Welcome to the third installment of our four-part Alts Academy series on Litigation Finance.
As you may know, we’re getting ready to launch our first litigation finance deal through Altea.
To prepare for launch, we’ve partnered with our friends at Homefront Group, who are helping educate us on this tricky area of alternative investing through a four-part series:
- We kicked off Part 1 by understanding the foundations.
- Part 2 was a fun look at different deal structures.
- Today, in Part 3, we’ll look at the risks & pitfalls — what can go wrong in this world, and how to mitigate the risk.
- Finally, we’ll end with a deal memo on the actual deal we’re putting together — which you can invest in.
If you’re interested in our upcoming deal, express interest here:
The legal world can be long, detailed, and boring. As always, we’ll explain things simply and make it fun.
Let’s go 👇
Table of Contents
How to manage and assess risk
If you don’t know what you’re doing, investing in litigation finance will feel like a high-stakes game of poker — strategic, thrilling, and nerve-wracking.
With each poker hand you’re dealt, luck plays a huge part in your success.
But in the world of litigation finance, your success hinges on diligent preparation and managing your risk.
Before placing a bet in litigation finance, smart investors diligence the case, the law firm and lawyers, and the defendants. It’s absolutely possible to get an edge with thorough research.
Due diligence
You need to by picking cases that have the highest likelihood of settling profitably or winning in litigation.
Big intellectual property cases have huge potential outcomes, like this recent $847 million verdict against Verizon. But they come with big risks and require expensive expertise.
Playing this game without an A team is like ponying up against the best poker players in the world.
A better starting point for new litigation funders are less complex, more predictable cases.
For example, veteran disability claim appeals tend to follow a fairly formulaic process:
- Roughly 80% of initial VA claims are denied due to poor supporting evidence.
- Yet, appeals win at a high rate because experienced law firms know what type of supporting evidence to provide.
Whether it’s a complex, high risk case or more predictable, niche case, smart investors bet on the right lawyers:
- Step one is to only back lawyers that are working on contingency. You want your team to have skin in the game.
- If you see a deal where the law firm isn’t working on contingency, you should pass.
- Beyond skin in the game, you want lawyers with a track record of success and deep subject matter expertise.
- Get good at vetting lawyers, just like you’re good at vetting entrepreneurs for angel investments.
As we mentioned last week, you also need to vet the defendants, to make sure they can pay.
Unlike poker, there aren’t muscle guys ready to shake down losers if they claim they can’t pay. You gotta make sure you’re playing with high rollers.
Diversification
Just like in investing, diversification is your friend in litigation finance.
At Homefront, we spread our bets across various types of cases, jurisdictions, and risk profiles. This means mixing high-risk, high-reward opportunities with more predictable cases to balance out the portfolio.
By funding different types of cases with varying payout timelines, we protect against the risk of any single outcome sinking the whole ship.
Whether it’s working cases in different legal arenas or varying stages of litigation, diversification is the ultimate insurance policy.
Stages of litigation
The stage of litigation can dramatically affect the risk and reward.
- Always remember that a whopping 95% of lawsuits end in pre-trial settlement.
- Cases early in the process usually have higher uncertainty and higher risk.
- Cases headed for trial or appeal still carry risk, but potential outcomes are more clear.
Homefront is smart about timing. We target more mature mass torts and cases that have already cleared significant legal hurdles.
In other words, we prefer to enter the game when the odds are more favorable, and the potential for success is higher.
A simple risk/reward framework for stages:
- Pre-filing: Highest risk but potentially highest returns
- Discovery: More information available, but significant costs involved
- Trial: Clearer picture of strengths and weaknesses, but risk of adverse judgment
- Appeal: Lower risk if judgment is favorable, but potential for reversal
Potential for counterclaims
After you’ve picked the case type, legal team, and timing, you need to assess possible negative outcomes.
For example, in Part 2, we highlighted business earn out disputes as an attractive niche to consider.
But you need consider the potential for counterclaims, which are becoming fairly common in contract disputes involving two businesses.
Structured investments
The litigation finance market is evolving. Funders do have some flexibility with investment structures.
Tranche investments is a common structure to help mitigate risk.
- Rather than giving 100% of your funding amount on day one, you can split the amounts over several months or years.
- This allows funders to get comfortable with their fundee, and have an option to pull out if certain requirements aren’t met.
- The tranche investment usually helps the receiving law firm too, because they often don’t need all the capital all at once. Delaying funding helps lower total costs.
Other deal structures to consider include hybrid structures which combine debt and equity elements, and capped returns in exchange for lower risk.
Keep in mind that, unless the firm is a DC law firm or Arizona ABS, most non-attorneys cannot be equity holders in law firms.
Ongoing monitoring & case management
Litigation finance is a passive investment, but it is not a “set-it-and-forget-it” investment.
Legally, as a funder, you cannot get involved in the casework itself, but you can (and should) stay informed (keeping in mind the amount of information may be limited to protect attorney – client privilege)
Whether you make direct investments or through a fund, you should receive regular case updates and progress reports. Just don’t expect to get nitty gritty info.
If you’re interested in our upcoming deal, express interest here:
Expert networks
If there’s one thing you do right, it should be picking the right law firm to back.
But this presents a challenge, because as a new funder, you are not going to have access to the biggest, most successful lawyers and law firms. They already have their money supply (usually private equity or family offices.)
To get your foot in the door, you can join a litigation fund or SPV. These funds and SPV’s look for experts (and emerging experts.)
Homefront Group fits in this expert and emerging expert category. Take our success with the Camp Lejeune water litigation which we discussed in Part 2).
Major law firms spent over $220 million on advertising, with a $5,000+ per case acquisition. Homefront, on the other hand, spent just $500 per case. Yes, one tenth the industry benchmark.
Homefront was able to acquire a significant number of high quality Camp Lejeune clients in large part because of trust. Homefront’s team of veterans are able to gain immediate trust with potential plaintiffs who are naturally skeptical of trial lawyers.
Technology and data analytics
It may surprise you, but law firms traditionally have been reluctant to adopt new technology into their practices.
While deep subject matter expertise and a track record of success are critical, smart funders look to back firms that are also leveraging technology. Look for firms that use technology to run more efficient practices.
The biggest efficiency gains tend to come from productivity. Specifically, record retrieval and review.
Firms using AI to review medical records to spot claims and evaluate cases tend to work harder, better, faster, and stronger than those using lower cost case managers and assistants.
If you really want to gain an edge, find ways to access and analyze data related to judges and jurisdictions. There’s big potential to limit risk and improve outcomes by crunching all this data. (Some companies are doing this already, but still, we think this is a good business opportunity…)
Ethical safeguards
The entire legal industry has robust ethical standards in place to protect clients.
We mentioned the attorney-client privilege above. When considering funding opportunities, look to see if there are any conflicts of interest.
It goes without saying, but needs to be said: Make sure your team is compliant with relevant regulations and ethical guidelines.
You don’t want to get involved with another Hedonova.
Closing thoughts
By employing these comprehensive risk assessment and mitigation strategies, investors in litigation finance can better navigate the complexities of this unique asset class.
While no investment is without risk, thorough due diligence, diversification, and ongoing management can significantly improve the chances of successful outcomes in litigation finance.
At Homefront Group, we limit our risk by focusing on mass tort cases and veteran disability claims appeals, two areas we know well.
We pursue mass tort cases that already have established MDL’s, but still have significant economic upside. The veteran disiability claims diversifies risk with more predictable outcomes.
Ultimately, Homefront only pursues cases we believe are winners, stacking the odds so they are always in our favor.
If you’re interested in our upcoming deal, express interest here:
That’s it for part 3 of this series. A big thanks to our friends at Homefront Group.
In Part 4, we’ll write up a full deal memo on the actual deal we’re putting together. This will be a special deal, and if you’re accredited, you can invest.
As ever, if you have any questions, just smash the reply button.
See you next time, Wyatt
Disclosures
- This issue was co-authored by our friends at Homefront Group
- This issue was not sponsored by Homefront Group. No money exchanged hands.
- This issue contains no affiliate links.
- As of this writing, Altea does not have any holdings in any litigation finance deals, or in any companies mentioned in this issue.
