For many investors, being able to invest in a legal settlement without being party to the suit seems like a dream come true.
These investors are tapping into a quickly growing industry called “litigation finance,” which allows these investors to provide plaintiffs in legal settlements with a cash infusion in return for a portion (if any) of their legal settlement when the case is won.
Many experts on Wall Street and beyond have highlighted this rapidly growing industry because of its high returns. It is generally not correlated to stock market returns. While investing in legal settlements seems like a great idea, it is not for everyone. To invest as an individual, you must be an accredited investor, which means you have a net worth of $1,000,000, excluding your primary home or historical and expected income of over $200,000 (per individual) per year. This is required because while the returns are high, investing in legal settlements carries a great amount of risk, including losing your entire investment into a case if it does not settle favorably for the plaintiff.
How does litigation funding work?
Most litigation funding companies have an experienced team of attorneys who have a swarth of experience representing plaintiffs in all types of litigation. These attorneys act as underwriters to review cases and choose which cases have the most merit and help value the claims as an investment. Once the underwriting team signs off on a deal, these companies will then have their investment professionals structure each deal individually based on numerous metrics.
Where does the money go?
Generally, the funds are used for three main things. The first is to cover the plaintiff’s personal expenses, such as rent or mortgage payments and medical treatment. Typically, when a litigation funder invests in a personal injury case, the claimant cannot work and needs cash flow coming in until the case settles.
The second most typical use of funds is working capital. Corporate plaintiffs in litigation matters such as breach of contract claims or patent litigation usually sue because they have suffered crippling business losses as a result of the defendant’s action. This puts them in a position where if they want to continue operating their business daily, they will require some sort of cash infusion.
The third and most common thing that funds are used for is case-related expenses. Hiring experts to generate reports, give depositions, and investigate the defendant can be enormously expensive, and sometimes attorneys will reach out to litigation funders to help finance these expenses. In this situation, the funds are normally paid back from the law firm once expenses and fees are taken out of the settlement.
The growth in the industry.
Most commercial litigation funding companies, such as Baker Street Funding, are privately held, but a few companies are traded publicly, such as Burford Capital. According to LexShares, in 2009, just six litigation funding companies were dedicated solely to legal funding. Today there are well over 60. This further accentuates the rapid growth in the industry and the growing demand of plaintiffs and law firms for investment capital.
Other Things to Consider
Not only is there a principal risk when investing in litigation finance, but there is also the risk of having your money tied up long term. Most litigation funders require their investors to commit capital for a minimum amount of time. While this is standard for most private equity companies, having your money tied up and unavailable to you is not something that every investor can stomach. Additionally, these investments carry a high amount of risk, and most financial advisors recommend allocating no more than 10% of your portfolio’s value into alternative assets such as litigation funding.