Litigation finance is one of the most interesting and lucrative investment classes to come along in years – at least based on the public filings and press releases put out by the major players in the industry. Yet, when many investors and attorneys say “litigation finance”, they are really thinking of only half the industry – the commercial litigation finance side of the field. The other litigation finance receives much less attention.
The other side of the field that I am referring to is the personal-injury side of the market. Personal-injury funding firms are major players in the litigation finance arena as a whole, and indeed they are a useful compliment to commercial funding for investors.
For those who are not familiar with personal injury funding, I highly recommend the extensive primer on the subject available from Bridgeway Legal Funding, available here. Essentially personal injury-funding is simply an advance to injured plaintiffs in the form of an upfront cash payment in exchange for a portion of the settlement, or court award later on. As with commercial-litigation funding, the money advanced is non-recourse, meaning that if the plaintiff loses, then the advance does not have to be repaid.
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In a lot of ways, personal-injury funding complements commercial funding from the perspective of attorneys, investors, and even funds themselves. The two groups are opposites in terms of duration, capital needs, plaintiff type, etc. While that reduces the economies of scale for a fund, it also provides valuable diversification benefits from a portfolio standpoint.
Plaintiffs in personal-injury cases are generally regular individuals with small-dollar claims. Personal-injury investments in a single case are typically 5-15% of the expected settlement amount, which means that the total investment in a standard case might be $5,000 on the low end and $100K on the very high end.
As a result, in order to be economical and profitable as a fund, the typical personal-injury funder like Bridgeway must invest in hundreds of cases. That creates the opportunity to do data analytics on a scale that few funds can do in the commercial space.
The funding of dozens or even hundreds of cases in any given year means that a personal-injury fund is more like a traditional bank or equity investment fund than a commercial fund is. Since they are analyzing so many cases, personal-injury firms can make greater use of pricing algorithms than commercial funds do.
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The size of the operations enable economies of scale not present in commercial funding today – funding decisions can be made in a matter of days, or sometimes even hours, if a fund has a well-designed algorithm for pricing claim values.
I recently worked on such a pricing algorithm for a firm in the space, and found that claims could be assessed for probability of settlement and priced by value using just 10 factors for a case. While I have done similar work for commercial funders, the models are harder to build due to lack of data.
For investors, commercial litigation finance and personal-injury litigation finance complement each other well in an investment sense. While commercial claims are generally large, multi-million dollar affairs, personal injury claims tend to be small matters. As a result, while the commercial claims side of the world relies heavily on qualitative judgement for valuation, personal-injury firms tend to be more quantitative and often fund dozens of cases in the time it takes a commercial firm to fund a single case. Commercial funds are perhaps more comparable to private equity or VC funds. Both sides have value, but they work best in a combined portfolio.
Overall, the personal injury and commercial sides have a lot to learn from one another, and a prudent investor should consider holding investments in both arenas. I’ll talk more about this in a future column.
Michael McDonald is an assistant professor of finance at Fairfield University in Connecticut. He holds a PhD in finance. Michael consults extensively with organizations ranging from Fortune 500 companies to start-up businesses on financial matters through Morning Investments Consulting. Michael has served as an expert witness in legal disputes, and is an arbitrator with the Financial Industry National Regulatory Authority (FINRA). Michael can be reached at [email protected].