Lawyers representing private equity and venture capital portfolio firms understand that their clients routinely face important business decisions about whether to initiate meritorious litigation claims that could result in substantial recoveries.
Yet convincing their clients to move forward with litigation—no matter how lucrative it may ultimately be—is another matter entirely. The main culprit for this hesitancy is a simple one: PE and VC firms are loath to saddle their portfolio companies with the expense of litigation when that precious capital could be used to enhance a company's operations or develop new products.
The very nature of complex litigation is enough to give private equity and venture capital investors pause. It is invariably prolonged and burdensome, not to mention inherently unpredictable. A single adverse ruling could obviate years of seemingly prudent legal outlays and dramatically diminish—or even wipe out—an expected recovery.
Unlike equity investments or loans, litigation finance is non-recourse and funders do not have a management stake in the litigation, let alone the company. If a case is unsuccessful, neither the PE/VC firms nor their portfolio companies owe anything to the funder.
Immediate financial benefits
Whether paying litigation fees and costs through the life of a single case or deploying capital to support pools of cases, litigation funding creates immediate financial benefits for portfolio companies and their PE/VC backers. For single cases, funders remove legal expenses from the financial statements as they are incurred. Without financing, this spend routinely creates a drag above the EBITDA line. For portfolios of cases, funders typically deploy capital in a large lump sum (or periodic lump sums) tied to the cumulative potential value of each litigation. These cash infusions are typically used to satisfy legal expenses, though they often contain a working capital aspect as well. This arrangement allows the company to book the capital infusion as a financial asset. And if a claim is successful, the portfolio company can record additional revenue, typically as an exceptional item, with a portion of the recovery going to the funder as a return on its investment.
Investing in several cases at once also allows the funder to significantly increase the level of investment it can provide. Funding from
The funder's involvement provides collateral benefits to counsel. It allows them to enhance their client relationship and potentially expand it across several pieces of litigation. Firms that are uncomfortable with the risks associated with a full contingency arrangement can build hybrid contingency stakes in a funding scenario. The funder covers a large portion of the firm's hourly fees, but also allows the firm to take a portion of its fee on contingency. This gives the law firm the ability to share in the upside of a strong recovery and better aligns its interests with those of the client.
A selective approach
The first step in ensuring the success of a funding arrangement is identifying the right cases to support with non-recourse capital. Reputable funders like
Funders turn down funding opportunities for a host of reasons, but most often because the merits are not strong enough, the expected recoveries are insufficient to provide the funder with an adequate return while also providing the claimant with a fair share of the proceeds, a case is not large enough for investment, or the matter presents disqualifying collectability concerns.
Most of the leading funding companies employ teams of litigation experts—often former litigators from elite private law firms to assess and manage investments. At
Prior to investing in a case, the team conducts thorough due diligence on the merits. Each case requires a sophisticated understanding of the current legal landscape of the jurisdiction in which it is filed.
Additional expertise
Reputable funders in
The investment management team can also help claimants review potential litigation before filing, to construct portfolios of meritorious claims. A portfolio investment approach substantially increases the level of capital a funder may invest, boosts the potential return on investment, and diversifies and cross-collateralizes the investment across several cases, thus helping reduce risk.
In addition, once an investment has been made, claimants can use the funding to engage top-notch counsel--a dynamic that invariably increases the probability of success.
Enforcing judgments
Aside from assessing the merits of a case, funders also must determine whether the opposing party has a clear ability to satisfy a judgment or pay a reasonable settlement. The funder enters a funding relationship with the expectation under reasonably anticipated outcomes that it will recover both its invested capital and an appropriate return, that the claimant should recover the lion's share of any recoveries, and that any investment partners (such as a private equity or venture capital firm), are able to exit the case in a timely fashion.
Parties often resist paying awards and judgments obtained in commercial and investment disputes for a host of reasons. Assets may be hidden or made otherwise inaccessible, and in cases where sovereign entities are involved, diplomatic issues may arise.
Any funder worth its salt should be well equipped to enforce judgments and take proactive measures to help prevent moves by an opposing party that may be designed to thwart recovery. For its part,
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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