Demystifying Litigation Finance & Other Alternative Credit feat. Eva Shang | Aspen Funds
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Demystifying Litigation Finance & Other Alternative Credit feat. Eva Shang

Curious about how alternative credit can reshape the financial landscape? Join us for a riveting conversation with Eva Shang, CEO of Legalist, as we explore this intriguing world.

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Ben Fraser: Hello, Future Billionaires! Welcome back to another episode of your favorite podcast, the Invest Like a Billionaire podcast. Today, we’ve got a really fun guest joining our show. Her name is Eva Shang. She is the CEO of Legalist, which is an alternative credit firm and a really fascinating conversation.

We dive into the world of alternative credit. So I come from a banking background, been in credit for a lot of my life, and I’d never even heard of some of these types of credit they were doing. So she tells her whole story, the origin story. She and her co-founder, dropped out of Harvard to start this business and have since had a lot of great success in litigation finance, debtor and possession financing.

And the last was government receivable. So really interesting verticals they’ve got into with their technology. Be sure to check out this episode. And as always, we got to give the disclaimer when we bring people on to our podcast that are raising capital. We have not done any due diligence. You have to do your own due diligence and this is just.

Purely informational. We’re curious about different things and obviously would hope that you would do full due diligence if you do decide to work with them. With that, please enjoy the show. 

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Welcome back to another episode of the Invest Like a Billionaire podcast. I am your co host, Ben Frazier, joined by fellow co host, Jim Mefuccio, and today we’ve got a really awesome guest.

Very excited to get into this interview. I’ve been looking forward to this one. With Eva Shang, she is the CEO of Legalist, which is an alternative credit fund or just firm. And doing some really cool things in the alternative investment space. So if you’ve listened to this podcast for a while, we love to just educate around alternative investing and, real estate’s a big part of that.

We talk a lot about real estate. There’s a lot of other cool things going on that people are doing and you guys are no exception. So Eva, welcome to the show. Thanks for coming on. 

Eva Shang: Yeah. Thank you so 

Ben Fraser: much. Yeah, so give us a little bit of background just on legalists and then I want to go back to your story because Obviously, you’re very intelligent.

You went to Harvard and you became your co-founder. I also spoke with Christian and just would love to hear the origin story of how you guys see 

Jim Maffuccio: It’s beyond intelligent people to go to Harvard Super, super intelligent people drop out of Harvard and say, I don’t know. I was intrigued by that. So cute.

Yeah, exactly. 

Eva Shang: Okay. To give you a little bit of background on myself, I am one of the co founders and the CEO of Legalist. Christian, my co founder and I actually started Legalist when we were undergrads at Harvard. When I was 20, the initial incarnation of Legalist was not quite as an alternative credit firm.

It’s not exactly the type of idea that two 20 year olds in a dorm room are like, oh, you know what we should do? We should start an alternative credit firm that invests in litigation finance. It was a little bit of a circuitous path that led us there. And the initial technology that we developed, what it did was it scrapped state and federal court dockets and it looked for analytics, cases that were about to win, information that you could glean from these public government records.

And our intention was to package it up and to sell it to attorneys. And that was our initial product idea. And off of that idea I got the Teal Fellowship, which allows you to drop out of school. Legalist got into Y Combinator, which is a Silicon Valley startup accelerator. And that’s how we ended up moving out to the West Coast.

Now, as soon as we got into Y Combinator, the general counsel at Y Combinator stopped us the very first day. We had just gotten in. And he was like, I hate your idea. And we were like, Oh no, we just got here and you already hate our idea. And the reason that he said he hated our original idea is that lawyers hate to pay for things.

And if you’ve ever been billed by a lawyer you know that they’re actually incentivized to not know whether your case is going to be successful. And they’re incentivized to stretch it out for as long as possible. And they’re also incentivized to be as inefficient as possible. So there are a lot of incentives working against you here.

And he said if your technology works so well, and if you can identify cases on a live basis that are primed to be successful have you heard about this alternative asset class called litigation finance? Where you can be an investor and actually take a stake in a litigation so then you can profit when the case is successful.

So you can profit from your knowledge and that can be your source of alpha. And we were like I haven’t heard about that, but that seems reasonable. And so we took our technology and then we repackaged it up. And we decided to try and raise a fund. Unfortunately, I don’t think anyone told us that it would be extremely challenging for two 20 year olds with no investment track record to raise a fund.

And that began one of the most difficult years of my life from 2016 to 2017 when we had just this technology, and we set out to raise a 10 million investment fund. Eventually, we managed to scrape together the money from mostly, high net worth, family offices here in the Bay Area, and that fund ended up returning over a 2x.

So it’s one of those really unlikely beginnings, but that catapulted us to raising a 100 million fund, then a 300 million fund. Branching out into other strategies like bankruptcy and government receivables lending all based on this tech platform. And today Legalist manages around 800 million and we’re about to close on another 200.

That’ll put us at around the billion AUM mark. So I’ll take a pause there and then we can dive in anywhere you guys find interesting. That’s an 

Ben Fraser: exciting ride and in such a short time, really relatively. So congratulations. Thanks. Yeah, I would love to go back to litigation finance because I think that’s where you guys started and you have other verticals now, but really break down what that means.

And, who are the counterparties? Why are they willing to, sounds like sell or take a settlement early and then they give you the. The back end if the case wins, right? So break down how that actually works. 

Eva Shang: Yeah. So the premise behind litigation finance is that it’s essentially an investment into the outcome of a case itself.

So I’ll take a pretty prototypical example of how it works. So let’s take Legalist as a company and let’s say that we were to be acquired by. BlackRock, right? A much larger company. And let’s say that in the course of that acquisition process BlackRock promises to pay us 10 million.

And after we get acquired, I’ve signed my entire company over and then renege on that and don’t pay 10 million. Now, as a plaintiff, not only am I out 10 million, but I also need to pay 100, 000, a few hundred thousand, a million dollars for legal fees. And that’s the situation that a lot of plaintiffs and users of litigation finance find themselves in.

And that’s really where litigation finance becomes relevant. So you have a great attorney that you found, but they charge on an hourly basis. And so what Legalist does is we come in, we identify that the case has been started, that it’s going well, that it’s the type of case we like to invest in, and we reach out to the plaintiff and we say, Hey, are you interested in litigation financing?

We can cover that million dollars of legal fees. And then if you’re successful, if you recover your ten million, then we’ll take a percentage of that. And if you’re not successful, then we’re just out a million dollars. And that’s our loss. And that’s really the value prop for these companies that we invest with.

We funded over 400 litigations to date. We have roughly an 80 percent success rate. And I think for everyone involved, the lawyers like to get paid. The investors like to get healthy returns. And the claimants really like to not have to be on the hook for the legal fees and to have a third party come in and really tell them whether their case is good or not.

Jim Maffuccio: So going back to the, going back to the 10, that 10 million case you’re making this commitment. Is it subject to some progress benchmarks along the way? Or, is it a one time commitment upfront and say, Hey, even if you like, let’s say you, the case looks really good to you on the front end.

But then things start to shift. A new piece of information enters the equation or the council is dropping the ball or goes south or whatever. Do you have contractually the right to say, hey, we’re cutting our losses? Sorry guys, we can’t go any further with you here. How does that work?

Eva Shang: So we do, so a case doesn’t go straight from filing to trial. There’s usually a two or three year process by which there’s discovery conducted there are motions to dismiss, motion for summary judgment motions for judgment on the pleadings, and if a case gets knocked out before the full million dollars has been spent by the attorney, then obviously we’re not on the hook for the additional 400 usually though, we’re pretty good at underrating for cases in the sense that if there’s something obviously wrong with it then it’s going to get knocked out.

But we don’t usually fund cases that have something obviously wrong with them. 

Jim Maffuccio: During discovery, for instance, you have all kinds of information coming in and depositions and everything. And are you guys privy to that? Do you have somebody sitting in or are you just taking your side’s word for it that, yeah, things are going really great.

Or that’s just seems I’m intrigued by it, but how do you navigate that? 

Eva Shang: Yeah. So we do ask for regular progress updates from the attorneys. We don’t scrutinize every piece of discovery. With hundreds of litigations, that would just be too much. But when we go into a case, there’s usually a factual record already pretty well laid out.

So we don’t go into cases where it’s highly speculative. We wouldn’t fund a case where the plaintiff says, I suspect that someone has stolen from me. That’s not enough to substantiate our underwriting. And that’s the reason why a lot of cases we fund are halfway through their litigation process already.

When you just have a suspicion that something has been kept from you, that’s usually not enough to qualify for litigation funding. 

Ben Fraser: And it sounds like what you said earlier, that this industry has been around a long time, this kind of transaction and the ability to come in and help. Get these cases to finish line and get a portion of the profits has been around, but you’ve created technology Initially for a different use case, but now you’re leveraging that to In your underwriting process, so it sounds like you’re able to use technology You know scour through all these different records to identify what you think are going to be the highest probability Cases to win and then you can use that as an initial filter, right?

Am I understanding that right? Is that kind of how you’re coming into space with the new edge? 

Eva Shang: That’s exactly right. So if you think about it, if you zoom out and think about what a credit fund does on a macro scale, a credit fund is really good at structuring and underwriting investments that a normal bank wouldn’t touch, right?

A normal bank would not lend you money against your litigation. That would just be insane. But what a credit fund or a litigation funder can do is we can say, Oh, we’re really good at underwriting that. We have lawyers that know how to look at cases and decide whether or not to invest. But that’s just the underwriting component.

The way that most litigation funders are set up is they have a network of relationships. So friends of theirs, people they’ve known through the years who bring them cases. But that’s a very limited set, whereas what Legalist has is Legalist has not only the ability to assess litigation once it’s interested in funding, but we have a bird’s eye view of cases as they’re ongoing through state and federal court systems, and we can reach out to them proactively and say, congratulations on surviving that motion to dismiss now are you interested in litigation funding?

And that opens us up to opportunities from lawyers that are way off the beaten path, plaintiffs that are not plugged into the litigation funding scene, don’t have well connected lawyers, but have really meritorious cases. 

Ben Fraser: Interesting. What other factors are you looking at in your underwriting to maintain that probability?

On the higher end, we said 80 percent success rate. 

Eva Shang: Yeah. When people think about litigation funding and doing it in a data driven way, they often think of us as being like D. Shaw or like a quant fund where you can say, oh, the stock is going to go up and then you can buy it. But with credit, it doesn’t quite work like that.

So let’s say we identify a case that is going really well, where liability is firmly established and it’s worth 10 million. Yeah. If we invest 11 million, then we’ve just lost money, even though the initial tech was correct. Or, if we invest 1 million and the case is worth 10 million, but the defendant doesn’t have the ability to pay 10 million, then that’s still not a good investment.

So we really break it down into liability, Is the case going to be successful? Damages. If so, for how much? And then collectability. If you do succeed and succeed in recovering damages, can you actually collect on those damages? Our tech can do a great job of screening for the first component, but it really can’t screen for damages all that well at the higher end.

And it can’t tell us how much money to invest and it can’t tell us whether the defendant is collectible or not, especially if it’s a private company. And so that’s where our team of expert underwriters comes in and they actually read the contract and say, okay, under what circumstances are they meant to pay you 10 million and how much money does this business actually make every year?

Very interesting. I 

Jim Maffuccio: suppose there’s also a political slash reputational motivation for you. You mentioned BlackRock before, there’s going to be certain companies that are going to be way more inclined to settle, even if maybe the merits aren’t as strong as they would be if it were, not that, that type of a company and they’ll, so you’re probably going to get a faster exit from somebody like that has a reputational concern or a political. 

Eva Shang: Yeah, that’s true. That’s one of those individual factors that we try to take into consideration. 

Ben Fraser: One last question on this vertical, but go back to the success rate.

What are the quantitative factors that you can assess to determine success? Probabilities are high because I would imagine a lot of it comes down to the nuances of the case, or if they hit a certain point, the data shows that most defendants are going to settle at this point. And that’s where we come in or what are the other factors you’re looking at?

Because to me, it seems hard to quantify in a mass way. Unless you have in-house lawyers that are reviewing every single case, which you said obviously you can’t because of the quantity of deals you’re doing. 

Eva Shang: So at the initial screening stage, what our tech does is it looks for roughly 58 different variables.

But the ones that interact the most are things like case type, the parties involved, and what type of entity they are. And the procedural stage of the case. So I’ll give you an example. There are certain types of cases like breach of contract where it’s very hard to knock it out on a motion to dismiss.

And then there are other types of cases like cases that are based on statutory matters where the law is the most important thing and most of them are knocked out on the motion to dismiss. There are certain types of cases where we might be comfortable reaching out to them and comfortable that we’re not wasting our time underwriting them as soon as they’re filed.

And then there are other types where we’re going to have to wait until They are much more procedurally advanced. And then there are still other types of cases, like patent cases, for instance, where you could have a judgment, and even at the judgment stage, 50 percent of patent judgments are overturned.

And so those we just don’t reach out to at any stage. And the interaction between those variables and the statistics on if you have a case that. As this characteristic, this judge, this venue, and at this stage, how likely it is to be successful is the basis for our initial outreach.

Granted, it’s not perfect, right? You can have contract cases that look the same, but the plaintiff is absolutely unhinged and that’s something that can’t be captured by the tech, and so we would just get rid of that at the underwriting stage. But as a whole, there are a hundred million civil court cases filed every single year and we boil that down to around 500, 000 that actually qualify for us to reach out and even say hi.

Ben Fraser: That’s so fascinating. I imagine to, I’m sorry, 

Jim Maffuccio: go ahead. Before you actually pull the trigger on it to say, yeah, we’re going to take this case. And of course, here’s what we’re going to offer because that’s a wide range there. I imagine. Do you have the equivalent of coming from the debt world?

Do you have the equivalent of a loan committee or an underwriting committee that says, okay, so and so manager brought this deal, we’ve had, the attorney made the first look at it to decide, yeah, we’re going to do this one. Is there some collaboration that happens in house or how does that work?

Are you the, are you it, are you the one who says we’re doing it? 

Eva Shang: Oh, absolutely. We have an investment committee. The cases are underwritten very carefully by a lawyer who’s an underwriter and when they get presented to the investment committee. Many of these factors that I just outlined have been already looked at.

So liability, damages, collectability, those are the table stakes. And then over time we’ve layered in other things that we’ve realized. So I’ll give you an example. They say that if a jury likes a plaintiff, they will drape the law over them to make sure they get something. And if they don’t like the plaintiff, they will interpret every single clause, even in a rock solid contract case in the way that is least favorable to them.

And so now we have a section in our investment memos that’s called plaintiff likability. Now of course, this is very subjective, objective. Yeah. But we trust our underwriters that if they just absolutely hate someone after spending an hour on the phone with them, that can’t be a good thing for their case.

Ben Fraser: That’s so interesting. ’cause there is so much of a human element to this, and I would imagine. As you guys continue to do this and sort of data driven, you’re going to build a database of this municipality and this judge and this day of the week. Chances go up for whatever.

And I imagine the amount of data that you’re able to start putting together over time will be very valuable as well, aside from just the the other quantitative things 

Eva Shang: you’re mentioning. Yeah, exactly. So at this point we have hundreds of realizations and we’re able to put them together to learn things from our underwriting and to build up muscle memory and in house analytics that really allow us.

to be more informed going into future investments. 

Ben Fraser: Very cool. So talk about some of the other verticals that you guys have gotten into. So the first one was this vertical. Actually before I got into that, one question that did come to mind is what do you view as your, say, total addressable market for litigation finance and still be able to keep the same success rate?

That you have, because I’d imagine over time, maybe you hit a certain cap on, there’s just these number of cases that are going to, that are, we like and that are going to have a high chance of success before you peak out in the market, or are you still far away from that? 

Eva Shang: We’re still pretty far away from that.

We identify a few hundred thousand cases every year and we’ve only funded four hundred in total. We’re getting there. We’re getting there. As we get more name recognition in the market, as litigation finance becomes a more commonplace occurrence, we’re finding higher pickup rates from potential customers just when we reach out to them.

Now taking a step back as to how we’re building the firm and how we think about scaling each of our strategies, we’ve always been of the opinion that there is a finite amount of alpha in every market. And so the more that you try to push a capacity constrained market to a size that it’s not well suited for, the less alpha you’re going to have and the more you’re just going to pick up beta.

So market returns are for returns for the risk that you’re taking. And so we’ve always been of the opinion that we don’t need each one of our strategies to scale to 10 billion, right? Our core innovation is this technology that underlies each and every one of our strategies. And if it’s able to pick up alpha in a relatively capacity constrained strategy, if it can do that across multiple verticals, then we as a firm can be scalable even if the ultimate strategies aren’t.

And that’s really where our other two verticals came from. So our second vertical that we launched is dip financing in bankruptcy. So bankruptcy is often a very scary word, but what dip financing really means is that if you have a company that’s filed for bankruptcy that has a bunch of assets and a bunch of liabilities, dip financing is a type of court approved financing that allows you to come ahead of other creditors.

And offer the debtor time to restructure or to liquidate its assets in an orderly fashion. So some of the companies that we’ve dealt with have been granite factories, they’ve been sawmills, they’ve been equestrian farms where they just need a little bit of time to liquidate and they can’t be rushed into a fire sale process, otherwise they’ll get pennies on the dollar.

But having a little bit of bridge financing during the bankruptcy process. Even if it’s only for 12 months or sometimes less than that, it gives them the time to conduct an orderly liquidation and maximize value for all the creditors. And then our third strategy one of our LPs actually brought to us.

So by this time he had been an investor in both our litigation and our dip strategies. And he said, Hey, I have this other manager that does government receivables and I really like this asset class because it’s incredibly liquid. Rock solid, you get paid directly by the U. S. government, but they can’t scale it, so they just have these relationships, and they’re capped at whatever their relationships can bring them.

If you can find me government contracts that are run by businesses that are looking to scale up and would be interested in a credit facility specifically against that contract receivable, then I think you could deploy a lot of money here. And that’s really how we got into our third strategy, the government receivables line.

But the thing that undergirds all three of these, even though they look different, is that they’re a type of esoteric or niche credit that Exploits some site type of structural alpha in the market and that investors would love to have more of if you could find them. And what our technology allows us to do is it allows us to find them.

Ben Fraser: Very cool. So on, on the government receivables, you’re basically going and buying somewhere to factory, right? So you’re basically buying. the future payout from whatever U. S. government entity to whatever firm that was contracted with them at some type of discount, and then you just go and collect the difference.

Is that what that line is? Or explain what the structure is on those types of deals. 

Eva Shang: So it’s very similar to factoring in that we are lending against government receivables. But unlike factoring where you have a one off purchase of a receivable, what we offer is a working capital line of credit where government payments are backed, or government receivables back up the payments that we make.

So it’s cross collateralized, senior secured, and we replace their line of credit from their bank. But unlike a bank line, which is Really, just based on last year’s P&L, the government receivables line that we advance is structured specifically for government contractors, and it’s of a size that can scale up or down depending on how large their contract is and what their operating cycle looks like.

To give you an example, if a government contractor made one million last year, one million the year before, but this year they’ve been awarded a 50 million contract to supply toilet paper or supply airplanes. We can cut out the toilet paper part because I don’t want to be on the record saying toilet paper.

But let’s say that they supply, although some of our contractors do actually supply toilet paper, they do maintenance work and other types of services for various agencies and naval bases. Anyway, let’s say that they’re purchasing airplanes. So what we might do is we might say, oh, you just got a purchase order from the U.

S. government to deliver an airplane on Monday, two weeks from now. You made a million dollars last year, so your bank line is roughly 100, 000 in size. But as soon as you deliver this airplane, you’re gonna get paid a lot more than a hundred thousand dollars. So we’ll advance you some percentage against that purchase order so that you can buy the airplane.

And that’s the difference between what we do and what a bank line does. A bank line is a blanket underwriting and then a blanket amount, whereas ours is specifically underwritten for the contract that they have. Yeah, 

Ben Fraser: That makes sense. So how does the technology help you generate? Alpha returns in that market.

Just finding the Companies that have the best contracts or certain types of contracts or just if they’re, the fact that the banks won’t lend purely on the asset or the collateral of the receivable that gives you just the structural advantage in the 

Eva Shang: marketplace. That’s a great question. And this is something that I think a lot of people don’t understand about our technology is that what we look for in different asset classes is different depending on what the investment mandate is.

So on litigation, for instance, you really don’t want to invest in the average litigation case because it’s not very good. But I would love to lend against any government receivable for the most part, like Boeing is the largest government contractor. If Boeing would be willing to take a credit line from me, then I would love to give Boeing a credit line, but Boeing does not need a credit line from me.

And the only type of company that specifically needs a credit line for against their government contract, where their bank line won’t suffice, and don’t get me wrong, the bank line is always going to come in at lower rates, it could be prime plus zero, right? We just can’t do that. But what we can do is we can help those companies that are at an inflection point in their business, where they made a million, two million, three million last year, but they’re going to make 10 million next year.

And that’s really where this line becomes incredibly valuable. So that’s what our tech looks for. We look for it. The size of the contracts they’ve gotten in the past and the size of the contracts they’ve recently been awarded. And we identified that need. 

Jim Maffuccio: What kind of, if you don’t mind me asking, if you can’t answer, that’s fine.

But, so you say, compared to bank debt, the cost of funds to the borrower is double what they pay a banker in our world, in our real estate syndication world, the preferred equity or mezzanine debt piece. It’s super expensive, a lot more expensive than the institutional bank money that’s in first position.

So I imagine there’s a pretty good premium. Keep the doors open, but can you speak 

Eva Shang: to that at all? Of our various strategies, we run All three strategies as uncorrelated strategies, but there is a range in terms of the net returns to investors that corresponds to the risk and liquidity.

So at the high end, you have litigation finance, which is an equity like investment, right? You’re taking equity in the case itself and you have the risk of loss of principle. So litigation targets have historically achieved 20 percent plus net IRRs. So in line with private equity and a little bit shorter than private equity durations.

In the middle, you have DIP, which is essentially a real asset backed bridge loan. And that target returns in the mid teens. And then finally, you have government receivables, which is a very short term, usually the average disbursement is outstanding for 84 days. And these are revolving credit facilities.

You’re targeting 10 to 12%. So that’s really the difference between these three strategies. And of course, the average is only one part of the story. We have. Loans that are higher priced and loans that are lower priced, but that’s what we tell investors our targets are. 

Jim Maffuccio: Very cool. And that sounds pretty reasonable to me if you’re out on that inflection type growth and you’re going, the example that you gave was like.

10 or 12 percent money for us to be able to actually serve the contract and keep growing and moving on. That’s pretty, that’s reasonable, I think, what do I know about? 

Ben Fraser: Yeah they don’t really have any other option at that point, right? It’s either get the contract and have life changing money or don’t.

So they’re probably willing to accept a much higher salary. Eva, this has been a really great conversation. Thanks so much for sharing with us all the things you guys are doing. It’s really fascinating. So for listeners that are curious, want to learn more about what Legalist is doing, what’s the best way for them to reach out and get into your ecosystem mailing list, if you have any kind of.

EBooks are things that people can download to learn more. 

Eva Shang: Yeah. So our website is legalist. com and we have a contact form on our website and our investor relations team reads and follows up with every single investor inquiry we get. 

Ben Fraser: All right. Awesome. Thanks so much for coming on. It was really a great time.

Eva Shang: All right. Thank you.


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