Funding Insights — Article
The Entrepreneurial Attorney: Insider Tactics for Obtaining Litigation Funding
Director of Investments
Vice President of Business Development & Investments
As economic uneasiness looms, with companies reducing overhead and investors emphasizing profitability, the legal finance industry's traditionally strong investment rigor is suddenly in vogue.
Attorneys who have inquired about third-party funding may confirm anecdotally what we have observed empirically: only a small fraction of parties seeking litigation finance successfully obtain it.
In fact, our analysis of data from more than 30,000 cases found that less than 12% of federal and state filings presented strong opportunities for litigation funding. This aligns with the consensus among industry players that fewer than 5% of litigation funding applicants ever walk away with a finalized agreement.
Fairly, litigators and clients may wonder why such a small percentage of opportunities cross the finish line. Although many factors can prevent the consummation of a deal, most can be attributed to a fundamental difference in mindset among the counterparties.
For non-recourse litigation funding providers, every engagement is full contingency. They not only seek a return on their investment but are also very focused on avoiding a total loss. Conversely, to applicants, pursuing third-party capital may feel much more like a transactional sales pitch than what it really is: a long-term partnership between parties with a common underlying goal.
To navigate the industry's rigorous diligence process, potential funding recipients should focus on presenting their primary asset — the underlying legal claims — much like an entrepreneur seeking venture capital would position her company.
Framing Your 'Pitch'
Any viewer of ABC's Shark Tank knows that most contestants fall into one of two categories: those who come armed with a strong story backed up by numbers, and those whose lack of thorough preparation makes for good television but poor dealmaking. Aggressive valuations, a limited track record of sales, and poorly conceived growth plans are all common reasons why an entrepreneur will hear, "I'm out."
Like the entrepreneurs on Shark Tank, parties seeking litigation funding can minimize their chances of hearing "I'm out" by presenting a realistic, evidence-based "pitch." Put another way, the ideal counterparties should not only believe in the merits of the claim, but should also demonstrate a grounded litigation strategy backed by compelling facts that substantiate their allegations and arguments.
How can parties seeking legal finance make a compelling case to a third-party funder? First, be upfront about the strengths and weaknesses of your case. Because attorneys are accustomed to being zealous advocates for their clients, discussing the weaknesses of a case does not always come naturally. They may also believe that discussing a case's blemishes could lessen their chances of obtaining funding. However, the opposite is often true.
Even the strongest cases have flaws, and they are typically uncovered at some point during a funder's diligence. By proactively discussing tactics for addressing those weaknesses and their contingency plans for suboptimal scenarios, counsel demonstrate that they have thought deeply, strategically, and realistically about the case, potentially putting them steps ahead of the adverse party.
And by surfacing any blemishes early in the diligence process, funders can give applicants a more expeditious answer on whether a claim will receive outside investment.
Consider a typical contract dispute. Many large commercial agreements contain provisions that will benefit the defendant, such as liability waivers, arbitration clauses, or limitation of damages clauses.
Counsel that have already considered these issues within the context of their case are less likely to be surprised in court — and will also elicit far more confidence from a litigation funder. While hoping for the best but planning for the worst may seem like common-sense advice, our experience reviewing thousands of funding inquiries tells us otherwise.
In addition to being upfront about a case's weaknesses, parties should not get lost in the details and always consider the bigger picture. The most effective funding applicants can weave a compelling narrative that speaks to the natural human motivations underlying any conflict.
For example, if a complaint alleges the defendant sabotaged a joint financial arrangement but fails to address why the defendant stood to benefit from doing so, would a judge or jury find such a story persuasive? Even worse, might a judge or jury suspect the plaintiff is papering over deficiencies in its case and subconsciously view the claims more skeptically?
Thinking Through the Numbers
Shark Tank's Kevin O'Leary likes to ask entrepreneurs, "how am I going to make money?" Litigators specializing in contingency work can empathize with third-party funders over the importance of realistically modeling damages and the defendant's ability to pay. While this may not be a particularly glamorous task, counsel taking a thoughtful approach to case economics are better positioned to secure litigation funding than their peers who gloss over these details.
To a funder, damages are just as important as the merits. Not all claims will be of equal strength or value, and some parties tend to over-plead — which risks detracting from the most meritorious claims and complicating negotiations. Several funders, including LexShares, will typically invest no more than 10% of what they determine to be the realistic recovery amount; inflated damages estimates can prolong this process.
When third-party funding is required at the early stages of litigation, some attorneys may prefer to rely on a damages expert or else defer damages questions to a later stage in the litigation. However, counsel who have at least formed a working theory on damages, given their track record of litigating similar cases, can expect to have more productive litigation finance conversations than other funding candidates.
Thinking through potential weaknesses in the damages model, such as the lost profits analysis in a trade secrets dispute, is also critical. Litigation funders want to see counsel demonstrate how they would combat a defendant's inevitable argument that the damages are too speculative if, for instance, the plaintiff has a limited history of financial performance.
Much like a lawyer would pitch her firm's contingency committee on accepting new contingency work, litigators seeking third-party funding should come prepared with a buttoned-up theory on the recovery across the spectrum of punitive, compensatory, and consequential damages.
Likewise, attorneys who have developed even a basic framework for collection from the defendant, given its financial track record and creditworthiness, are going to merit a closer look from litigation funders, which require confidence in the likelihood of a judgment or settlement leaving the defendant's pockets.
With a potential recession looming, the defendant's ability to withstand an economic downturn and avoid bankruptcy is vital for litigation funders that stand to lose their investment principal — even if the case is highly meritorious.
Crossing T's and Dotting I's
On Shark Tank, some sources estimate that 40% of deals accepted on-air in the show's early seasons fell through during diligence. While the close rate is far lower in the litigation finance industry, the same principles hold for attorneys as entrepreneurs. Even after making a strong impression on their potential investment partners with the case narrative and damages model, litigation funding applicants must back it up with evidence during the final stages of diligence. Canal, Emily. "We Fact-Checked Seven Seasons Of Shark Tank Deals. Here Are The Results." Forbes. 21 Oct. 2016
During final diligence, plaintiffs and counsel will need to satisfy a checklist of requests that will allow the litigation funder's investment team to properly understand the case. Typically, these requests are limited to non-privileged materials, such as public docket entries, complaints, briefs, and unsealed hearing transcripts, as well as material information on case merits, damages, liability, and any expert reports that have been prepared. (As a best practice, reputable funders will execute non-disclosure agreements as one of the first steps in the investment process.)
Completing final diligence of a case requires time, and candidly, clients who are slow to respond to diligence requests are a common reason for delay. Packaging diligence documents in an organized and timely fashion can eliminate an avoidable hurdle late in the funding process and put your client a step ahead of other applicants.
In some cases, factors beyond counsel's control can also derail litigation funding arrangements during final diligence. A funder may have the utmost confidence in the case merits and the track record of the plaintiff's legal team but, after further review, lower the amount of funding to be deployed upfront due to concerns over the defendant's ability to pay or the damages model.
Conversely, it is not uncommon for litigation funders to provide follow-on funding for cases that require additional capital and have passed key procedural milestones.
As with the deals that ultimately close on Shark Tank, the strongest litigation funding applicants are those who present a compelling case and support their "pitch" with persuasive evidence. With the right mindset and a better understanding of the process involved in obtaining legal finance, we sincerely believe attorneys can consistently leave their clients well-positioned to obtain third-party funding.
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Director of Investments
Vice President of Business Development & Investments