Themis has recently written about how Claim Based Funding can be used by private equity sponsors and by general counsel offices as a tool to unlock value from meritorious claims that might not have been pursued because of the cost, risk and time lag to realization. Today we will turn our focus to how law firms with a portfolio of good cases on contingent fee arrangements can use Claim Based Funding to manage cash flow, finance growth and reduce risk.
Law firms which handle a substantial amount of their case load on a contingent fee basis enjoy the potential for out-sized profitability when those cases are resolved successfully. However, the timing and amount of the cash flow generated by such cases is very difficult to predict. If a case settles quickly it generally means that the law firm has invested a relatively smaller amount of lawyers’ time and out-of-pocket expense and the law firm will receive a faster, albeit typically more modest, payout. When a case goes to trial the firm’s investment of time and out-of-pocket expense becomes quite significant and the firm faces the prospect of a binary outcome when the verdict is read. A win at trial typically signals a larger recovery but a loss means that the firm’s investment may be lost.
Law firms that operate on the contingent fee model face business challenges that are different from the traditional multi-practice law firms which generate cash flow from regularly billing and collecting on their time. Naturally the contingent fee firms have recurring expenses for associates and overhead and in many cases the obligation to fund out-of-pocket costs for their cases. Without predictable cash flow and facing the risk of occasional loses, these firms must maintain a significant level of working capital to continue to finance their operating expenses. These challenges are even more acute for growing firms that have the opportunity to take on an increasing number of quality cases but must add overhead resources to handle the expanding caseload with potential payouts years in the future.
Claim Based Funding can help law firms finance their working capital requirement and, thereby, offer the firms a way to make their cash flow more predictable. A Claim Based Funder like Themis can evaluate the merits of a firm’s portfolio of cases and anticipate the amount of fees that are likely to be generated by the portfolio. With awareness of the strength of the cases in the portfolio and the likely recoveries, Themis can structure transactions that would allow the firm to draw down funds against the portfolio as cash flow is needed. The firm would repay the funder when the cases are resolved and the contingent fees collected. The net result for the firm is reduced risk of loss, reduced volatility of cash flow and a reduced need to hold excess working capital.
For the funder there are several considerations that also need to be addressed in the transaction. The funder would not want the law firms to keep the best cases to themselves and finance the weaker and less profitable cases. The funder also wants to diversify its risk and, therefore, a larger pool of cases is generally more attractive. Accordingly, the funder will typically look to take an interest in a broad cross-section of, if not the entire portfolio of, the firm’s contingent fee cases to provide diversification and to avoid adverse selection.
Themis looks to build these investments into long term relationships with its counterparty firms. Once Themis starts working with a firm, we learn more about the firm’s portfolio of cases, case selection practices, trial skills and unique cash flow requirements. As the relationship evolves, Themis can refine the structure of its offerings to provide tailored solutions which can best address each firm’s specific needs.