Venture Capital & Litigation Finance

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This article is part of a series from Lake Whillans Litigation Finance devoted to addressing common questions that arise in connection with commercial litigation finance. This week, we will be discussing the potential role for litigation finance in venture capital. We hope you’ll find this article to be the beginning of an informative dialogue.

Venture capitalists invest in early stage growth companies, typically in high technology industries, such as biotechnology, energy, or IT. While many of these investments go on to become Tesla, Amazon, or the next life-saving pharmaceutical, about 65% of venture financings return 0-1x. Many of these investments fail simply by virtue of the high-risk nature of venture capital: the product never garners adoption, or a competitor develops more rapidly. These are anticipated risks, and top venture capitalists can be valuable in their ability to help their portfolio companies adroitly navigate these pitfalls.

Some of these investments, however, fail because a strategic partner misappropriates a trade secret, or a buyer breaches a contract, or an established player seeks to illegally preclude a start-up’s development. Venture capitalists are not as well equipped to navigate these pitfalls, and when faced with these challenges might not be in a position to devote fresh capital and resources to defend the portfolio company.

A few reasons why:

  • Difficulty assessing the prospect of success: venture investors are often ex-entrepreneurs and/or possess great domain expertise in an area of innovation. Assessing a legal claim is typically not a core specialty and quantifying an investment in a legal claim can be a treacherous endeavor, and outsourcing that task to a litigator may not be an option.
  • Risk/Reward may not align with target investments: as the post linked to above indicates, venture capitalists make the vast majority of their returns from a few portfolio companies that generate outsized (20x or so) returns. While a portfolio company may have a valuable and meritorious claim, realistic damages are often less than what would have been achieved had the company become a dominant player in the relevant market. Therefore, it may not make economic sense for a venture capitalist to reinvest in a company that has a relatively low ceiling for return when compared to their target investment returns.
  • Fund/Investment Size: many venture capital firms raise relatively small funds (on the order of $100M - $200M). It would be difficult for these firms to invest $5+ million in a legal claim without significantly over allocating the fund’s resources.

Litigation funding companies, such as Lake Whillans, can help venture capital portfolio companies that have nowhere else to turn. In these scenarios, litigation financiers can provide financing to both sustain the company’s operations and pursue any legal remedies. Lake Whillans, for example, does not face the same obstacles that venture capitalists do. Our investment team is composed of lawyers whose core expertise is assessing legal claims; our business model accounts for lower returns on a per investment basis than a typical venture capitalist; and 100% of our capital is dedicated to investing in legal claims.

This column is one in a series by Lake Whillans Litigation Finance. To learn more about us, and litigation finance generally, visit us at our website, lakewhillans.com. To ask a specific question, suggest a topic, or simply say hello, drop us a line at inquiry@lakewhillans.com.

Related

Private Equity And Litigation Finance

About a month ago, I discussed the venture capital landscape, and why litigation funders are attractive partners for VCs and VC-backed companies in need of resources to adequately defend their businesses. A similar, but distinct, phenomenon exists in private equity.