If you haven’t heard much about litigation finance, that may change soon. The practice dates back decades, though it’s been picking up momentum since 2006, when Credit Suisse Securities founded a litigation risk strategies unit that it later spun off.
What is litigation finance? In a nutshell, the idea is to fund plaintiffs and law firms in cases where it looks like there will be a winning ruling. When everything goes the right way, the capital that helps fund the lawsuits is returned — and then some — in return for the risk taken. Litigation finance firms — and there’s a growing number of them — basically want to estimate as accurately as possible the risk involved so they can bet on the right horses.
Interestingly, one of the newest entrants onto the scene wasn’t founded by career attorneys or spun out of a hedge fund or private equity group. Instead it’s a young, 11-person company called Legalist that’s run by a 23-year-old Harvard dropout named Eva Shang, who co-founded the company with her college classmate Christian Haigh, who also dropped out.
As interestingly, the pair, who say they honed the idea as part of a Y Combinator batch in 2016, just secured $100 million to put it to work. That’s roughly 10 times the $10.2 million they raised for a first fund that tested out their ability to find and finance civil lawsuits that pay.
We talked with Shang late last week to learn more about the new fund, which was raised from nonprofit endowments, family offices and institutional investors (including an insurance company) and that’s styled like a private-equity fund with a traditional management fee and carry structure.
TC: First, how do you find these plaintiffs that you’re backing? Do you reach out to them?
ES: We do occasionally get cases directly from plaintiffs, but attorneys are the usual point of contacts for us. They’re the repeat players in the litigation funding industry; they’re seeing a lot of cases.
TC: And who are they telling you about? Who fits your criteria?
ES: The plaintiffs we work with are involved in smaller cases, meaning they require less than a million dollars in funding. It’s a lot of money to pay a lawyer, but in the world of litigation, it’s akin to seed-stage investing. Once [we’ve found candidates], then our algorithms help our two underwriting attorneys perform diligence more quickly.
TC: What kind of information or patterns are they seeking out?
ES: We scrape state and federal court records and look for indicators, like whether a court is favorable to plaintiffs, if particular case types tend to win, who the judge is. We also check for points at which the case could be dismissed. We’re focused exclusively on commercial cases, so often breach-of-contract [disputes] where it’s a David and Goliath situation and the smaller company is typically underfunded. When there’s litigation, we help pay for attorneys’ fees and if it’s successful, we recover and if not, we don’t.
TC: How many cases have you backed so far, and how many have you won?
ES: We’ve funded 38 cases, half of them have received a settlement, judgment or been otherwise resolved. Of those, over 80% were positive.
TC: And that has translated into what kind of return for your investors?
ES: We can’t talk about fund returns, but we scaled up our funds 10x [based on that performance].
TC: That’s a lot of cases to churn through. When do you step into the process in the lifespan of a lawsuit?
ES: The cases we’re [involved with] are more advanced and are showing success indicators, so we have a shorter time frame. We also fund smaller cases than most other litigation funders. Because of our approach, where we’re using tech to speed due diligence, we can do that.
TC: You can’t discuss returns, but can you tell me what your investors expect to see back? We aren’t talking venture-like returns, presumably.
ES: Not venture-type returns, but high-yield returns.
TC: There is movement in a small but growing number of states that want more transparency into third-party litigation funding agreements. It aims mostly to protect consumers, but it sounds like some outfits that fund commercial litigation aren’t so thrilled about it, either. What are your thoughts?
ES: We actually don’t mind disclosure regulation so much. As long as litigation funding is becoming more widely accepted, that’s a good thing and the rules shouldn’t impact us so much. I also think in the long run that it’s inevitable and won’t be a huge problem.
TC: Do you syndicate deals? Do you go it alone?
ES: It’s not like in VC. When we invest in a case, we’re [aren’t teaming up with other sources of funding].
TC: Who owns equity in Legalist? You went through Y Combinator. You raised a little venture funding. But you also now have this fund.
ES: Y Combinator owns 7% of the company [because Legalist went through its accelerator program, intending to become a legal analytics company]. [Other stakeholders] include VY Capital and Refactor Capital .
TC: How will they eventually liquidate their stakes? Does a company like Legalist go public?
ES: There are two publicly traded litigation private finance companies. We’re a tech company; there are exit opportunities.
TC: How long will it take you to invest this $100 million?
ES: The total fund life is five years, but we expect to deploy the fund in two years across 100 to 200 cases.
TC: What have you learned in those cases where your investment has gone to zero?
ES: That there’s idiosyncratic risk in the court system that can’t be anticipated. If a jury likes you, they’ll find a way to drape the law over you so you win, and if they don’t, you won’t. We see that. There’s also luck involved, as well as having a meritorious case. That’s why we want to diversify across a larger number of cases.
TC: You dropped out of Harvard because you were accepted into Y Combinator. Around the same time, you also received a Thiel Fellowship, wherein recipients are provided with a $100,000 grant to work on something for a couple of years. What do your parents think of all this?
ES: They really don’t understand it, but they can see that I like what I’m doing. My mom does keep asking me when I’m going back to school. She’s like, “I thought the Thiel fellowship was over after two years!”