Getting Started with Litigation Finance and Other Alternative Investments

Everybody is familiar with traditional asset classes, such as stocks and bonds, but not everyone is as familiar with alternative and specialty investments, such as litigation financing and real estate. We asked the co-founders of YieldStreet, Milind Mehere and Michael Weisz, to take us through the basics.

This interview with Milind Mehere and Michael Weisz has been condensed for clarity. Have something to contribute? Email us at media[at]valuepenguin.com. We also talked with Milind and Michael about how their company is opening up alternative investments to everyday investors—see that interview here.

How would you explain litigation finance to someone who isn’t familiar with it?

Michael: There are various types of litigation finance products that we offer at YieldStreet. I’ll give you the three top ones.

The first product is called pre-settlement financing. The finance company makes an advance to an individual who sustains a personal or physical injury and has a pending lawsuit. As an example, one of the lawsuits that we funded was in New York. A few years back, there were three teenaged troublemakers who took a shopping cart and threw it off the fourth floor of a Target in Harlem. It hit a woman who was buying candy, going to a local charity in Harlem. She fell into a coma. She was the breadwinner for her family and was obviously no longer able to work. The family needed emergency funds so they weren’t thrown out of their home and they could pay for their children’s school and their life needs. The company helped provide some of that financing to that individual. We typically take such individual cases and create a portfolio of cases between 50-300 cases and offer it on the YieldStreet platform.

The second is loans to law firms. Contingency law firms, as most people know, work for free until the case is settled. It requires them to make significant investments and hold the costs and expenses until the case is settled. We help provide financing to those firms as they’re bringing cases on behalf of individuals to fruition.

And the last one?

Michael: There are settled cases that take a long amount of time to pay. For example, the 9/11 first responders—so FDNY, EMTs, etc.—still have not been paid for medical issues that they sustained—cancer and other problems—as a result of 9/11. The U.S. Treasury is the obligor of the settlements. The settlements are supposed to be paid between 2015 and 2017. Even though you know how much money an individual is getting, it can take additional time to get that money. So we help to provide settled case financing to those individuals during that time. When we look at litigation finance, it’s a business that’s been around a long time and has an excellent track record for over 15 years.

Do law firms or lawyers themselves participate in any of this financing?

Michael: We have lawyers that invest in our platform in these transactions, but it is unethical for a lawyer to lend a client money, because they could potentially have a conflict of interests: should I settle now so I get my money back, or should I wait to get the right settlement for my client? You’ll have lawyers invest in other client’s cases, but lawyers do not invest in their own cases.

What should a new investor be thinking about before investing in alternatives?

Milind: People who are new to alternative lending should focus on understanding the investment. If there were broader shifts in economy, is their capital or principal protected? And how do you protect that capital? You should ensure that the investment is non-correlated to the market and backed by assets or collateral, so if something were to happen, such as broader shifts in the economy, nothing will happen to the underlying asset value thereby preserving your principal and earning yield.

Number two, they should think about duration. Some platforms out there have 36- to 60-month terms. A lot of our investments on YieldStreet are less than 36 months. I think that gives people flexibility as they get periodic liquidity and a rolling portfolio. It also shields them from broader economic shifts that might happen. Three years is still a relatively short term in an investment horizon. Again, some of things that I’m saying are central to what we do at YieldStreet as a part of our investment philosophy.

The last thing is something I learned from the book which is kind of my semi-Bible—the book is called “Richest Man in Babylon”. Let’s say you wanted to invest in real estate, and you’re given two options: invest with a guy who has 10 years of real estate experience or your uncle who is just dabbling in real estate. Who would you choose? And the premise there is that if I were given that choice, I would always choose the guy who is the domain expert. That’s critical criteria that everybody should think about. Invest with active, experienced managers. Your uncle may be very sweet and nice, but he will not know what a person knows after having worked in the investment industry for 10-15 years. I think that is very important for you to ensure that you’re investing with people that know what they’re doing and have seen credit cycles in the business environment.

What are the risks that are unique to these types of asset-backed investments?

Michael: The risk that we take in our business is generally related to duration risk. In the case of a litigation settlement, while we think we have generally a good idea of how long deals will take to pay off, we could be wrong: they could take a little bit longer or shorter. In the real estate bridge loan business, we could make a $5 million loan to a borrower on a property in New York that’s worth $10 million. That’s a great investment, and obviously if anything were to go wrong we’d be able to foreclose and get our money back. Again, the problem that we could experience is relative to timing—if we have to go through the foreclosure process, that takes time.

Is there a rule of thumb for how much of an investor’s portfolio should be allocated to alternative investments?

Michael: It really depends on specifics. What’s your age? What are you already invested in? I’ll give you a couple of quick examples. Say you’re in the real estate investment business, and you have some additional income. I probably wouldn’t recommend you put too much in the real estate, because that’s where you’re already making money. I’d tell you to diversify away from that: maybe look at litigation or receivable finance. That’s one way to look at it.

Another way: let’s say you’re in your mid-50s or 60s and want passive income on a recurring basis. You want to receive monthly checks from something that’s important to you. Then I probably would tell you to look at loans that have a payment schedule on a monthly basis as opposed to companies where it may take a year to get your first payment.

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