sun Jul 08, 2018 5:09 pm

HornedToad wrote:
Sun Jul 08, 2018 4:10 pm
I agree with the previous Lawyer's advice.

The only thing that is strange to me, and probably because I'm less familiar with Law firms than other professional services firms is that the buy-in is facilitated by a loan from a bank instead of by the company itself where you just have a lower draw until it's paid off. But I guess they want it to be more strictly separated. In other industries the partnership buy-in is slowly phasing away or at least interest free loans but the supply/demand curve for Big Law probably hasn't hit that point yet.
This is typical from what I have heard from others at other firms - the partnership needs the capital and doesn't want to take (or be in the business of managing) credit risk. Leave that to banks best equipped to price and handle it. The loan terms tend to be pretty reasonable anyway.
Amateur investors are not cool-headed logicians.

JuniorBH
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Re: Borrow for BigLaw Partnership Buy-in?

Post by JuniorBH » Mon Jul 09, 2018 9:19 am

smectym wrote:
Sun Jul 08, 2018 4:36 pm
OP will not score points by getting crafty and trying to reverse engineer the model.

Smectym
As someone in a professional services firm who's reasonably close to a similar decision, I agree with this. Just part of the process, but I'd focus on the bigger picture for what this means for your career long-term. There should be resources at the firm who can help with logistics, tax considerations, etc.

SouthernCPA
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Re: Borrow for BigLaw Partnership Buy-in?

Post by SouthernCPA » Mon Jul 09, 2018 3:40 pm

JuniorBH wrote:
Mon Jul 09, 2018 9:19 am
smectym wrote:
Sun Jul 08, 2018 4:36 pm
OP will not score points by getting crafty and trying to reverse engineer the model.

Smectym
As someone in a professional services firm who's reasonably close to a similar decision, I agree with this. Just part of the process, but I'd focus on the bigger picture for what this means for your career long-term. There should be resources at the firm who can help with logistics, tax considerations, etc.
When I was in public accounting, this was similar to how CPA firm partners were admitted. You buy in. Some firms finance it in house for you, others you seek financing by a 3rd party or pay cash for your interest.

I work in a commercial real estate development partnership now and it's similar, but just on a deal by deal basis and without all the billable hour/realization stress...

SouthernCPA
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Re: Borrow for BigLaw Partnership Buy-in?

Post by SouthernCPA » Mon Jul 09, 2018 3:47 pm

smectym wrote:
Sun Jul 08, 2018 4:36 pm


The capital contribution never accrues interest. My wife just got hers back after over 20 years--the same amount she put in. That's the business model. OP will not score points by getting crafty and trying to reverse engineer the model.

Smectym
I understand the capital contribution never accruing "interest." That said, wouldn't the value of your partnership interest go up if the firm has grown and your ownership % has not been diluted? I would assume $150k would buy you X% worth $150k on year 1 and as the firm is more and more successful over the years, your same % (ignoring subsequent additional buyin through distributions,etc) should be worth a lot more since the overall firm is worth more. Why wouldn't that same % be bought out from incoming partners at a higher value later down the road?

chazas
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Re: Borrow for BigLaw Partnership Buy-in?

Post by chazas » Mon Jul 09, 2018 10:57 pm

Whether it accrues interest or not depends on the firm (ours does), but the value of your capital account otherwise doesn’t increase over time. That’s just not how they do it. They’re effectively using the partners to guarantee a portion of their working capital line.

Borrow if you get good terms. In my firm the interest the firm pays slightly exceeds the interest cost on the loan, so it’s basically a wash.

You probably don’t have a choice, but be aware that this money really is at risk. Firms do fail, I’ve been through that. When partners start leaving it’s a downward spiral and unless the firm gets acquired by a white knight, you could end up losing your capital. So make sure you believe in firm management.

SouthernCPA wrote:
Mon Jul 09, 2018 3:47 pm
smectym wrote:
Sun Jul 08, 2018 4:36 pm


The capital contribution never accrues interest. My wife just got hers back after over 20 years--the same amount she put in. That's the business model. OP will not score points by getting crafty and trying to reverse engineer the model.

Smectym
I understand the capital contribution never accruing "interest." That said, wouldn't the value of your partnership interest go up if the firm has grown and your ownership % has not been diluted? I would assume $150k would buy you X% worth $150k on year 1 and as the firm is more and more successful over the years, your same % (ignoring subsequent additional buyin through distributions,etc) should be worth a lot more since the overall firm is worth more. Why wouldn't that same % be bought out from incoming partners at a higher value later down the road?

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