Litigation Finance, Litigators, Money

The 2017 Outlook For Litigation Finance

Why is the litigation finance field so small?

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gavel money litigation financeWhy is the litigation finance field so small? Going into 2017, this is the fundamental question that all litigation finance market participants need to be asking themselves.

There are three changes in mindset in the litigation finance market that could help it to grow more rapidly in 2017 and beyond: restructuring of deals to provide greater transparency, a focus on speaking the language of finance through data and quantitative metrics (especially to institutional investors), and broadening the set of investible assets used in the industry to include alternative forms of legal claims such as construction claims.

To understand the opportunities of 2017, though, we first need to understand the story of 2016 in the litigation funding world.

2016 was a good year for the industry, capped off by the sale of Gerchen Keller Capital (GKC) to Burford for $175 million (inclusive of earnouts). The Burford purchase was notable for many reasons, though two serious possible implications stand out for the broader industry.

Burford’s acquisition suggested first, that Burford might be facing limited available ways to deploy their own capital at this stage, and second, that the industry definitely still has a lot to learn about attracting institutional investors.

Only time will tell if either of these fears about the limits on the litigation finance field are accurate. Still it is clear that the industry needs to evolve to be considered a mainstream asset class – the Burford acquisition was for only $175 million. To almost any individual, $175 million is an enormous sum. In the world of finance, it is almost spare change. Burford and GKC both had less in AUM than many mid-sized RIAs that are not household names.

The “small” size of the transaction is significant because it represents a deal between two of the industry’s largest players. And if these are the industry’s biggest players, it means the industry still has to grow significantly before it can be recognized as a major asset class. No one talks about tax lien investment firms, because tax liens are not an important investment group.

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If 2016 does not set the stage for growth in the litigation finance space, then nothing will.

The field stated to garner mainstream interest in 2016 thanks in large part to the now famous Hulk Hogan versus Gawker case, which Peter Thiel played a pivotal role in. That case illustrated the power of deep pockets for plaintiffs, but it also illustrated the limits of contemporary litigation finance.

Hogan reportedly was unaware that his case was backed by Thiel as that relationship was handled indirectly via Hogan’s attorney. The Gawker case illustrates a possible factor in one of the two issues bedeviling litigation finance: limited deal availability and limited investment appetite.

The lack of disclosure in the Gawker case is one of the troubling facets of litigation finance to many regulators and legal industry participants. It’s probably also a part of why the industry remains small in that it feeds into a stigma about litigation finance that helps restrain both investment supply and investment demand in the litigation finance field.

In 2017, the litigation finance field needs to rethink how it handles many aspects of its business. Greater disclosure could help take away some of the stigma that many still feel about the field. It also creates some distortions to incentives around investment that have to be handled carefully.

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In 2017, litigation finance also needs to begin to look more like an extension of the finance field and less like an extension of the legal field if it is to grow.

The large majority of litigation finance participants seem to be attorneys. That’s understandable. But there are actually relatively few participants with a background in investment banking, trading, or other areas of pure finance. As a result, many litigation finance firms overlook the power of data and the usefulness of time-test financial concepts. That oversight restrains investor supply in the field, and also makes it more difficult to communicate pricing in a transparent and effective way to prospective recipients of litigation finance investment.

As strange as it sounds, the focus in litigation finance as it pertains to pitching institutional investors should be on correlations, duration, portfolio stress testing, and valuation modeling rather than legal analysis.

Finally, litigation finance can benefit significantly by broadening the kinds of claims it considers for investments. This will have the effect of both broadening the deal funnel and raising the industry’s profile. There are reportedly more than $1.2 billion in construction claims available for funding by litigation finance firms for instance. Yet it’s an asset group that is barely on the radar of many funders. Crowdsourcing of small and middle-market claims presents another great opportunity in the space.

Einstein supposedly said that the definition of insanity is doing the same thing over and over again and expecting different results. This year is the litigation finance field’s chance to show that it can think critically about how to improve its business model and grow into a major investment class.

Michael McDonald is an assistant professor of finance at Fairfield University in Connecticut. He holds a PhD in finance. Michael consults extensively with organizations ranging from Fortune 500 companies to start-up businesses on financial matters through Morning Investments Consulting. Michael has served as an expert witness in legal disputes, and is an arbitrator with the Financial Industry National Regulatory Authority (FINRA). Michael can be reached at M.McDonald@MorningInvestmentsCT.com.

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