How Legal Finance Can Unlock Assets for Law Firms

January 28, 2019

Key Takeaways:

  • Legal finance can help your clients and your law firm
  • Finance is not limited to litigation matters—it is available based on a variety of contingent legal receivables including uncollected client fees or damages awards
  • The proceeds from a legal finance deal do not have to be used for litigation—the money can be used for any appropriate business purpose

Funding provides law firms with capital sources beyond client fees

The best corporate lawyers are sensitive to the business needs of their clients, including capital needs.  But law firms are businesses too.   And law firms run on cash.  Whether to pay overhead expenses or expand into new practice areas, firms have traditionally drawn the funds they need from three sources: client fees, partner contributions, and bank loans.  In the current legal market these sources are both scarcer and less attractive.

The realization rate on client fees has been steadily declining since 2010.  Clients are less willing to pay the full billable rate and have also become more proactive in negotiating alternative fee arrangements.  Equity partnership has shrunk partly in response to this downward pressure on fees.  And the decline in the number of equity partners, in turn, places a higher financial burden on individuals when it comes to partner contributions.  The issue with bank loans is that they fund business development in the long term but they require repayment in the short term—often before new revenue has begun to materialize.

Legal finance entered the U.S. market about 12 years ago and has created new capital opportunities for law firms.  One focus of funders, including Validity, is to help law firms and companies monetize the value of legal claims and legal receivables.

Litigation Finance helps firms share risk, on a single case or a portfolio

Litigation funding for a single case is the most basic form of legal finance, and according to surveys, it’s the structure with which American lawyers are the most familiar.  In single-case financing a funder invests in a plaintiff’s potential or pending claim in exchange for a share of any damages award.

Single-case funding is available to your corporate clients with the firm agreeing the share risk with the funder by investing hours while the funder invests capital.  If the case is successful, your firm and the funder will share a portion of the damages award. If the case is unsuccessful, your firm's losses are only 50% of what they would have otherwise been had the case been run on full contingency.

Litigation funding is also available for a portfolio of cases which are becoming increasingly popular with law firms of all sizes.  In this scenario, the funder invests in a portfolio of cases and received a returns from the portfolio’s aggregate yield.  Law firms tend to find this structure more efficient than single case financing because it allows them to spread risk across a number of cases and share it with a third party.

Because the funder’s return can come from any of the cases in the portfolio, the portfolio structure also opens up the possibility of funding for defense-side cases.  Defense-side funding has not been available historically, and this innovation allows a firm to take on corporate defense work that would otherwise be financially risky.

Legal Finance goes beyond litigation

People often refer to the “litigation finance industry,” but the term is a misnomer in two important ways.

First, legal finance does not require litigation. Litigation finance—which is funding based on potential or pending litigation matters—remains the most common model.  However, the legal finance industry is expanding to allow firms and companies to monetize other legal receivables, including outstanding client fees or contingent or uncollected damages awards.  As with a litigation finance transaction, funding based on these alternative assets is non-recourse.

Second, the term “litigation finance” is misleading because it suggests that the proceeds of a financing transaction must be used to pay litigation costs.

This is a myth.

The money your firm raises in a legal financing deal can be used for any appropriate business purpose, whether you need to make payroll or fund your business development activities.

Innovation is a core part of the legal finance industry

Commercial legal finance has evolved significantly in the twelve short years since it became available in the U.S.  It will continue to expand and evolve to meet market needs.  One of the most effective ways for legal finance to expand and evolve is through collaboration between law firms and funders.

At Validity we are dedicated to designing creative solutions that directly address your needs. The conversations we have with creative lawyers and enterprising law firms will shape the future of legal finance.