Burford Capital: Competitive Landscape

Burford’s sprint upmarket has created holes all over the industry for competitors to fill. Large corporations demand scale from legal finance companies. But this does not mean that all of the latter require scale to operate profitably. In fact, the bottom end of the market is getting increasingly fragmented.

How does the competitive landscape look like? Could these legal finance firms cause trouble to Burford as they scale? What are some examples of other public legal finance firms? Is there competition for Burford at the high end?

Bottom End of the Market and Different Approaches

Lawsuit-related expenses, mostly consistent of legal fees, range from the tens of thousands of dollars to the tens of millions. Burford’s strategy has revolved around rapidly attaining a spot at the high-end of the industry, servicing big corporations and law firms, both of whom offer Burford the possibility of investing in portfolios of legal claims. Additionally, corporate relationships give room for monetization of claims. These two elements have been vital in allowing Burford to deploy more and more capital.

However, this caused management to skip multiple tiers of the market, leaving unattended demand. There are still SMBs who need capital, though in lower quantities, to pursue legal claims. There are still individuals who are in a similar situation, but lack the funding. Demand such as this has created room for multiple legal finance players. Tribeca, for instance, provides funding up to a million dollars for individuals. To this point, it is crucial to understand that both consumer and commercial legal finance are almost entirely different enterprises.

“Commercial legal finance as practiced by Burford and consumer litigation funding are as distinct as investment banking is from payday lending. The former comprises multimillion-dollar nonrecourse investments with law firms and corporations represented by world-class counsel, and the latter comprises cash provisions to individuals in economic distress who may not be experienced in or savvy about negotiating legal transactions”

Although there are similarities and some common patterns might arise between cases, they are idiosyncratic. The region wherein they originate matters. Legal systems vary. Burford notes in their annual reports that other firms might follow a completely customized approach to doing deals, which results in clients benefiting from more competitive terms. Local dominance can occur within regions, as legal finance firms gain brand recognition and some scale within it.

Similarly, the nature of lawsuits differs among different industries. Different knowledge is required. Hence, legal finance firms can leverage their experience and take an approach that is claim or industry-specific.

Legal finance companies have different sources of capital. On the one hand, firms can allocate capital from its balance sheet, as Burford historically did. But they can also be asset managers. Raise capital via private funds, deploy it, and charge management/performance fees, such as Omni Bridgeway. A mix of both is the approach Burford now takes.

As a reference, some of the players I found are: (i) Nera Capital operates in England and has invested over £125m since inception; (ii) Therium, funded in 2009, has raised 1.1bn to date through 18 private funds; (iii) LexShares was founded in 2014 and has deployed over $100M at an average deal size of around 1-3M; (iv) Longford Capital, which has AUM that exceed $1.2bn and has recently raised a $682M fund.

Finally, there is a public company that caught my eye. Briefly expanding on their operations will give a sense of how smaller players are positioned and provide some color on Burford’s business.

Litigation Capital Management

Litigation Capital Management is an Australian company that was founded in 1998. Patrick Moloney served as director from 2003 until he became CEO in late 2013. Importantly, the first fund was established in 2009. LCM reported assets under management of A$484M in October of 2023. The company operates in London and the APAC region, and has delivered an accumulated, 12-year, 78% IRR.

LCM follows the same business model as Burford. It invests its balance sheet and manages private funds. All investments that seem profitable are offered to both of these. As a general rule, 75% of the invested capital is provided by the funds, and the remaining 25%, by the balance sheet.

Litigation Capital Management has seen the number of applications rapidly rise as they scaled, in financial and branding terms. Their conversion rate has averaged 3-4% over the past couple of years. Management expects this to increase over time, as investment managers learn more and more about certain industries. Moreover, presence in specific claims tends to attract parties of similar characteristics to the funded one.

The team mentions that a higher conversion rate can be achieved without compromising the quality of investments. This is an important detail, as we find Burford having a 4-8% conversion rate on 1000-1500 annual applications.

Historically, the investments LCM has made took an average of 28 months from capital deployment to realization. Management expects duration to increase to around 36-42 months as the company scales. “The practical reality is that people fight longer and harder over larger amounts”. This is something we are starting to observe with Burford as well.

Litigation Capital Management represents exactly the type of company Burford describes as able to out-compete them in terms offered. The company defines its arrangements as completely “bespoke and tailored to meet the specific needs of the funded party.” This is a feature that can make some legal finance firms stand out from their peers and larger firms, who might not find worthwhile to match the smaller player’s terms. I’m inclined to suspect this occurs at all scales.

Barriers to Entry

Significant capital is required, at whichever scale, for achieving proper portfolio diversification. Legal claims have a binary outcome. The plaintiff either wins or loses. Assuming the case will settle is too risky. If the investing firm does not manage risk accordingly, it can rapidly go out of business, which in turn makes the accessing capital much more difficult. Investors realize these are risky investments and are therefore not willing to provide funding lightly. Burford occasionally stated that $100M might be a minimum for operating in the low-end of the industry, but a larger sum of capital would be considerably more desirable. The high-end of the industry demands even more capacity for capital deployment.

“During the past year, we have seen some compression in the market as smaller operators have failed due to the tightened availability of credit.” LCM 2023 AR

The second variable that prevents competition is the relevance corporations and law firms give to branding. In a similar fashion as it works in investment banking and consulting, relationships matter. Firms that solicit litigation funding for the first time will look for financiers with a legitimate track record. On top of this, relationships have already been established. Law firms and corporations can function as originators. Both will approach the legal finance firm with which they have already worked. That’s what causes 70% of the Burford’s clients to come back to them for more business.

Legal finance works at the intersection of investing and law. Only peculiar characters excel at both areas, fairly limiting the number of potentially successful operators. For proper due diligence and the underwriting process to function correctly, more of these people need to be hired. A lack of judgment from the investment perspective in applications reviewers might cause large bottlenecks. In addition, headcount is a requirement for being competitive in claims worth several millions of dollars. As legal finance firms scale AUM, their headcount needs to increase, unlike private equity. Assembling this team, in parallel to raising capital and convincing investors, is a challenging endeavor.

Finally, legal assets are something that still portray novelty to the general market. In consequence, there is no secondary market for claims. Even if the public was fully aware of legal assets legitimacy, details about specific claims are confidential. The buyer needs to either find information on their own or trust the seller. Some liquidity might emerge as Burford scales, gets better known and gains reputation, but this is a market with no liquidity nor capacity to mark investments to market.

Burford’s Positioning

Management efforts to rapidly push the company upmarket should pay off. I cannot think of any way in which one could disrupt a capital allocation business model. The barrier for capital and relationships will always be there. Unlike investing in businesses, investing in a team that deploys capital in legal finance is much more uncertain. A specific skillset is required, the outcome is binary, and legal finance firms cannot disclose information about the assets they invest in.

“But in terms of where we sit at the high dollar commercial end of the market, there hasn't really been a dramatic change in the competitive landscape.” FY 2021 Transcript

Raising billions of dollars is what allowed Burford to start doing deals with large corporations. The prestige this grants to Burford’s brand is not to be overlooked. These large clients will return to Burford in the future. Lawsuits are recurrent. As companies work through litigations, more lawsuits are filed against them. Further, the visibility Burford has gained in the recent past should allow them to capture new business.

Being at this spot exposes Burford to the largest number of litigations through portfolios of claims. The proprietary dataset the company has built is unmatched in the industry and should continue to provide them with a competitive advantage. Having data about the outcome of multiple litigations, information only known to them, facilitates risk assessment and, in turn, pricing.

Finally, I came across the hypothesis that capital will tend towards commoditization in small cases. A significant variable that goes into corporations decision-making process is how much value can the funder add to their legal process. Larger stakes tilt clients towards partnering rather than simply receiving capital. Consequently, pure-play legal finance firms should dominate. In small cases, it is likely for supply, from legal finance firms, to increase indefinitely. At the same time, the economics for funding small cases might not allow for legally assisting the plaintiff. The payout might not support incurring expenses on headcount. This is something I don’t expect to happen at the high-end of the industry, providing Burford with the appearance of having the most durable returns on the industry.

“And in terms of the question about the competitive dynamics in smaller versus larger, we have found that when there have been new entrants over the years, and I have not really noticed an influx recently, they have started at the smaller end of the market, and they have not been institutions of Burford’s caliber and have had a harder time providing a full service solution to the large companies and leading law firms that are our lifeblood. On the other hand, the people who would target larger outlays, a hedge fund model, are more likely to be looking at lower risk, lower return portfolios. Equity investors generally do not have the risk orientation we do where we are willing to take binary risk because we put it in a portfolio to mitigate that risk and we generate higher returns as a result. It is just not necessarily the mindset of somebody who comes at it from the hedge fund side where they are looking for a more muted risk.” HY 2022 Earnings Call Transcript, August 2022

Competition Potentially Emerging at the High End

Fortress Investment Group, a private equity firm, acquired Vannin Capital in 2019, a London legal finance firm. A year later, the PE created its own legal finance funds, and integrated Vannin to operate under it in 2021. In October of last year, Fortress announced it was planning to raise a new fund for litigation finance.

“Since forming its litigation funding arm in 2013, Fortress deployed more than $4 billion into a “diverse pool” of legal assets globally. It currently has 20 employees on a dedicated team” Article

Fortress has not made much commentary on their operations nor on the returns they’ve had. This definitely raises several questions, all of which will be answered with time. Fortress Investment Group will act as a perfect example in the near term to observe how the dynamics will play out in the high-end of the industry. Although Burford claims capital is not a commodity here, only competition flooding the space is what will prove them right or wrong.

“We are in no way complacent about competition. But this isn’t a business where someone can show up with a checkbook and buy their way into the market simply by offering slightly lower pricing. Clients come to Burford— and keep coming back to us—because we add value” 2021 AR

Personal Commentary

I hope you found the article useful. The one will be on pricing and returns, how durable they are and what might be expected moving forward. The following one will be on the company’s portfolio and relevant metrics. Perhaps after that one, I’ll turn to a new business.

If you want to, I can alternate between Burford and other companies. The other two I’ll be covering in the near future are Winmark and Construction Partners. Bakkafrost and Topicus, unfortunately, are indefinitely postponed.