A secondary deal occurs when an original, or primary, investor sells its interest in an investment to a separate investor. Though these transactions are commonly used by private equity funds to monetize assets and pay investors when it’s time to close a fund, they are fairly rare in litigation investments, with a few exceptions. Gerchen Capital, a new venture, has raised $750 million to change that.
At the helm of this new fund are Adam Gerchen and Ashley Keller, who both ran a legal investment and advisory firm that raised more than $1 billion in closed-end funds. The pair sold their firm to a large litigation funder for roughly $160 million in 2016 and went on to establish a plaintiff law firm that championed a mass arbitration strategy that used large employers’ own individual arbitration clauses against them. Now, they’ve spent more than $225 so far on acquiring portions of high performing lawsuits and settlements from other funders.
Skeptics may think that primary funders will only give up claims they don’t expect to pay out, that valuations and motivations among competitors are suspect, and that selling to secondary funds means losing value for investors who want high returns from an asset class that is still proving itself.
But the new fund views a secondary market as creating risk management opportunities for primary funders as litigation finance matures as an industry. Primary funders can sell off litigation risks that have gone through a portion of the litigation cycle, perhaps adding value, but which no longer meet their needs. Investors keen to put their capital into a new fund or strategy may grow frustrated with the duration of a litigation finance portfolio and wish to liquidate remaining cases. Managers may seek to dilute funds that are saturated with a particular kind of risk or quickly produce returns to investors at a rate that is greater than their original cost or equal to their internal assessment of the case’s current market value.
Gerchen Capital believes it can garner returns comparable to those of initial investors in new claims but in less time. By investing the cases that have progressed past some potential negative outcomes, their loss ratio should decrease. The fund has mostly focused on portfolios of cases, which gives funders liquidity and a third-party valuation that allows them to indicate a higher carrying cost for the investment.
Time will tell whether secondary transactions will become as commonplace in legal finance as they have in other areas. But it can’t hurt to have experienced litigators and funders leading the charge.
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