Monday, June 26, 2017

Budgeting 101

The first time I was asked to prepare the legal department budget I had no idea what I was doing.  I’d inherited a budget made by business people with little to no experience in managing legal matters.  I’d only started a few weeks prior, so had absolutely no insight into the priorities, strategies or cadence of the business. I really could have used a Budgeting 101 crash course.

This isn’t unusual when you’re taking over (or starting) a legal team.  But it is a challenge.  The budget you inherit may or may not be reasonable; if it was created by business people it most likely leaves out operational costs they’re not used to having, and will almost always under-estimate outside counsel spend. Unfortunately, you won’t be in a position to determine any issues with your budget until you’ve lived with it for a few months.  By then you’re having to justify deviations from the budget, getting approval to add expenses that weren’t complicated, and if you’re really lucky you may even save on some line items.

The real fun begins when you enter the next budget cycle (this is especially true if it’s your first time creating a legal budget.)  You’ll rack your brain to think of everything that should be included and how to value the contingencies that you should reserve for – and those that you shouldn’t reserve.  Depending on the size and maturity of your organization and the industry that you’re in, the average legal budget ranges anywhere from 1-5% of the company’s revenue. So if you’re a small to mid-size private company in a reasonably regulated area with $50MM in revenue, you should expect your budget to be around $500k.  Larger companies, more regulated industries, or companies with a history of complicated litigation or major intellectual property issues, you’ll be closer to the 5% mark.  If you’re a startup just out of stealth mode, expect your budget to border on non-existent and ‘I can barely pay you, please don’t spend anything else.’ 

Now you know what your ceiling is expected to be, don’t forget the important things.  Salaries go into the budget – marked up with the fully loaded cost. That’s usually your biggest cost. Legal software like contract management, matter management or IP docketing also need to be included.  Although depending on the use and integration you may be able to allocate some of this cost to other departments. For example the cost of a contract management software that plugs in to SalesForce may be shared with sales if they use it to process all sales contracts.  Registration fees for IP or other licenses are generally going to be allocated to legal.  Immigration costs may fall under legal, HR, or may be allocated to the hiring department.  And don’t forget professional development – your bar dues, CLE expenses, conferences, etc.  If they’re not in the budget, they're coming out of your pocket.

The harder part of the budget it’s the contingent expenses.  No matter how good of a lawyer you are, you will need outside counsel or other outside advice.  The trick is budgeting for it.  If you know you’re involved in litigation, that’s easy.  But how do you plan for potential litigation, the patent registration fee for the idea that hasn’t been disclosed yet, or that tricky corporate matter that only comes up because of something a board member says or does?  There is no right answer to this one.  If you ask ten GC’s how the account for this, you’ll get ten answers.

Because I work in technology companies, IP has always been important.  I work with the engineering, marketing, and finance leads to come up with an estimate of how many applications we can reasonably expect to file in the year.  As a startup, that is generally in some type of fundraising all the time, I always add a small amount for the random corporate question.  And my CFO and I typically agree to treat new litigation as extraordinary expense that doesn’t get budgeted until it’s reasonably likely to happen. 

Even with all of that planning, you’re likely to need to make mid-year adjustments.  This is why it’s important to know the business side of your business. Knowing the cycles, the priorities, the business risks, and the company strategy will help you to more accurately predict the costs of the legal services it will need.  Knowing the personalities in charge of the departments most likely to generate legal work is also critical.  Maybe most importantly, being on good terms with your CFO and finance team will help you to navigate those unbudgeted matters in a way that best protects the business.