Litigation funding may never make the same noise as private equity but it is growing fast, says Chris Smith of Vannin Capital.
I do not come from a traditional background for litigation funding. Before I joined Vannin I was a corporate lawyer, focussing on international private equity transactions, rather than a litigation or arbitration practitioner. As a consequence, I entered the market without any preconceptions and have been excited about the opportunities that funding offers for claimants, lawyers and investors.
The benefits for claimants
Whilst the funding market is still relatively young in the UK, the benefits for claimants are relatively well understood. Funding increases access to justice by enabling claimants to bring meritorious claims that they would not otherwise have been able to bring owing to a lack of funds, budgetary constraints/internal policies, or a need, or desire, to deploy money in other parts of their businesses.
At the same time, funding de-risks the claim (the claimant pays nothing if the claim is unsuccessful) and allows it to be taken off balance sheet. This is particularly relevant to businesses that are focussed on producing a certain level of EBITDA as a self-funded claim will result in a reduction of EBITDA equal to the costs of the claim (likely spread over a number of years) but any damages won will be recorded as a one-off item (with no positive impact on EBITDA). I am sure that my former private equity clients will be very focussed on encouraging their portfolio companies to explore funding in the event of a dispute to avoid impairing EBITDA which could, in turn, have a very negative impact on exit valuation.
A driver of law firm growth
Funding can also offer law firms a range of benefits. Most significantly, clients do not currently pursue all the strong potential claims that they have in their businesses because they have to work within a limited legal budget and the board/management will have a limited tolerance for risk. Funding can address both these constraints on activity and generate increased work flow for law firms. Law firm partners should, therefore, ensure that their clients are fully appraised of the benefits of funding.
Other benefits include the ability to tackle ever increasing fee pressure – in essence funding offers law firms the ability to arrange finance for their clients for the expensive purchase of litigation or arbitration services – and increased certainty around recovery of fees and disbursements, which are guaranteed by the funder provided the agreed budget is adhered to, and cash-flow.
An emerging asset class
Whilst claimants and lawyers are already taking advantage of the benefits of funding, there is a longer term story here. Litigation funding is emerging as an interesting alternative asset class for investors. As a lawyer, I worked for nearly a decade with the world’s leading private equity firms and witnessed the explosion of the asset class. When I was accepted for a training contract in 2003 and I explained to my friends that I was going to work at a firm famed for its private equity practice I received mostly blank stares; nobody really knew what private equity was. Fast forward to the present day and private equity has entered the mainstream and is never far from the headlines. Is it possible that litigation funding is set to follow a similar path with an explosion in activity that will grab the headlines?
It is unlikely that funding would ever achieve the same scale as private equity, after all the number of fundable disputes is rather smaller than the number of acquirable companies. That said, funding is unquestionably growing and at Vannin we are seeing a significant uptick in demand, particularly in relation to international arbitration matters. We are also seeing the market at the top end thin out, with only a small handful of credible companies capable of addressing a large pool of potential claims.
Ultimately, it is the nature of the returns generated from litigation funding activities that will make a wider base of investors start to take interest. First, returns are uncorrelated with the public equity markets – funding is a defensive and counter-cyclical play not significantly impacted by wider economic sentiment. Secondly, there is the potential to make outsized returns where the cost of funding is dwarfed by the damages received. Thirdly, there are sufficient cases in the market to enable a portfolio approach to maximise the upside and protect against the downside.
Funders who are well capitalised, benefit from significant market experience, have built a demonstrable track record, employ a strong bench of legal, financial and commercial talent and have developed a rigorous, but efficient and flexible approach to case selection look set to thrive.
Chris Smith, Vannin Capital. For more information go to www.vannin.com