TEN THINGS: HOW TO PREPARE AN ANNUAL LEGAL DEPARTMENT BUDGET

Fall is my favorite time of the year.  The weather’s cooler, the trees change color, and football (American style) permeates the airwaves.  If you’re big into Halloween (and I am) you get to decorate the yard with zombies and gravestones and then hand out free candy to the neighborhood kids – and snag a few Twix bars for yourself.  However, there’s more going on in the Fall than wearing a Nebraska Cornhuskers sweatshirt, admiring the foliage, and handing out candy.   If you are in-house counsel, you know this time of year means one particularly thankless task: preparing an annual Legal Department budget.  Adding to the fun is that you must figure out in October what you’ll be spending in August of the next year.  But no one in the business is crying any tears for Legal.  They are all going through the same process.  And as we all know, Finance is telling you to be prepared to cut spending (or at best be flat year-over-year).  Somehow, someway, you’re going to have to find a way to come up with a spending plan that tries to account for the knowns and unknowns associated with providing legal services to the company.

I recently got back in the in-house game and took on the General Counsel role for Marketo.  Which means after two+ years of not having to worry about legal budgets, here I am with my dry-erase markers and my big white board of numbers planning for 2018 legal spend.  And as I sit staring at this mess of numbers, I figure that there might be in-house lawyers out there who have never prepared an annual budget, are going through it for the first time, or are just interested in learning how others do it.  While there is a lot written about budgeting for specific legal matters, I found very little written about preparing an annual budget.  So, this edition of “Ten Things” will walk you through the process I am going through right now as I prepare our annual Legal Department budget:

1.  What goes into a Legal Department budget?  The very first thing you need to do when preparing an annual legal department budget is to understand and account for all the different items that make up the budget.  If you forget something, you can end up with some big, costly holes.  So, it’s worth sitting down and thinking hard about it.  Here are the high-level categories I have written on my white board:

• Salaries & benefits – this usually comes from HR, but it accounts for salaries, benefits, bonuses, 401k match, and anything else that goes into the “fully loaded” cost of each employee in the department.
• Allocations – this number comes from Finance and accounts for the Legal Department’s share of rent, utilities, technology, copiers, phones, and any other costs associated with operating the company that are spread among the different business units and staff groups.
• Department specific technology – besides technology generally provided by the company, the Legal Department may have its own specific technology such as a contract management system, e-billing system, matter management, etc.
• CLE/Training – every Legal Department needs to keep its people trained and up-to-speed.  Includes conferences, seminars, and so forth.
• Travel – another must have.  Be realistic here.  Travel involves a lot more than the cost of airfare.  Spend some time thinking about each month of the year and who will travel where and what will they will realistically spend per trip.
• Bar fees/legal memberships – this includes state bar fees, membership in organizations like the ABA, CLOC, or ACC.  Don’t forget certifications, like CIPP.
• Subscriptions/Books /Newspapers – these cover things like Westlaw, Lexis, Practical Law, CEB, Law360, and any other subscriptions or books/periodicals, etc.
• Outside counsel fees/Contractors – Other than perhaps salaries/benefits, this will be your biggest line item.
• Team events – Have a holiday lunch, or work a charitable event, or planning on an offsite?  You need to account for it.
• Postage/office supplies – unless you never use FedEx or buy pens and paper, you must account for this line.
• Miscellaneous – basically, everything else, like translations, notary public license fees, trademark watch services, corporate secretary services, mobile phone reimbursement, etc.

2.  Look at historical spend.  I know this seems obvious but if you’ve never built a legal budget before outside counsel/vendor spend needs to go to the top of the list.  The first thing to look at is spending for the current year and then projecting a “run-rate” for the full year.  For example, if you have spent $500,000 through September, divide by nine to get a monthly average spend of $55,555.  Multiply by the remaining months of the year, three (3 x $55,555) to get your estimated remaining spend for the rest of the year: $166,665.  Add everything together ($500,000 + $165,665) to get your estimated annual spend: $665,665.  You can use this as a starting point for estimating next years spend.  Next, look at all your open matters and which matters will likely roll over into the new year.  Work with outside counsel to estimate the fees for those matters in the coming year.  Then look at your historical averages over the past several years (if you have that data).  That will help you ballpark your expected range.  Be sure to discard any unusually high numbers (e.g., a massive antitrust case) that are not likely to repeat.  Finally, work with your team to use everyone’s knowledge of what’s coming (see Paragraph 7 below), trends, their gut, and their experience (i.e., chance + probability) to estimate the new types of matters that might arise in the new year.  All of this becomes your data pool to draw from.

I then like to write out on a whiteboard (or spreadsheet) my main categories: litigation, employment, IP, commercial, corporate secretary, real estate, privacy, regulatory & compliance, and so forth, and start to plug in numbers for each area based on my analysis of the above.  And I ask my team – especially those that manage outside counsel – to step into my office and help me review and refine my numbers.  I do something similar for my “essentials” (See paragraph 6 below).  When I am done, I have a pretty good estimate of our legal spend for the next year (even if next year is months away).

3.  Make a friend in Finance. You will save yourself a lot of problems and turmoil if you set out to make Finance a friend of the Legal Department.  This means a number of things: a) always be responsive to their requests for information (no matter how annoying); b) invite them to attend your monthly budget meetings/spending reviews – make them feel like part of your team; c) take the time to explain what matters Legal is spending money on and why (don’t assume they have any understanding of the legal process or how legal issues evolve – they will appreciate you taking the time to teach them); d) listen to their suggestions and ideas about legal spend; e) talk to them frequently during the budgeting process; and f) give them accurate information and forecasts about legal spend so they look good to their bosses and the CFO.  If you do these things, you will likely have someone on the “inside” of the process who will support your budget request (and fight for you) and will give you the scoop on how things really work when the budget is set and how best to position the legal budget to get the maximum amount possible.

4.  Involve the entire department. If you want to create an accurate budget you need to involve the entire Legal Department in the process.  In particular, you need them to help you think through all the different types of spend the Department might incur in next year based on their direct knowledge or experience.  Basically, ask everyone who manages spend for their ideas on what they will need to spend next year in their area.  Without this “frontline” input, you will be guessing vs. forecasting.  And there is a big difference between the two.  Guessing is one step above useless.  Forecasting means you’ve taken time to educate yourself about the likely scenarios and outcomes.  It will not be perfect, but it will be in the ballpark.  Also, other than specific individual’s compensation, the budget should not be a secret to the members of the Department.  They should know how the budget was built, what choices were made and why, their responsibilities around managing and forecasting spend, and – most importantly – if mid-year corrections are needed it will be much easier to explain “why” and “how” because they will be fully vested in the process.  If you keep things hidden or play everything to close to the vest then your team will check-out and the budget will become solely your issue.  I like to encourage my team to shoot for the moon, i.e., “tell me what you want.”  But, I always caveat that with it’s likely I will come back with “tell me what you need.” And, ultimately, “here’s what you get.”  But, so long as they feel you heard them out and then understand “why,” the odds of serious rebellion or grumbling are low.

5.  Don’t forget about accruals. Want to mess up your elaborately planned budget in the first few months of the year?  Forget to properly accrue for some of the prior year’s legal invoices.  As you probably know, law firms can be notoriously slow in sending their bills to you, especially firms in foreign countries.  When there is a delay between when legal services are provided and when they are actually billed and paid, you must “accrue” for that spend.  Simply put, you put down a marker that you owe firm X $5,000 for services provided in November.  When you get the actual bill in January or February, you pay it out of the accrued funds and not the new year’s budget.  All of the unbilled services for the prior year should have an accrual and the bills charged against the accrual as they come in.  If you forget to accrue for something (especially those bills toward the end of the year) and the invoice comes in during the new year, it hits the new budget and not the prior year’s budget.  That can be a real kick in the shins, especially if it’s more than a few invoices.  As you near the end of the year, make sure your accrual process is properly set, that you notify all your firms that you need their accrual amounts as soon as the month ends and that they need to get their invoices to you within 30-60 days of month’s end.  This is best accomplished with a reminder email toward the end of the year.  If a firm sends you a bill in May for work done last November, my suggestion is you reject it and tell them “sorry, too late and out of policy.” For more on accruals see this series on the topic (Part I and Part II).

6.  Plan for the essentials.  Focusing on outside counsel fees is easy because such fees are the most obvious source of spending by the Legal Department.  They also tend to be the most visible to those outside the Department, e.g., the CEO or CFO.  But, when planning your budget, you need to be sure to capture all the “essentials.”  These are the things you must absolutely spend money on just to keep the lights on.  And they can add up, which means if you don’t account for them they can become a nasty surprise as you monitor legal spend over the course of the year.  I have listed a number of these above in Paragraph 1, in particular, things like state bar fees, technology costs, and subscriptions.  But, you really need to comb over the current years’ bills and expense reports (and interview your team) to capture everything.  Don’t forget things like fees to maintain patents and trademarks, business license fees and secretary of state annual reports, fees associated with your registered agent, stock service agent (if publicly traded), occupation taxes, and host of other fees and costs needed just to run the Legal Department and provide legal services.  As you dig into this area, you may well find costs that have been paid year after year even though no one wants or uses the services anymore but are automatically paid every year because no one said: “stop.”  Likewise, you might find that you have several individual memberships to an organization that can be consolidated into a less expensive group membership.  The lesson here is don’t focus only on outside counsel fees when you plan your budget.

7.  Know the company’s plans for next year.  It’s very difficult to plan a budget if you have no idea what the company’s business plans are for the next year.  Is the company expanding into new geographies or new lines of business?  Is M&A on the horizon?  Will there be new products coming online (which may need trademarks, copyrights, or patents)?  Do you need to prepare to go after a large amount of accounts receivable that are way overdue?  Whatever it may be, you need to know about it now, because now is when you are planning your budget.  There are two ways to get this information.  First, you should be highly tuned into presentations and discussions at the executive level about the plans of the company.  It’s rare that by this time of the year there are not several stakes in the ground about where the company is headed.  Unless highly confidential, those plans should be shared with the Legal Department and especially with those involved in planning next year’s budget.  Second, ask someone.  Unless you work in the strangest Legal Department I have ever heard of, you should have unfettered access to the business unit leaders and their chief lieutenants.  Ask them to share their plans with you and use those to determine what the Legal Department will be dealing with next year.

8.  Move special projects/costs off the Legal budget.  Don’t assume that every legal-related cost must be borne directly by the legal budget.  Depending on your ability to “make the case” it’s possible to convince Finance or various business units that certain costs should be borne on either a special cost center or paid for directly by the business unit.  For example, M&A work is something that should not fall on the everyday operating budget of the Legal Department unless the budget process allows you to account for that spend at the time you set the budget.  Otherwise, the cost of legal services related to a merger, acquisition, or disposition should just be assigned to a special cost center where all the expenses for that project are placed.  It’s just part of the ROI of the transaction.  Same for something extraordinary like an IPO.  On a more day-to-day front, consider whether the Legal Department should bear the costs of immigration services or should that be part of the cost of hiring the person and charged to the business unit.  Likewise, why should Legal bear the cost of outside counsel services relating to sweepstakes and contests when that should be a marketing expense tied to the ROI of running the sweepstake contest?  Lastly, you can argue that the cost of domain names, trademarks and copyrights should be a marketing expense, especially when we all know that if the Marketing Department views these as “free” they will have no reason to limit their requests.  If they have to pay for it, you will see only requests for services that have passed some type of business case before coming to the Legal Department.  Look through your legal spend carefully, and see if you can make a case for moving some of the expenses off of the legal budget.  Even if you don’t get all of them, you might get something and it’s worth a try

9.  Be willing to move legal work.  One thing you’ll need to consider when planning your budget is the likelihood of a fee increase by your law firms.  You must account for this in your planning.  That said, the annual budget planning process is also the perfect time to take a good hard look at all the law firms you are using and whether you believe you are getting the right value for your spend.  First, don’t be afraid to tell your law firms “no” to any proposed fee increase.  You don’t have to accept it.  Second, do not hesitate to move the work.  If you are unwilling to move work to a firm that can provide better value then you need to ask yourself are you serving the interests of your client (the company) or are you deferring to some feeling of loyalty to your outside counsel?  The interests of your client come first.  Additionally, if the budget grim reaper is appearing at your doorstep and you’re told to take a 20% cut in your budget, changing law firms may be the only way to make it work.  Don’t fear, there are a lot of amazing law firms out there that have high-quality lawyers doing great work at significantly lower rates.  You may even find some solo practitioners out there who were once with one of the AmLaw 100 firms and just decided they needed a different lifestyle.  Talk about a bargain!  Just remember you’re not a hostage, so don’t act like it.  Vote with your feet and your money.

Additionally, you need to review your outside counsel spend and consider whether there is additional work you can move in-house, either utilizing the existing team or, if the numbers add up, by adding a new person.  If you think it makes sense to add a head to the Department, be sure to “show the math” to Finance and others who must approve expanding headcount.  Typically, this involves showing a history of legal spend in a particular area and then showing the cost of hiring someone to do that work in-house.  When calculating the cost, be sure to include the fully-loaded cost of an employee vs. just salary.  There can be a big difference in those numbers when you add in benefits, travel, bar fees, employment taxes, etc. to the salary cost.

10.  Prepare to be disappointed.  I learned this lesson early in my in-house legal career: there is never enough time, people, or money to do all the things the business asks of the Legal Department.  Get used to it.  At the end of the day, the Legal Department is a cost center and in most companies, costs get cut.  So, you can prepare a highly detailed budget with every penny justified and tied to some strategic imperative or dire need of the company, but just be ready to hear “you need to cut this back.”  It’s not personal and no one is picking on Legal, that’s just the way of the world.  And if for some reason you submit a budget and it comes out intact on the other end of the process, it’s time to go buy some lottery tickets because you are one in a million!  Which leads me to my last point about budgets – ask for more than you think you will need.  You might get it (or some of it) and if you get cut, you might get cut back to a level you think you can live with.  Am I suggesting that you try to game the system a bit?  You’re damn right I am.  If you’re not trying, you’re probably the only one in the entire company who’s not.  I am not telling you to lie but if you think you might do 10 trademark applications next year, then put that down (vs. going with the five applications you think you can live with).  You need to fight and scrap for every penny you think you can squeeze out of the company budget.  You’re a lawyer, think like one.  Make all the arguments for why you need the money and take your best shot.  You might actually get it.

*****

Well, there you have it.  The “Sterling Miller Legal Budgeting 101” course.  My way is certainly not the only way to prepare an annual budget and the key overall is to work closely with your Finance team to make sure you understand exactly what they want from you in terms of planning.  Anyway, after a lot of work (with help from my team) and wearing out a number of dry-erase markers, I have sent my budget off to Finance.  Now, I will just sit back, relax and wait to be disappointed.  It’s good to be back!

Sterling Miller

October 16, 2017

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