Legal expenses, like legal outcomes, can be unpredictable. Whether your company is planning several big transactions, is facing the threat of litigation, or is simply proceeding in its ordinary course of business, issues can pop up, skew your legal spend, and cut into your bottom line.
Accurately forecasting your annual legal budget depends on several factors, including business strategy and future growth. Here are our tips on how to master legal spend management:
1. Don’t start your legal budget process from scratch
Some recurring expenses can be accounted for ahead of time. Start by looking at your itemized legal expenses from the past year (or years). Annual administrative fees (like corporate filings) will likely remain the same year to year. Existing flat fee arrangements with outside law firms are also relatively stable and predictable. For hourly engagements, consider negotiating for flat fees if you can be relatively certain you’ll come out ahead, or if maximizing predictability is more important to you than minimizing your spend.
Of course, if your company is growing, you can’t necessarily rely on the previous year’s numbers, since with new growth comes additional legal fees.
2. Talk to your colleagues on the business side
When thinking through your annual legal budget, it’s important to talk to your colleagues on the business side about your thoughts on managing legal spend. Familiarize yourself with next year’s product and business roadmap so you can use your legal experience to spot issues that will impact future legal spend.
Here are some examples of events that could trigger increases in your legal expenses during the year:
- Plans for new technology (patents)
- Any new branded products (trademarks)
- Joint ventures with companies
- Financing (equity or debt)
- New contractors or deals with outside companies
- Potential sponsorships
- Potential sweepstakes
- Updates to product such that you need new user terms
- M&A activity
In addition to discussing these events with your colleagues on the business side, consider speaking with outside counsel to price them out in advance.
3. Evaluate your litigation history and risk
Generally, the more successful your company, the bigger litigation target you are. When preparing your litigation budget for the upcoming year, start by assessing litigation costs from prior years. Is there a trend? If so, you may be able to extrapolate. Then, ask yourself what litigation matters are already pending and being carried over from the previous year. Finally, evaluate the upcoming year’s business strategy and product roadmap for potential vulnerabilities (such as intellectual property or employment disputes) and take steps to mitigate the risk through preventative legal action.
4. Adjust the numbers
Unless you have a crystal ball or a time machine, your numbers are not set in stone. Consequently, it can be helpful to think about your planned legal expenses as a range, with different events that can ratchet the amount up or down:
Chance and probability. With litigation, you need to take into account the likelihood of various outcomes, such as settlement, discovery and trial. For hard numbers, you can use a traditional expected value model that multiplies total loss (via settlement, legal fees, and/or damages) by probability of the loss.
Growth. Chances are your C-suite has prepared a growth plan for the following year to present to your company’s board and investors. You can use their projected growth rates to calculate a range for expected legal expenses as well. Do a gut check on both the high end and low end of the spectrum.
Billing rates. Don’t just look at what you’re spending money on – look at whom you’re spending money on. Are you using big firms with high billing rates? Are there routine matters for which you can use smaller firms with lower fees?
Once you’ve arrived at a range, put your legal spend management skills to use by identifying areas where you can lower costs, improve efficiency and ultimately tighten up your company’s P&L. A company’s legal spend is one area where cheaper isn’t necessarily better – it’s important not to skimp on quality or avoid expenses now that could prevent major legal headaches (and fees) in the future.
The legal budgeting process for a business can seem like a black box, but it doesn’t have to be. Although it’s impossible to have perfect foresight, by understanding your company’s historical legal spend as well as potential issues on the horizon, you can go a long way toward accurately predicting future expenses.