August 27, 2020
When reading fiction, some of us love a mystery. But when evaluating financial service offerings, probably not so much.
One thing may feel mysterious to lawyers and companies seeking funding: How do funders select the cases they invest in?
To many, the process may seem high on subjectivity and low on transparency and if prospective litigation finance clients don’t understand how funders make decisions, they may struggle to present their case in the best light or waste their own time talking to funders who can’t or won’t invest in their case.
At Validity, we want things to be easy, efficient and transparent for you. Below we shed light on some of the important factors that funders consider when evaluating a case for investment.
Most funders have a type—a type of case, that is. Funders usually formulate clear criteria in advance for the types of disputes they will invest in. For example, some funders may exclude IP litigation from their portfolios, while others may fund only IP litigation. At Validity, we currently focus exclusively on U.S. litigation and international arbitration, while others may be open to funding disputes in foreign courts.
A funder’s investment criteria are often informed by rigorous analysis, including an assessment of the risks involved and the funder’s particular underwriting capabilities. Although a funder may occasionally make exceptions to its criteria, convincing a funder to depart from its preferred case criteria may be an uphill battle. It might be a better use of time to find a funder with a track record of investing in your type of case.
Size matters, that’s the reality. The average investment made by most commercial litigation funders tends to be $2 million or above. They invest in fewer, higher-stakes disputes, but may have a ceiling on the amount they can put into any single case. By contrast, other funders may have a high-volume, rapid deployment strategy focused on investments of under $1 million. A funder taking that approach may not be interested in making a large investment in a single case. As with the funder’s preferred case type, you should be able to discern its investment range early in the process.
In most circumstances the expected damages in a case, conservatively estimated, should be at least 10x the amount of the funder’s proposed investment amount. That may seem high, but if the expected damages are too small, then one of two things may happen: Either the funder will not receive its full return or, alternatively, the claim holder and lawyer will not be fairly compensated. An experienced funder can avoid these unfortunate scenarios by creating rigorous financial models of the range of outcomes prior to investing. Lawyers and claim holders will be best served if they develop a case budget and damages analysis before speaking to a funder, so that the financial modeling process can be collaborative and thorough. Working together helps avoid an investment scenario that ultimately falls short of expectations.
There are threshold questions a funder asks before turning to the substance of the case: case type, investment amount and expected damages. Many litigation funders are staffed by former litigators who can form an opinion about the case’s prospects in litigation. They ask questions similar to those that the claim holder’s legal team and counsel have already explored, including whether the facts are strong enough to support the claim, the nature and quality of the evidence, whether there are obvious defenses or jurisdictional risks, and whether the claimant will be sympathetic to a jury.
Each funder has its own risk-tolerance. For example, a funder may be loath to invest in a case where the important facts will only emerge in discovery, while other funders feel comfortable taking that risk.
Many funders tend to be more risk-averse than lawyers who take cases on contingency. A funder’s rejection of a case does not necessarily mean that the funder believes the case is weak. Rather, it more likely signifies that the case did not meet the funder’s particular risk criteria at the time, which can vary according to circumstances that are unrelated to the merits of a particular case.
Everyone wants to avoid litigating to the bitter end of a dispute, only to find that the defendant is unwilling or unable to satisfy the judgment. Experienced funders assess the collectability of a potential judgment during the diligence process. Funders may reject a case if competing claims threaten to strain the defendant’s assets, or if the recovery process looks like it could be overly complex, time consuming or expensive.
Timing is everything, as the saying goes. While timing may not be everything to a funder, it does matter how long it will take for a case to conclude and to be able to collect a judgment. Some jurisdictions are known to be slower than others, while some cases may be more likely to settle early than others. The funder is managing an entire portfolio of investments, and needs to develop some sense of the time horizon on each one. Time-related consideration will impact the funder’s return on its investment and thus, should be part of the dialogue.
Finally, the quality of the funder’s relationship with the lawyer and client is an important but often unspoken factor in a funder’s decision to invest. Litigation funders are more than just providers of needed capital. Ideally, they are true partners who work with claimants and counsel to strengthen claims, find solutions (including how to finance expensive litigation or keep a company’s doors open throughout a case) and see a case through to resolution. Trust is essential to the healthy functioning of any financing deal. If a lawyer or client does not trust a funder – or vice versa – the investment should be declined.