Investing in Litigation Finance with Your IRA

Welcome everyone to the Directed IRA Podcast. This is Matt Sorensen, and I am lucky to be joined in an episode in studio with Chris Kohlberg from Privati Capital. We're gonna be talking about litigation finance. This is an interesting asset class. Um, I've got to know Chris through Alex and the people at Privati, and I've been super interested in what they've been doing and the success that they've had with their fund. So I figured we'd have him on today to talk about an asset class I bet you have not heard about, and that is litigation finance. So Chris, welcome to the podcast and thanks for coming in studio.

Thank you, Matt. Pleased to be here.

All right, well, let's dig into it. Obviously, we have a lot of people who use their IRAs, people who invest in alternative assets, they're familiar with The different, you know, classes— private credit, private equity, real estate, oil and gas— but I'll bet they are not as familiar with litigation finance.

Certainly. I mean, it's, it's something that is growing. Certainly it's becoming its own asset class in its own right, but it is growing. It's a growing asset class, and it's not the obvious choice, even though as an attorney you understand that the legal vertical in this country is a $400 billion-plus revenue Yeah. So, it's one of the largest in the United States.

Yeah. So, what is litigation finance? I mean, it's a big business. Obviously, everybody knows lawyers. There's all the TV shows about it. I'm going to bring up the movie A Civil Action as we're talking about today, one of my top 10 favorite movies of all time, which does have litigation finance in it.

Certainly.

If you're familiar with the movie.

Certainly.

You guys, anybody familiar with it? Okay. All right. So, let's dig into it. What is the income opportunity there? Like, what— how is litigation finance this revenue opportunity? Let's keep it simple here.

Certainly.

Like what the loans are and how this is working.

Absolutely. What I'll do is, for the benefit of the— of your viewers, I'd like to maybe just sort of start off, talk a little bit about the big picture, what litigation finance is, and then sort of bring it forward. When you say to someone who maybe is perhaps familiar with litigation finance, automatically their mind goes to, well, I understand that it's when a Litigation funder funds a case, the expenses for a case, and then that case can be carried forward, right? Because usually attorneys will look at this and really it's because of the length of the case it takes. It's their design to make sure the case goes through because attorneys may not get a fee on the case for a couple of years.

Yeah.

Because of the time it takes for this. That's traditional litigation finance, non-recourse. Fairly long, can be 7 to 10 years. It's got a binary component to it, meaning that you either win or you lose.

Mm-hmm.

That's litigation finance. Law firm portfolio finance, on the other hand, is where the lender will take a look at the entirety of that law firm. They will take a look at the entirety of the law firm and lend money to the law firm based on a number of qualitative measures, That really takes a look at and then has recourse on the entirety of that law firm's cases and their receivable and perhaps even their future cases. So those are 2 very different things, and there's recourse within this. So that's the landscape as it exists right now.

Okay. So it could be individual cases here that there's financing for, and there is— or it's a portfolio of that firm's, you know, 100 cases that they might have, 1,000, whatever this could be. case is.

Yeah.

Um, uh, what is it— why does that business opportunity exist though? Like, are the banks lending in this space to these lawyers and law firms? That— where did that opportunity come? Because—

Yeah, and that's interesting. That's a great question. Post-'08, really the global financial crisis, is really where litigation finance, in terms of what we do, really came to the fore. Because prior to that, banks were, were, were able to lend in the space, but Basel IV's banking regulation that prevents banks from utilizing collateral for the law firm and recognizing the cases as the collateral to lend to the law firm.

So, it's like an unsecured loan for them.

Correct.

They can't consider it secured.

Correct. So, that's why we exist because we have the specialty, that knowledge base in order to assess those cases, provide a value, understand in terms of what you're lending against, what you're pledging and lending to for the firm. And it's a variety of different things, not just are the cases, is that the specialty of it? There's much more there.

Yeah, I mean, you hear Jamie Dimon complaining about how their hands are always tied in all these financing situations. It's got to be the exact same for litigation finances. Like, the bank just gets— they get penalized really in how they're regulated is when they lend in these areas. Even though they might view it as secured and a secured asset, it's, uh, I didn't realize that for litigation finance, you're in that same classification.

Mm-hmm.

Um, okay, so, so there's a lot of this non-bank lending here, I guess we could say, in that space. Um, but the yields have got to be attractive, right? I mean, what's the, the yield opportunity when you're out lending, um, to these law firms? I mean, this is what's creating the income opportunity for investors on the back end, right?

That's correct. I mean, the income opportunity on the law firm portfolio finance can vary, but the stated industry sort of, the industry norm can be anywhere from 16% to 24% compounded annually.

Wow.

Yes, yes. And that's an important consideration because when you think, when you're lending to a law firm and you're thinking, wow, that's 16% to 24%, hmm, that's interesting, you have to also ask yourself, You're smoothing out the income for the law firm at that rate, and the law firm can repay that. It's just a matter of smoothing out that income stream. Those law firms must be doing fairly well. And yes, it's not a sign of the firm is weak that they need the cash flow. It's just an imbalance between when the cases are heard and then when that fee is collected by the attorney. And that's what we do. That's what we're solving for the law firm. But it seems to be something which is growing. In fact, I believe it's growing. It's projected to get to about— it's currently right now about $30 billion in size and projected to get in the next 10 years to about $50 billion in size. So, the demand is really there. Yeah.

Let's look at some of that demand. I want to talk about the market right now. I can already hear some people that are like, wait, if I invest in this fund, is this fund You know, are they lending money to the guy on the billboard driving down the street and he's going to— they're funding that plaintiff's lawyer that I don't like? You know, I mean, that's the question. I'm just going to leave it at that. What's the answer to that?

Well, I think it's twofold, really. I mean, when we're taking a look at firms, I mean, traditionally what we're looking at is we're looking at firms for the Law Firm Portfolio Finance. They happen to be some of those people that we're talking to, right? That we're lending to that you see on the billboard or the side of the bus or the Yeah. Absolutely, 100%. And by nature of the way those firms operate and the fact I said there's a delay in collecting the fee, that's where this is necessary for them to have. Yeah.

I mean, that is the opportunity for the investor too, because that plaintiff in that case, that person that's been injured, right? They're not going to pay a fee upfront.

No, it's contingency.

It's all contingency success fee type work. Well, these lawyers take on these cases and we've all seen the marketing on this, right? They don't get a fee and there's no fee earned by the lawyer unless the client wins. So, that case has got to go to trial. They've got to settle the case, right? And so, the nature of that, the way the industry is built, which is customers aren't willing to pay upfront.

Mm-hmm.

Need some revenue, correct, is what's created this income opportunity for this private lending, correct? And so whether you like it or not, I mean, my answer to my own question, which I know some of you are listening thinking this, is that's where the business opportunity is, um, and that's why you get— why you have that type of yield you can get on those types of loans.

Absolutely correct. And, and again, just to step back for a second, we just opened up by talking a little bit about the 2 areas in the litigation finance. We're talking and focusing now on law firm portfolio lending as well as single case. Single case, I mean, by the nature of lending to these types of cases, they can have a venture capital return profile anywhere from 2 to 10x. But the nature of what they do, they're usually complex commercial litigation cases.

Okay.

Right? And we lend into that. And so that is also the element of what the investor would be looking at to evaluate the merit of this investment if it Makes sense.

Yeah, I mean, I see— my guess is like those— the loan amounts need to be enough to make it worth it, whether it is that, that complex commercial litigation that's, that's a big deal type case. They're not settling— those cases are not tens or hundreds of thousands of dollar cases. Those are million dollar cases, right?

Yes.

Or you've got the law firm portfolio which has got the 100 cases, and there might be some million dollar cases, some hundred thousand dollar cases, some thousand dollar cases, but But the lending opportunity needs to be enough to make it worth your while, I presume, where you're going in.

It does. And we've historically— that's a key consideration. It really needs to be enough to make it worthwhile. But you have to understand, too, a lot of these firms that basically take on these accounts, their cases turn on a regular basis. So there's an ongoing need for this.

It's almost like a revolving line almost.

Correct. It's a revolver in a sense. So it's longer-term relationships as the As the firm grows, they grow with you. And you're providing bespoke access to capital because of the nature of what we've been talking about, the contingency element of this.

Yeah. What are you seeing right now? And why are you— because you guys have had— you've grown, and you're also not new to this, right? You guys have experience. You've been doing this for a while. What's happening right now? And what are you guys excited about right now in this industry?

Well, we think a couple of things here that really excite us. But just to give you a little sense— and thanks for that—

a little sense of of our background.

The firm's been around since 2013, Providi Capital. Our founder and CEO, Alex Shoukry, has been in this business since 2003.

Yeah.

So we've really seen a lot from just funding individuals now to, as it states, starting to fund into these mass tort cases to evolve and go into this where we see it now, where it's law firm portfolio finance. The elements that we really get excited about are twofold. It's the growing need for this, the awareness of looking at this as a true alternative, becoming an asset class, I would suggest to you. And then also, as we sort of grow, it's this non-correlation which keeps coming up, right? Doesn't mean it's not without risk.

Yeah.

It just means it's not really correlated to what we see. The Fed says something, they're going to raise or lower interest rates, hopefully lower, but raise interest rates, not affected. Stock market goes up or down. Not affected, right? So, it's that element of non-correlation, which people are sort of looking to round out and complement their other existing alternative investment portfolios.

Yeah. So, walk me through the underwriting process and how you guys are deciding on where to lend the money. I presume you've learned a lot over the years.

100%.

And what does that look like when you're evaluating to make these loans? Because you guys are the ones, your team, I presume there's You know, people with expertise even within your guys' team.

Yes.

That do this. How does that look? Because I think anybody investing in the fund like this, you guys are out sourcing these opportunities, putting the capital to work, and making those decisions on the deals you're funding, the firm portfolios you're funding or not. Like, what are you guys looking for in that? What's the underwriting look like?

Great question. I mean, it really comes down to whether we're looking at just the single-case events or law firm portfolio finance, it really comes down to understanding And within Privati Capital, speaking just internally, we are vertically integrated. So our underwriting's in-house. We have attorneys on staff, paralegals on staff. Our asset management's in-house. Alex Shukri, I said, is very long-dated in terms of his experience in this space. We've done over 8,000 transactions. So we have a very robust dataset to look at.

Yeah.

So some of the characteristics you look at, if you're looking at a law firm, you want to make sure that we particularly at Privati, we don't work with startups. So, you're going to have to have some metrics established. We're going to have at least 3+ attorneys. Typically, 3 to 10 attorneys is a minimum bar we're going to take a look at. The attorney's going to have to have in-house legal or in-house accounting. Excuse me. You're going to have to take a look at the law firm, not just from the firm in terms of what has happened, what are the attorneys doing, what are their core competencies. You're taking a look at them personally in terms of—

Yeah.

what they're doing personally. You want to make sure that how is the cadence settling? How are they at settling these cases, right? Is there concentration risk? It's very important, right?

Yeah.

And how are you managing duration? And then ultimately, what is the actual strength of the underlying business itself? So those are all key considerations that we look at. We get an awful lot of inbound requests. We're very fortunate our time in the market allows us. We get about 200 inbound inquiries a month. So, just from attending a lot of the conferences, being in the legal space for so long, being known. But again, we're very picky in terms of our underwriting. So, we basically would probably fund— of all the inquiries we get, we fund about 1% of those inquiries. But it's growing, it's robust, and you have to be careful. You have to know.

Yeah. So, obviously, the income opportunities there, the kind of yields we talked about earlier, that 16% to 24%, but you want to You're going to minimize that risk on the downside by some good underwriting here. Um, and it seems like those are a lot of principles no matter what the asset class is you're going to do. Um, but sorry, so there is kind of a secured interest though. I know, like, you know, the banks aren't getting credit for it here, but in the sense that there's like a security interest on the case itself and the fee earned on the case.

Correct.

Um, are you— this is just funny— I— A Civil Action is one of my favorite movies. I, I even just reread the book Just recently. John Travolta stars in it. And there is actually a litigation financier in it. I think they call him the banker in the show. I don't know the real story of it. This is the movie, of course. But it's based on a true story. But he had the lien, he had the mortgages on the houses of the lawyers. They had personal lines of— they had personal guarantees. How far do you guys go on that? Do you stick it, keep it at the business level, or do you go— just curious.

Well, no, that's a good question. I mean, what we do at Privati is we're very careful about this, right? Over the entirety of Privati, we've been doing this. We're actually just launching our 7th fund as we speak. With all of this, all the underwriting, everything we're talking about, all are being careful. We're sub-2% loss capital over that time. So, what we do in terms to get recourse is we're going to have a first lien position on all of the receivables and cases of that firm. We're going to have first lien position on all future cases of that firm. And we're going to have, in a lot of cases, personal guarantees of the partners. So, we're very, very careful about underwriting. And I said, wanting to make sure you lend money, but you get your money back. Yeah.

How does the fund look? So, that's what the fund's out doing. I mean, what fund are you in? You've had multiple funds in the space? Yes, we have.

This is our 7th fund. So, we're currently offering our 7th fund.

All right. And what's the amount you're trying to raise in that? And just curious, like the investor opportunity for that. I kind of want to dig in specifically to the fund.

Yeah, absolutely. Well, currently right now, we're looking to raise $250 to $350 million with a hard cap at $400 million. And really, this is what we're looking to do. And it's a 5-year structure. So, a drawdown structure product. So, the The first 2 years were capital raise, right? We're raising capital for the fund. And then there's a recycling period in the 3rd year, and then the harvest begins in the 4th and 5th year. So, that's really what it looks. For clients, what an expectation would be for an investment like this, given the elements of what we talked about, it's a low-midteen return profile, right?

Mm-hmm.

So, anywhere low-midteen return profile, uncorrelated to these other asset classes, very stout A strong underwriting cadence, understanding the 8,000 transactions that we have, our time in market, really understanding what's out there in the space and being able then to grow with the space as well. Yeah, that's really what we're doing.

Is that return profile, is that kind of based on what you've had in prior funds and kind of the projections that you've made?

Yeah.

Like, I guess the rates you can charge, being 16 to 24, that could be a big difference on what you're getting there, I guess. Like, how is that? Like, is this track record-based? Like, what is the— on how you get to that? Because it's a great return, right?

Yeah. I mean, the track record-based, if you look at us, we had a third-party due diligence report done on the firm at large, and they took a look and unpacked really all of this. If you took a look at all of the vintages that we've offered, right, we're a little over 13% net IRR.

Okay.

And a multiple on invested capital since—

That's track record performance.

Yes, that's track record performance. Now, the statistical information that people look at is what is the multiple on what I made? Like, what's the multiple on the invested capital? With us, it's 1.51. So if you rank that in terms of characteristics, it's a very strong private credit offering right now. Very strong in terms of the asset-backed lending space as well. But I would touch upon it. This is not without the risks. And I hope we could touch upon a little bit of what the investor needs to be aware of, what can go up or down within this space.

Yeah.

First of all, if you take a look at what they're doing, they're hearing cases, you're funding these matters, making sure these cases go through. Anything that would interrupt the calendar of the court would be an impact. And we experienced that. COVID.

Yeah, COVID.

COVID really impacted this in terms of, in terms of extension of these cases. So COVID stopped these for about 2 years.

Yeah, nobody could go to trial. I mean, I think in a lot of those cases, that's your ultimate tool of negotiation is a trial date. And if you couldn't get a trial date, you're cooked.

You're cooked. So, what that does to a fund is that creates what's known as an extension risk, right? And we've had that and we've experienced that. So, we know what that looks and feels like. So, instead of getting a 13%, you can go down to get a 10%, 11% just due to the fact of the time.

Yep.

Another aspect that you'd want to take a look at, and we've had this experience, is we've financed over 250 We've worked with over 250 law firms in our history. And we've had very good experience. In fact, a lot of these law firms, we've seen them grow. They're repeat clients of ours, very good, strong. We look at and view them as partners. Time to time, you may get an attorney who is less than wanting to pay you back. It's never really a question of ability to pay, it's willingness to pay.

Mm-hmm.

And in all of these cases, we've had to deal with this only 4 times.

Yeah.

But it's consuming. It takes a lot of your time. So, we are very prepared when that happens. We simply don't write it off. We go after and put those recuperation methods, litigation— I like that.

Recuperation methods.

Yeah. Right, right. To make sure the investors, to make sure we're getting paid back. And so, when I say loss to capital, it's not permanent loss of capital. It's just basically renegotiating out when that attorney— and we've taken these few attorneys, we've taken them to task. And had our cases and sued them, right? And we haven't lost a case.

Yeah. Let's go through what this does look like to invest. You hit on some of the risk factors there, the court system, anything that kind of disrupts that and delays that can cause it will eat into your returns. Nobody bats 1,000. You're going to have some of the lawyers that go bad. This is just like the Multifamily deal with the tenants you got to evict, right? It's a numbers game. You got— you have more winners than losers and your numbers still work out well. Um, anything else on the risk side? I kind of want to get to some of the documents here and what it looks like, but that you'd want to highlight.

Yeah, I think you also have to be cognizant of regulatory risk, right? There are a few states out there right now that maybe have some regulatory issues around the nature of litigation finance, or broadly speaking, and then you need to be able to adapt to what the regulatory environment looks like. We're not simply looking just within Arizona or the Southwest. We have a national footprint, right? So we're able to adapt to whatever regulatory situation comes up. We have that ability. So that's another thing I think investors need to be looking at.

Okay, cool. All right, let's dig into what this looks like. I mean, what are the fund minimums and what's that doc, that process when someone's like, I want to learn more about litigation finance. This sounds like an interesting asset class. My guess is most people would be new to it. I mean, there are other funds out there, but what's that process look to get educated on this? And also, what does that document and investment process look like for new investors?

Certainly. Well, we have— when people engage us, they really want to get educated. They want to come in. And that's sort of the first engagement. We talk to them. I typically talk to them. We have a couple of other folks on our team. We basically educate them in terms of what they're trying to accomplish, talk a little bit about the space, educate them, talk about what we do. And then engage them. If they want to look further at that, then basically we would have them sign an NDA and then we'd open up our data room to that. And then really have— we have a lot of detailed information, summaries and the DDQs you might expect for investors to have. We really have a very robust data room that we put together for investors so we can get them comfortable in terms of having enough information where they can really— are in a situation where they can make a decision now. In terms of the fund minimums and how that works, currently right now, we have a $1 million minimum. However, we have GP discretion on that. So, people can come in with what we do at about $250,000. And then, we also have that ability in terms of executing in terms of a lot of what we can through DocuSign. And certainly, we want to encourage folks to utilize your services as well in terms of where people come into us to get to know us. Yeah.

Yeah. So, and I think our, as many of you know, with your self-directed IRA, if you know, this needs some, a lot of directed IRA resources or through my channel is, you know, our role is just to process transactions. Your job is to find the investments, conduct your own due diligence, of course. We don't endorse any investments or like, you know, we're not giving you, telling you what to invest in or what not to, but we want to give a lot of education about what you can do. And that's why I want to have Chris in here. and Pravati talk about this because it's an interesting asset class. I think a lot of people talk about the riches are in the niches, and sometimes you find these opportunities that are super interesting and compelling, and they can be great income opportunities. And as I talked to Alex and we met, I was like, man, I know you guys typically raise from institutional investors.

Yes.

Or it's million-dollar checks, but what about the individual that wants to get their head around this, They need to be accredited.

Correct.

But they don't have to be a qualified purchaser.

Well, we accept both. Actually, you can be accredited.

Okay. So, if you're at least accredited, qualified, you have to have $5 million of investable assets, but accredited, it is $200,000 net worth, or sorry, $200,000 annual income single, $300,000 married, or $1 million net worth, not excluding your home, either one. A lot of people fall into that, of course, nowadays. So, but they could be, eligible to invest in this, and the minimum discretion, you guys go down to $250,000.

Correct.

For certain individuals.

Certainly. Yeah, we have that discretion in terms of what we see fit in terms of our minimums.

Okay. All right. Where can people learn more? Is there a site or anywhere I should send them to just learn more about you or where they can reach out to contact you guys?

Certainly. You can reach out to me directly, chris@privaticapital.com. You can visit our website, privaticapital.com. Uh, you certainly could reach out to me directly if you'd like. I can give my phone number if you'd like.

Yeah, do it. Like, I like it old school. We'll put this all in the description below, but just for anybody listening on the podcast driving down the side of the road, you know, just know it's down in the description.

Certainly.

Throw the number out though.

You can reach me, 623-521-7343.

Does that ring directly to you, Chris?

It goes directly to me.

I love it. Okay. Wow. You guys, you got the direct number. I like it. Um, well, thanks so much for coming in to talk about litigation finance today and what you guys are up to at Pravati. We'll have the slides. We did actually have some slides we were referencing through here. They'll be in the descriptions below, as well as some links, emails, and direct phone numbers for Chris and Parvati where you can reach out to learn more about them. And remember, our Alt Asset Summit is coming up October 22nd and 23rd. That'll be in Costa Mesa, California. Please get signed up for that. We'd love to see you there. There's always a few hundred attendees there, a few hundred on the livestream. We're going to have 2 days of learning about alternative assets. So get to altassetsummit.com. We'd love to see you guys there as well. And make sure you are subscribed to the newsletter so you get updates on this. You know what's going on at Directed IRA. You can get that at directedira.com. We will see you next time. Until then, stay calm, self-direct on.