Since 2009, the legal finance market has matured to meet the needs of the legal industry. In the beginning, most of Burford’s investments fell under the category of “traditional” litigation funding: Burford provided capital to a firm’s client to fund a single case, often due to financial necessity when a firm had a client that was unable or unwilling to pay the firm’s hourly fees. More recently, however, firms themselves have pursued outside capital as a smart business and risk-management strategy, seeing it as a way to be more proactive about managing firm finances, increase profitability and help limit firm risk. As a result, firms have sought increasingly creative financing arrangements—including portfolio finance.
Even as traditional single-case financing remains the manner in which most lawyers first experience legal finance, portfolio financing is an area of growing interest and opportunity for clients and law firms. Burford’s own investment portfolio reflects this trend: In 2016, Burford committed over $330 million—a substantial majority of all of our new capital commitments—to portfolio and other complex arrangements.
Yet many lawyers remain unsure of how portfolio litigation financing works, and when it is best used. What follows is a guide on portfolio financing—specifically addressing how law firms use portfolio finance. (We’ll address corporate portfolios in a future article.)
Portfolio finance structure
There are two basic structures for law firms considering portfolio finance, which reflect varied needs and risk tolerance:
#1. Monetization portfolio
- Purpose: A firm wants flexible capital that can be used for a variety of potentially non-case-related purposes, including partner distributions, firm overhead, et cetera.
- Who it’s for: A firm with a substantial existing book of full or partial contingency cases at a variety of stages in the litigation process.
- Case profile: Portfolio includes several “anchor cases” that are particularly large or that are close to maturation, which form the principal collateral for the portfolio, with additional cases of varying sizes and profiles.
- Investment size: Burford works with firm to value case collateral and the appropriate loan-to-value ratio.
- Pricing: Cost is typically lower compared to single cases or risk-share portfolios; Burford’s return is typically structured as a non-recourse rate.
- Diligence process: Diligence is prioritized based upon the value of cases to the portfolio, with a closer review of the anchor matters and a lighter-touch process for other cases.
#2. Risk-share portfolio
- Purpose: A firm wants to invest resources in its practice or increase its proportion of at-risk or contingency matters while also managing its risk exposure.
- Who it’s for: A firm that wants capital to pay a portion of fees or expenses as they are incurred, with matters early in the case lifecycle (similar to traditional litigation finance).
- Case profile: Portfolio consists of at least four or five large cases, which can be identified at the outset or added to the portfolio on a going-forward basis.
- Investment size: The firm and Burford agree on risk allocation and an overall portfolio commitment amount. Burford then invests that share of fees and expenses as they are incurred in litigating the cases in the portfolio.
- Cross-collateralization: If a case in the portfolio loses, Burford and the firm recover investments in the losing case from the next winner, reducing the binary risk of loss.
- Pricing: Deal structured so that returns for the firm and Burford depend upon their respective investments in the portfolio and its overall performance.
While these are the two basic portfolio approaches, Burford regularly customizes solutions to meet specific firm needs.
Portfolio finance has several financial benefits over self-financing:
- Efficient expense management: Because law firms operate as cash businesses, when a firm advances out-of-pocket expenses for a client, they are paid with after-tax earnings, meaning the firm essentially spends $1.30 or more, depending on state tax rates, to invest $1.00 into new cases—so portfolio financing that covers out-of-pocket expenses effectively lowers the firm’s investment costs in addition to lowering its risk.
- Cash flow: Portfolio finance enables the firm to manage annual cash flow by generating revenues as expenses are incurred—instead of waiting for a resolution, the timing of which is largely out of the firm’s control.
Ultimately, portfolio finance is a form of corporate finance that helps a firm efficiently manage its income and expenses.
“What about privilege?” is often one of the first questions lawyers ask about litigation finance. There is broadly recognized work product protection for communications with outside providers of litigation finance (see the Summer 2015 issue of the Burford Quarterly and the Burford blog for an overview of caselaw). Moreover, out of an abundance of caution, despite the strong caselaw we are also circumspect about what we request in the diligence process to avoid any risk of a waiver.
Burford makes a portfolio deal directly with the firm, but Burford’s role is that of a passive investor—Burford has no settlement rights or control over case strategy or decision-making.
A new tool for law firms
Portfolio finance is emerging as a powerful tool for law firms ready to think beyond the traditional hourly fee or pure contingency models to increase profitability, invest in growth and actively manage the firm’s finances. And in a rapidly changing marketplace with increased pressures from clients and the competition, understanding how portfolio finance works is important for every firm.