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The couch picture is a tradition at asset management firm Legalist, writes Andy Thomson. It’s a reminder of the early days of the firm when it was run out of a garage covered in graffiti in one of San Francisco’s less glamorous districts. As the garage “was about to be torn down”, says the firm’s co-founder and chief executive officer Eva Shang, the couch was being moved across the road to a new office. That is when the team decided to pose for a picture – a picture which included cars coming to a sudden halt behind it.
The concept of the office is now in Legalist’s past – still technically based in San Francisco, Shang says that everyone in the firm works remotely. But the team will occasionally come together, including every July for the couch shot.
The word ‘unconventional’ is easily applied to Legalist, and to Shang herself. The firm was launched in 2016 when Shang dropped out of Harvard University as a 20-year-old to develop a business with the help of Y Combinator, a Silicon Valley technology accelerator.
The firm that emerged was based on proprietary technology that trawls public government databases to search for investment opportunities that meet certain pre-specified criteria. Today, it has around $700 million in AUM across three strategies – debtor-in-possession financing, litigation finance and government receivables lending – all run by portfolio managers but based on the technology.
Shang says the firm’s approach is based on being ‘top-down’ rather than ‘bottom-up’. The latter is where firms are typically brought opportunities by the likes of brokers and bankers and will choose their deals from what comes across their desks. Legalist has what Shang calls “a very intentional approach. One of our investors calls it ‘portfolio by design’. We decide in advance what the ideal opportunity looks like and then we go out there and source it”.
She adds: “That’s the reason why our strategies centre around government proceedings. Anything that touches the government in some way creates a public record, which then gives us a bird’s eye view of the entire world of credit opportunities in that space.”
Further differentiation is provided by a focus on niche areas, or what Shang describes as “hyper-specific buckets”. While debtor-in-possession (DIP) financing is often a part of the toolkit for distressed investors, Shang says that most LPs she speaks with have never come across a DIP financing-specific fund. Legalist is currently in the market with its second such vehicle. Shang says the strategy is favoured because it’s high up in the capital stack and the firm dodges competition by avoiding the larger deals that the mega-sized distressed funds tend to chase – focusing instead on tickets of around $10 million-$20 million.
PE-like returns
When it comes to litigation finance, Legalist – as with DIP financing – uses its database to identify target cases that best fit its criteria. It backs single cases and targets private equity-like returns of 20 percent or more. The newest strategy, government receivables lending, involves providing financing to government contractors that may need extra finance to support the costs of a contract during the period before the government pays them. “It’s like factoring but we’re not buying the receivable – just lending working capital against approved government payments,” says Shang.
Reflecting on the early days of the firm, Shang says she and co-founder Christian Haigh (now the chief investment officer) had little idea of the future shape of the business. The early motivation, says Shang, was Haigh’s obsession with data. Beyond that, not a great deal was clear, and she compares the business plan with one formulated by the cartoon South Park: one, collect underpants; two, question mark; three, profit. The Legalist plan was near identical, she jokes, with the only difference being that step one was to collect data.
She says a coherent plan started to come together with the help of an adviser at Y Combinator, who pointed out that with an overview of a sufficient amount of data it was possible to search in real time for things you wanted to invest in and create your own market. This was the inspiration behind the litigation finance strategy, for which Legalist scraped together a $10 million first fund in 2017 before managing to close a much more substantial $100 million fund a couple of years later.
Shang stresses that plenty of blood, sweat and tears separated the first and second funds. Amazed by the ability of some brand-name spinouts to raise $1 billion “right off the bat”, she reflects: “At 20, I spent a year doing the first fundraise. If I went back in time and told myself how difficult it would be to raise that first $10 million, I would probably have packed up and gone home. That’s why so few firms are built from the ground up.”
She says the capital mostly came from high-net-worth individuals and concedes that she hadn’t quite thought through the fund economics, which meant that the $10 million raised translated to just $250,000 in management fees for a firm developing its own proprietary technology and seeking to build a team. It wasn’t until the $100 million fund was raised two years later that the firm made its “real start as an asset manager”.
Since then the fundraising has accelerated. Six months ago, AUM was around $200 million. This has since risen to $700 million and is expected to reach $1 billion once the firm reaches a final close of its second DIP fund, which is aiming for $300 million. The third litigation fund is also pegged at $300 million, while the first government receivables fund, launched earlier this year, has a $100 million target.
For litigation finance firms, finding the right lawsuits to invest in requires quite a bit of time, effort, and capital.
Like other nascent investment strategies, high returns are the result of highly knowledgeable investors, of which there are few and far between.
But Eva Shang, co-founder of Legalist, is trying to change that. Her firm uses quantitative techniques and machine learning applications to find easy-to-manage deals in litigation finance, bankruptcy, and government receivables.
Founded in 2016, the firm now manages more than $650 million and is on track to hit $1 billion in assets under management by the year’s end. So far this year, the firm has built a board with ex-Nuveen and Canyon Capital executives and garnered investments from endowments, foundations, and insurers.
And the strategy is all about the technology. “Even though each of our strategies is hyper-targeted, our core thesis is that our technology allows us to scale across asset classes,” Shang said. She added that the strategy generates alpha by sourcing deals quickly across the databases it scours.
Sitting outside of a Midtown, Manhattan coffee shop, Shang pulled a laptop out of her backpack to demonstrate the firm’s proprietary technology. She dove deep into Legalist’s tech, peppering in anecdotes and even threw in a few memes during the conversation.
Legalist’s application crawls government databases, including Pacer, as well as more than 200 databases representing state courts and government contractors.
The program — which Shang’s team calls a “truffle sniffer” — looks for static variables like defendants or lawyers, as well as time series variables, which include the events associated with cases. The technology is looking for key litigation dates, such as “creditor motions” in a bankruptcy.
Then, machine learning comes in. The app classifies the data by the type of case, individual, and event, among other variables, creating a decision tree that ultimately leads to a decision on whether the firm will finance the case.
Once Legalist has identified the cases it finds attractive, the firm sends an automated and customized email to the parties in the case the firm wants to finance. These emails explain what litigation financing is and introduce the firm to potential loan recipients.
If those loan recipients are interested — and about 20 percent of those emailed are — Legalist’s underwriters get in contact with the lendees, and soon have a term sheet on the table.
“If we have data origination right, it’s much easier to send term sheets in a few weeks,” Shang said. “The deals we target are less hairy than our peers.”
There are, of course, still errors. Shang said the litigation fund has about an 80 percent success rate. But her team tries to limit potential losses with its standardized process.
Shang, as a recent Wall Street Journal profile pointed out, is different from many in the finance industry. She and her co-founder Christian Haigh launched the firm in 2016 as 20-year-old Harvard dropouts after completing Y Combinator, a startup accelerator program. Shang eschews “cutthroat” finance culture, saying she wants to “grow the pie,” not push others out for a slice of her own.
The Legalist co-founder is inspired by Rishi Ganti, the founder of Orthogon Partners, whose M.O. is discovering un-traded assets, then investing in them. But Ganti’s guiding philosophy goes well beyond niche assets.
“He basically says the way to get alpha in any kind of asset is to be there early where there’s no competition,” Shang said. “It’s like going to a little league game where you scout players. There’s no market yet.”
After launching Legalist, Shang set off on her first fundraise — bringing in $10 million from potential investors. “I don’t think I understood the challenge of raising a $10 million fund as a 20-year-old without investment experience,” Shang said. “It took me a full year to do it.”
By 2018, the firm had already started identifying attractive deals but had little capital to put to work. It partnered with a large, publicly-traded firm (not Burford Capital, Shang clarified), to make three co-investments and get the business off the ground.
The firm first focused solely on litigation finance and has since expanded into bankruptcy financing — particularly lower middle market debtor-in-possession loans — and government contracts.
“For any manager that starts off, the core question is can you scale,” Shang said. “There are a lot of very successful niche managers that never crack the institutional world, no matter how great their returns are.”
Expanding into new strategies has kept the firm growing without having to compete with litigation finance behemoths like Burford or Parabellum Capital.
Legalist now is raising its second bankruptcy fund and has filled the founders’ share class. The firm has raised capital from endowments, foundations, and insurers, among other investors.
The litigation financing fund is targeting a return of 20 percent net of fees, with a five-year lock-up period. Bankruptcy investments, meanwhile, target high-yield-like returns, with capital held for between four and five years. The firm’s government receivables fund is evergreen, but redemptions are available to investors, as the time horizon on those loans is quite short, Shang said.
Despite the recent downturn in the markets, Shang is optimistic.
“Litigation finance is definitely uncorrelated and counter-cyclical,” Shang said. “I know our IR team has been heartened by rising interest rates.”
There have been times when market ideas, boldness and technology have come together at the right time and the right place. Think D.E. Shaw or Renaissance Technologies.
If Legalist CEO and Founder Eva Shang’s first few years in business are any indication, lightning may have struck again in the arena of private credit in San Francisco.
She may only be 26 years old, as a recent Wall Street Journal headline informed the world, but Shang and her team have already analyzed tens of millions of legal cases and received tens of thousands of funding applications all the while raising a cool $400 million in the last six months. Her advisory board includes William Von Mueffling, founder of Cantillon Capital Management; Margo Cook, former president of Nuveen Advisory Services and independent director on the operating board of directors for Bridgewater Associates; Andrew Gundlach, co-CEO of Bleichroeder and director at First Eagle; Michael Fisch, founder and CEO of American Securities; and Dominique Mielle, former partner at Canyon Capital.
In an exclusive interview with Alternatives Watch, Shang observed that many of the successful asset management companies of our day were all founded around the same time. Many of them, like her today, leaned heavily on the emerging technology of their era whether it was for derivatives trading or for macroeconomic analysis.
At Legalist, she has been thinking a lot about the future of asset management. And for Legalist, that future differs — not only because the company has a female is at that helm, but also because Shang and CIO and Co-Founder Christian Haigh are Harvard University dropouts, giving Legalist the vibe of an edgy tech startup rather than a traditional money management firm.
“What we always wanted to do was to utilize the full potential of our technology,” said Shang, who readily admits she didn’t start out — at the ripe age of 20 — with an eye on asset management back in 2016, when Legalist won backing from Y Combinator. The idea was to build a powerful technology platform that had its roots in crunching of data from the Massachusetts’ state court website. That same year, the pair received a $100,000 grant from Peter Thiel, who himself financed litigation against Gawker Media.
The seed had been planted, and Legalist was encouraged to consider litigation financing as an asset strategy. And with no previous work experience in asset management, she and Haigh, who met in an entrepreneurial group at Harvard, busily began hired staffers with experience in underwriting and law and computing. Together they are shaping a unique vision for what asset management looks like. Firstly, there is no office or headquarters. In fact, the firm’s 30-plus team of engineers, credit analysts, lawyers and investment professionals all work remotely, and did so even prior to the pandemic.
As the firm soars past $665 million in assets under management, Shang is optimistic that Legalist has hit on a segment in the lending sphere where an influx of powerful data analysis could yield results. Legalist uses proprietary algorithms to find patterns within pools of unstructured, publicly available data at an unprecedented volume.
The firm’s first fund was raised in 2017 at $10 million and focused on litigation financing. A second fund focuses on bankruptcy cases with companies that own real assets and is known as a debtor-in-possession (DIP) loan strategy. A third fund is focused on government receivables lending, which is a form of high yield credit secured loans based on payments owed to labor and service providers by federal and state governments. Legalist’s litigation finance strategy targets private equity style returns of low to mid-twenties, while the DIP strategy targets high yield credit returns in the mid-teens.
The team is in the middle of raising capital for a second DIP fund. All the while, Legalist continues to grow its ranks to further its investment edge. Last year, Legalist added Fox Rothschild partner Jaemin Chang as assistant general counsel and Anand Upadhye, vice president for business development at legal research software company Casetext, as director of investments.
DIP Fund II’s focus may be timely, especially should bankruptcies rise. What makes Legalist’s approach different, according to Shang, is its “targeted origination” that stems from the firm’s “microcap capacity” that has been constructed where Legalist can use its technology as an advantage. For instance, they are not going after high-profile bankruptcy cases such as Toys “R” Us, but the more numerous smaller cases where they have the ability to generate decent returns by relying on proprietary algorithms to invest in Debtor-In-Possession loans to small to mid-sized companies in Chapter 11 bankruptcies.
The aim is to source opportunities conventional lenders, including hedge funds, are unable or unwilling to access for their clients. For now, Shang and her team are focused on expanding the opportunity set for their current and new LPs.
And while the numbers may seem staggering, whether it’s the assets rolling in or the millions of legal cases the team has collected data on, Shang keeps a calm and determined demeanor as she plans to rewrite the code for success in alternative asset management.
Photographs by Marissa Leshnov for The Wall Street Journal
Eva Shang is doing the hedge-fund thing her way. That means making money but also making time to blog about dreams, her labradoodle and her fear of becoming a Silicon Valley has-been at age 26.
Legalist Inc., Ms. Shang’s technology-powered investment firm, raised about $400 million in the past six months. Its funds focus on private debt, a hot patch of Wall Street populated mostly by men with pedigrees from top investment banks and private-equity firms.
Ms. Shang and fellow Harvard University dropout Christian Haigh launched Legalist with a splash in 2016 when she was 20, then struggled for years to attract backers.
“I don’t blame them,” Ms. Shang said about the investors who swiped left on Legalist. “If I were an allocator, there would be no reason to take a 20-year-old dropout with a computer seriously.”
Now, Legalist’s flagship strategy of litigation finance—where fund managers back plaintiff lawsuits in exchange for a percentage of court-awarded judgments—has a record of gross annual returns around 25%, people familiar with the matter said. Insurers and endowments are buying into its funds, which manage $665 million, and the San Francisco-based firm has expanded into corporate bankruptcy loans and lending to government contractors.
Ms. Shang had no formal investment training before starting Legalist, doesn’t own a suit or a car and lives in a shared house with four other startup founders where her wardrobe leans heavily on jeans and Patagonia jackets. Her big splurge last year was on the labradoodle she named General Partner, a legal term often used to describe a hedge-fund founder.
In her off time, Ms. Shang volunteers with a local Girl Scout troop, helps high-school seniors with college applications and travels to Boston to visit her sister and mother. She also writes a blog, for a subscribership of about 60 friends and colleagues, and science-fiction stories for herself.
“She’s an interesting kind of smart,” said Dominique Mielle, a former hedge-fund manager who sits on the company’s advisory board. “I get the sense that she reads a lot and is able to seize on very difficult issues and boil them down to a few simple questions.”
Ms. Shang recruited Ms. Mielle by contacting her on LinkedIn after reading her memoir about navigating the hedge-fund industry’s notorious gender gap.
Some question Legalist’s claims of innovation in litigation finance. The firm advertises its proprietary artificial intelligence built to comb through public court databases and identify cases with a stronger chance of winning.
“[There’s no] technology we’ve tested, or that a tech shop has even approached us with, that could help us to price risk in a way that would enable us to make a successful litigation-financing decision,” said David Perla, co-chief operating officer of Burford Capital Ltd. , a large litigation-finance company.
“You can’t invest based just on the tech,” Ms. Shang said. Legalist’s algorithms help it find better deals faster but, like its competitors, the company employs human “underwriters” to ultimately decide whether to invest in a case, she said.
About 80% of the lawsuits Legalist backs end up winning, according to Ms. Shang. The average success rate in litigation finance is 65%-75%, said an industry executive.
“We don’t know whether [their AI] works or not,” said an investment adviser who has recommended Legalist to some clients. “There are positive indicators from their track record that the mousetrap is able to catch the mice.”
Ms. Shang emigrated to the U.S. from China at age 3 and grew up mostly in a Philadelphia suburb where her mother supported the family working as an actuary. Ms. Shang began proofreading her mother’s résumés at age 7, she said, and helped care for her younger sister, Melissa Shang, who has a form of muscular dystrophy and uses a wheelchair.
In 2013, the year she started at Harvard, Ms. Shang helped her sister petition toy maker American Girl to make a doll representing disabled children. Melissa Shang is now a Harvard undergraduate and a disability activist.
The American Girl campaign turned into a TEDx Talk, which connected Ms. Shang to Mr. Haigh, an engineer with a knack for scraping online databases. They became friends and decided to scrape the poorly organized Massachusetts online court system using a jury-rigged network of used Apple computers, hoping to repurpose the data and sell it.
Ms. Shang didn’t fit into Harvard’s culture of exclusive social clubs, she said. She and Mr. Haigh dropped out and moved to San Francisco in 2016, when they raised their first $1.5 million by making it into startup accelerator Y Combinator. An adviser at the accelerator suggested they use their database for litigation finance, an idea the pair spent a year marketing to mostly uninterested investors before raising their first $10 million fund.
The duo also received a $100,000 grant in 2016, from Peter Thiel, who that same year financed litigation against Gawker Media. The grant was part of Mr. Thiel’s program to fund startup founders who leave school and gave him no stake in Legalist.
Since then, Legalist has developed a business model of scraping new databases to repeatedly identify niche markets. The firm’s staff of about 50 is fully remote, something that helps it attract talent that wouldn’t normally work for a hedge fund, Ms. Shang said.
Bankrupt companies that Legalist lent to include Maryland-based landscaping company Moon Group Inc. and Buyk Corp., a New York-based grocery-delivery service, according to court documents. The firm is working on a loan this year to a pilot-training company that won a contract from the U.S. Navy, Ms Shang said.
Legalist’s growth plan is to keep using its data to find trades overlooked by hedge funds staffed by more conventional finance professionals, the firm’s adviser Ms. Mielle said. “No one else is going after that market,” she said.
Achievement and identity feature prominently in Ms. Shang’s blog, where she discusses her anxiety that she won’t live up to her early promise. “I’m reminded that the world I inhabited is quickly being replaced by one in which I am no longer a Young Person and instead have to compete in the grown-up’s lane,” she wrote in a post last year.
Her self-reflection is one more thing that sets Ms. Shang apart, said David Lee, a venture-capital investor and one of her earliest backers.
“The ability of founders to write well and to express themselves correlates highly with their ability to lead and manage people,” Mr. Lee said. “There are a lot of great writers that are founders, but not that many are beautiful writers. She is.”
More than a year into the global coronavirus pandemic, businesses across the United States are still filing for bankruptcy at high rates. Investors who make bets on litigation are eyeing the economic turmoil with visions of big returns.
Commercial Chapter 11 bankruptcy filings spiked by 29% in 2020 with 7,128 filings compared to 5,518 in 2019, according to data from Epiq, a legal services company. Although Chapter 11 filings for 2021 Q1 fell by 25% compared to the same period in 2020, experts anticipate the numbers to surge again as government stimulus measures wind down.
As businesses file for bankruptcy, litigation finance firms see opportunity for investment. These firms make their money by up- fronting the costs of third-party lawsuits in exchange for a percentage of the financial outcome. The business is considered countercyclical rather than acyclical: litigation funders have more investment opportunities when other businesses are in a crunch.
There hasn't been a "juicy" moment this ripe for litigation funding since the 2008 financial crisis, according to Connor Murphy, director at Burford Capital, which finances larger litigations requiring an average of $10 million in investment.
Burford committed $99 million to insolvency and bankruptcy-related matters in 2020 — up around 20% from approximately $83 million in 2019.
Bankruptcies can be complicated legal procedures: some of the best opportunities for investment returns come out the litigation they create.
A distressed company's "most valuable asset may be a litigation claim, but may not have assets to afford high-quality representation to pursue that claim," said Matthew Oxman, vice president of business development and investments at litigation finance firm LexShares. "To avoid having to settle for a small amount, litigation finance enables them to hire quality counsel and to pursue their claims vigorously."
LexShares, whose typical investment size ranges from $200,000 to $4 million, has recently seen an uptick in bankruptcy claims they've been asked to fund.
Most litigation funders lend cash to both debtors and creditors in bankruptcy proceedings.
Oxman said the nature of the business — providing capital to keep companies afloat — makes litigation finance more "appropriate" for debtors. Extra funds can help a bankrupt company maximize financial recovery for itself and creditors, according to Oxman.
Litigation funding can also be used to help litigation trusts, which typically benefit creditors. With additional capital, a trust can prosecute legal action against the auditors that drove the company to reorganize, enabling a faster and larger recovery for creditors, according to Stuart Grant, cofounder and managing director of Bench Walk Advisors, another litigation finance firm.
Funds are often provided on a non-recourse basis, meaning the recipient of the funding doesn't have to repay the litigation funder if it loses the case.
The US government's economic stimulus packages have pumped additional liquidity into struggling industries like retail, initially keeping the brunt of bankruptcies at bay. But litigation funders expect a surge in bankruptcy filings and related litigation as business conditions return to normal.
"Everybody's watching to make sure that creditors throughout the capital structure are protected and that assets aren't being spun out of the company or spun away to a specific group of creditors or equity holders. And those are the kinds of things that tend to lead to litigation," said Emily Slater, managing director at Burford.
In a sign of litigation funders' growing appetite for making bets in bankruptcy, Legalist, a startup that uses AI to make high-volume investments in smaller court cases, announced in March that it closed its first-ever bankruptcy fund with $50 million, which will be used for debtor-in-possession (DIP) financing to small businesses. Shang said Legalist chose to target DIP financing because it's one of the lowest-risk forms of bankruptcy financing, but isn't widely available for many small businesses that are its core client base.
"Some of the most prominent defenders are large distressed funds that have recently raised billions of dollars. They're not going to be making $3 or $5 million DIP loans to Main Street businesses that are in bankruptcy," said Legalist cofounder Eva Shang.
Things are only going to get busier for litigation funders. The need for legal finance tends to linger a few months after bankruptcy filings, and Slater from Burford said she expects to see even more demand for third-party funding in 2021.
"I think there'll be law firms and advisors who are now a little more opportunistic after seeing a lot of claims fall by the wayside," said Bench Walk's Grant. "The availability of litigation funding may well spawn a cottage industry of those who can look for meritorious claims."
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