Burford Capital: Pioneering Litigation Finance

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Can we step back to the early 2000s, when you started Glenavy? What market opportunity did you see at that time?

Glenavy was, at its inception, a technology and media venture capital investing platform and I had come from Time Warner where I first served as global general counsel but later moved into a pure business role in one of its largest operating businesses in Time Warner Cable. Time Warner Cable is the umbrella provider of broadband services and advanced technology and so that was the era of early adoption and great market excitement around concepts like broadband and voice over IP, which today we take for granted. At Glenavy, we used private capital to build a series of technology-focused investments, mostly in Europe and Asia. It was a classic tech venture capital vehicle.

We did that for a while then added some public capital over time. Litigation finance was a hobby that ran alongside my day job, but there were notable parallels. Burford and litigation finance have several venture capital or private equity like characteristics.

Given your experience running Churchill and the VC-like business, how would you compare venture capital to litigation finance as an asset class?

The methodology has a lot in common. In all of those disciplines, you take a large number of potential investments and potential inputs and do a deep dive diligence on them to, ultimately, get a diversified portfolio of a much smaller pool of investments. That is exactly what Burford does; it looks at between 1,000 and 1,500 investment opportunities every year and choose 4% to 8% of those opportunities. Much of what we and technology venture capital firms do is spend time and energy looking for desirable and compelling high conviction opportunities. Obviously, what we do has a substantively different methodology there are many similarities.

How would you compare the cash flow profile?

That is where there are some interesting differences which make litigation finance particularly attractive. Candidly, that is why I ultimately elected to pivot from technology VC. Although I enjoyed technology VC and it was successful for me, there are several structural characteristics which favor investing in this litigation asset class. There is no realistic exit in technology investing – you have to get to an event – whereas in litigation, you do not need to create an exit or sell a business or take it public. The litigation or adjudicative process provides an automatic exit for us in every investment we make. We literally do nothing at all and can be a buy and hold investor and simply ride out the investment until it comes to a natural end. That end is either a settlement – a resolution agreed by the parties which is the majority of outcomes – or a court or arbitration adjudication which happens in a minority of cases.

That end is also not influenced by the market or broader economy. There is no cyclical dynamic that you have in venture capital and private equity of valuations and when you are going to be able to sell at a desirable level. Here the system simply generates those outcomes for you. The other thing about the litigation system is that while it is not speedy, it is also not slow. You do not see the on average five to nine year hold periods that you see in other kinds of business investing. Our mean time to resolution is between two to three years, and sometimes less in settlements.

The final advantage with litigation finance investing is the underlying dynamic of settlement. Litigation settles more frequently than it goes to adjudication. That is not unique to Burford's portfolio; it is prevalent across the litigation landscape. The reason that it happens is that while parties may use the litigation process to resolve disputes, many parties dislike the risk profile of having their dispute adjudicated by a third party. The reason settlements are significant compared to venture capital is that they remove risk from the equation. 61% of our current investments resolve by settlement, which removes the risk and we are paid in those investments. That foundational layer does not exist in a pure equity investment in a VC or private equity world.

From your reports, cases settle in 1.6 years which is far shorter than the seven to 10 year fund life of a VC or private equity firm?

Exactly and the reason that happens is because the catalyst for settlement is often seeing the progression of the case and coming closer to a trial or an adjudication result. Generally, as a defendant, if you are unsuccessful along the way in getting a case knocked out or doing something tactical to limit its value, you are now exposed to meaningful risk so you negotiate a resolution as opposed to throwing yourself in the hands of a judge or jury. The timing means you will realistically settle most cases before walking into the court room for trial.

It’s common knowledge that VCs have seven out of 10 zeros but the 3 winners have to be huge home runs. How do you compare the return profile of VC or private equity versus litigation finance?

We get to desirable returns in a different way because of the structural dynamic of having three possible outcomes of any piece of litigation; settlement, adjudication winning and adjudication losing. Those three combine to generate the desirable returns that we are showing. The majority of matters which settle produce mid-range returns, therefore we do not have the same desire for as many losses as a VC does in order to enable eye-popping returns. Instead, we have middle of the road cases which fuel the business by providing basic returns, and we have a real asymmetry between wins and losses.

When we lose, we lose the capital we invested for legal fees but when we win, we win a share of the ultimate damages. Nobody rational will spend $20 million in legal fees in an effort to win a $20 million judgment. When we go to trial and win, we have a strong performance; we will make five times our money. But when cases go to trial and lose – which only happens 10% of the time – the losses are much smaller. We combine a much less risky diversified portfolio than venture capital do, to generate comparable unlevered returns.

So private equity is somewhere in the middle?

Yes, because private equity relies significantly on leverage to generate returns. The comparison is slightly less apt. We have elected not to engage with that kind of leverage, simply because of the risk profile of the assets, but our returns are on an unlevered basis and are significantly higher than private equity returns.

What is the maximum leverage Burford could achieve?

It is not something I focus on because our approach to leverage has historically been quite conservative, which has to do with the assets themselves. The cash flow streams from these assets are inherently unpredictable on a period-to-period basis and you do not want to have so much leverage on the business that you worry how you will satisfy your debt obligations. Burford is a significantly employee-owned business. The management and employee population, as a whole, are either the largest or close to the largest shareholder in the business. We are conscious of the fact that the more leverage you pile on top of yourself as an equity holder, the more you risk your own position. We prefer being confident in equity value as opposed to maxing out the debt.

Some describe litigation finance as a book of options where some are zero, some positive and others home runs. Do you look at it similarly, rather more like a linear kind of book of assets which grow?

I do not find the distinction to be particularly useful in practice. At the end of the day, we put capital behind the performance of an underlying case, and whether you call that case an asset, which it is technically as a legal matter, or whether you call it an option, simply a right to receive future payment based on the outcome of something else, you get to the same outcome. Burford diversifies across geography, industry and type of litigation to optimize for cash to flow, whether it flows because you characterize it as an option premium or a return on invested capital.

Is this a more attractive asset class than private equity or venture capital given the shorter duration, three definitive ways to exit and higher odds?

I am biased but made the conscious choice to do this full time instead of continuing with it as a hobby and doing tech VC full time.

I’d like to walk through a typical process of funding a portfolio. Firstly, how does Burford typically think about case origination?

There are two different things going on for corporate clients. The first focuses on the corporate P&L which is how litigation funding got its start. Companies dislike the impact of litigation costs on their P&L; they hit their OPEX line, drive down EBITDA and do not get a market return for the wins. Being able to offload the cost of litigating to somebody else is very desirable as it solves the P&L and budget problems for corporate clients. Historically, the dynamic around simply getting legal fees paid was that corporate clients would say to their law firms, I would like to hire you for this case but I will not pay you the way you would like, so go figure it out.

That put the law firm in the role of needing to solve the client's problem and the law firm had a strong positive incentive to do that as it was the way for them to get hired and paid. That part of the market still flourishes and Burford remains a major player, but is more law firm than client driven because the law firm has the client and is trying to land the financing. It is not exclusively that way because clients come to us directly, but a decent amount of the P&L, fees and expenses funding side of the business comes through law firms. Burford originates business by having significant relationships with over 90% of the world's largest law firms. We also do a variety of ongoing marketing and outreach as well as traditional marketing and business development.

We have a significant brand in the market which causes people to bring matters to us. We have a variety of ways things come in the door and go through our investment process. The other side of the business is the corporate balance sheet and this is where you move from litigation funding to litigation finance, or legal finance as we refer to it today. A CFO or general counsel has a significant piece of litigation with a real future value. They expect the case to win or settle and when it does, a material amount of money will become due, but that currently does nothing for the business. It's not an asset on the balance sheet and investors pay no attention to it.

It's effectively sitting there, an invisible but quite valuable asset, and even when the case succeeds investors will not get particularly excited by it. Companies are increasingly monetizing the current value of that asset in advance. The law firm plays no role in that. The company wants the capital for its own operational purposes and will put that capital on its books. We do most of those deals directly with companies through traditional marketing, business development and outreach and, given our position, companies come to us directly.

Is that balance sheet side typically more attractive deals because you are going direct to the corporate?

No, we underwrite to the same levels regardless of the use of the capital, but they are attractive to us because they tend to be larger transactions. The limitation of the traditional litigation funding business is that it costs a finite amount to bring a case; even in complicated cases you will struggle to spend over a certain level in legal fees. Inherently you can only provide a certain level of financing per deal, whereas our average deal size has continued to increase significantly over time as we do more balance sheet monetization activity.

Is it difficult for smaller private funders to get access to those direct deals?

It is simply a question of size, scale, capital-ability and sophistication. Many firms do a good job on fees and expenses funding on $2 to $4 million deals, but they are not competitive. We do deals above $200 million which is several times the entire capital of some funders.

Is the balance sheet side a unique opportunity for Burford, given their scale?

There are opportunities on both sides of the equation. Despite the fact we have experienced a very desirable level of growth, Burford's portfolio has grown over 50% in five years. That come off a relatively small base of a $500 million portfolio, which today is $4.5 billion. It remains a small portion of the overall universe of legal spending and judgment value. We remain in the relatively early innings of adoption of legal finance as a product by corporations. Both the P&L fees and expenses side or the balance sheet as a monetization side, are continuing opportunities.

What could give a funder an advantage in winning cases on the litigation funding side with the law firms?

This happens in any kind of capital provision financial services market. This is a competitive market with several players, as you would expect and desire. It is unhealthy to have markets containing only a few members. What you have here is the same way you see competition among private equity firms, investment banks or other sophisticated financial services players. Factors for that competition are scale, reliability, reputation, brand, prestige and ease of working. If you went back a decade when Burford was still a nascent business, somebody else could have built an identical Burford-like business alongside us if they had had the necessary inputs to do that.

We were the first to institutionalize this business and capitalize it well. If Blackstone had done it that probably would have been just fine. Having a decade head start gives us several significant advantages as we are the entrenched brand in the industry. We have the relationships which give us business but also an extraordinary amount of proprietary data from being in a confidential business for a long time and having seen thousands of matters. We put that data to use in our investment process which is neither publicly available, nor replicable. Our team and collection of repeatable processes around investing in this asset class are all proprietary. Somebody with deep pockets who wanted to enter today would face a meaningful disadvantage in terms of being able to catch up on those fundamental points.

Is it really just Burford's scale, brand and reputation which gives an advantage to do larger deals?

There is a common misnomer in some capital provision businesses. With investment banking, you choose Goldman or Morgan Stanley for your IPO because there are many elements which go into executing an IPO and successfully creating company stock post-IPO, than simply the day of the deal and the check you get for going public. The same analogy can be made here. Burford have 140 staff and invest globally in every kind of law, which makes them the partner that global law firms and companies go to when they have their own needs. It is unappealing to choose a small player who only do one thing, are more nascent and have less reliable capital behind them. Those are all factors which go beyond simply who writes the check.

With 140 people there is $95 million annual labor cost or OPEX; how does that scale as a percentage of the book Burford manages grows?

It is similar to the way you look at private equity and venture capital. There is a degree of operating leverage built into these kinds of business, whether it be Burford or another capital provision business. That operating leverage comes from increasing average deal size and engaging in repeatable processes or adding deals where the fundamental diligence has been done. We do that regularly where we go into an area, do one case and like it. We become deep experts in that which allows us to easily add on other client's cases in the same area where we are familiar. There is an element of operating leverage in the business and it is not a one-to-one relationship. You would not need to double the labor pool to double the size of the portfolio.

Historically, our OPEX has risen slower than our portfolio size. That being said, operating leverage has a limit in capital provision businesses and every deal you do requires a level of diligence and human capital investment to close that transaction and so as we continue to grow, we grow the team commensurately with those needs. There is a balance to be struck there.

But it seems more of an operating business than the likes of a KKR or LBO fund where you have 10 guys investing in companies. The due diligence work required is different in nature making it less operationally-levered?

No, it is specialist but is no different to KKR or Blackstone, which have grown their head count and OPEX significantly as they continued to grow. An LBO team can only do a certain number of deals at one time and if you want to do more deals, you have to add more people.

How important is it to own the asset recovery business internally?

It is valuable as a meaningful incremental part of what we do. The diligence process in any investment begins with looking at the underlying piece of litigation or arbitration which is a merits-based question. What will happen with the case? Will it win, lose or settle? We try to screen out cases which we think are affirmatively substantively bad. You go onto the case economics of the case worth, its settlement value and the realistic damages number which would be awarded in court if a court were to try the case. That is a heavily financial and economic area which is why we combine lawyers and finance people in this business as opposed to a litigation lawyer picking cases.

Once you have a case you believe will deliver real value, will you get paid? Credit analysis has to be done as to whether the defendant will still be solvent by the time you get to the end of the process and need to collect, or if their assets are located such that we can obtain them. That is where the asset recovery business comes in. Most defendants pay judgments or settlements once they have been reached and simply wire the money or send a check. Others litigate because they are unhappy with the idea of paying money to the opponent, and even after they lose in court, they remain unhappy and take advantage of multi-jurisdictional strategies to try to make it more difficult to collect that money. Some people simply give up.

We do a lot of third-party independent research which shows most corporations have uncollected judgments where they have successfully gone through the process of litigation but do not have the cash, and simply give up because it is hard work. The asset recovery business helps us make sound investment decisions on the front end so that we maximize our ability to collect on judgments once we win them. We have never had a significant judgment where we have been unable to collect. It is also its own line of business because there is significant demand from corporate clients for assistance in collecting their difficult judgments.

Can we walk through the unit economics of a portfolio, starting with the cash flow and the difference between the commitment and deployment schedule. If we have $100 in year zero, what does the cash flow typically look like?

It comes back to the distinction we drew on earlier between funding the fees and expenses side of the business and monetization. To make the math easy, we have 10 cases in this $100 portfolio, each at $10 of expected fees and expenses. We will enter into contractual commitments to pay up to that $10 per case. We will go through the litigation process and pay as the case costs are incurred. Cases run for various lengths; some settle earlier and only use part of our capital allowing us to get a return.

Others go all the way through trial and appeal and use all of our capital, so we will take longer but generally get a higher return at that point. Those are the statistics you have seen in the aggregate; it takes between two to three years on the way to the average basis and we generate IRRs in the high 20s, low 30s and returns on invested capital in the 80s and 90s. That is how that portfolio tends to work and, as with any portfolios, there will be some tail elements to it. It will take several years to extract all the value from a portfolio. The other side of the business, the balance sheet business and monetization of corporate claims, is more a single dollar investment. We tend to invest all the capital at the time of closing the transaction, because the corporate client's incentive is to use our capital to get liquidity in their hands. We make a single payment up front and then that case simply runs through its life cycle and gets to resolution.

What is the mix between balance sheet and funding side in the portfolio?

It is hard to tell because we do several hybrid deals where we fund the fees and expenses and also pay some capital toward costs. If you look at the published split between law firm and corporate originated business, it is currently close to even.

Do you expect that to change much going forward?

As corporate monetizations grow, I expect us to continue to skew in that direction.

Does that make it harder to manage the cash flow?

No, in some ways it makes it easier because with monetization deals you are putting out whatever capital you are using at the time of closing, whereas on fees and expenses deals you need to maintain a reserve of cash for those fees and expenses. That is not a problem because the fees and expenses deals are smaller and the cash outflows are predictable. We know the average time to trial in every location where we have a case. If you come today with a New York case, you will not get that case to trial until 2023 at the earliest. We know the stages and costs of litigation and therefore have a clear sense what our outflow needs will be.

But the balance sheet side may require more capital up front?

Correct.

How do you expect IRRs to change between balance sheet and funding?

We are obviously building a diversified portfolio and price to risk. There is a wide range of individual economic terms inside our portfolio, but our overall goal is returns which are unaffected by deal type or structure.

What is the most challenging part about managing cash flow between commitments, deployments and return of capital?

The most challenging part of the entire business, not only from a capital management perspective but also from an investor management perspective, is that everybody likes the idea of an uncorrelated business. We all found out in the financial crisis that many things which people said were uncorrelated, turned out to be correlated. That is why this business was able to secure the capital it did shortly after the financial crisis, because people realized this was in fact one of those truly completely uncorrelated businesses. That is an enormous investment plus. But what makes it uncorrelated is that cash flows emerge entirely from the timing of judicial decision making, and while it is predictable in the aggregate in the sense I can tell you on average how long cases will take in New York, I cannot tell you how long individual cases will take.

If our case lands with a slow-moving judge or one who has a terrorism trial which will take priority to our civil case, that means you cannot reliably predict on an individual case basis the timing of your cash flows. That can be frustrating for investors because it means we have volatile cash flows in the business. We will have busy periods with many things happening and slow periods where very little happens. We had an enormously active first half of 2020, in terms of generating cash, but a sleepy second half for no reason. That is simply the nature of the business.

How do you manage the uncorrelated nature of the asset class with the ability to leverage your existing knowledge of certain cases when it could lead to a situation such as YPF where 40% of Burford’s book is one case?

On the YPF point it is important to remember what we are measuring. That is true as a paper accounting matter but untrue as a cash matter. The YPF case has already been an enormously net profitable matter for us. We invested less than $30 million in the case and have already received over $200 million in cash proceeds which are ours to keep. Even if the YPF case were to stop today and nothing further was ever to come of it, it would remain one of our most successful investments ever. YPF is currently a free option for us as to future proceeds. The future of YPF is either zero or greater than zero, but there is no circumstance under which it is a negative.

That has accounting implications which I frankly do not worry all that much about because I run the business on a cash basis. More broadly though, it goes back to some of the themes we touched on earlier around the conservative management of the business. We have deliberately not run this like a tech business. We have not said there is a huge opportunity we see and ran at the wall as fast as we possibly could without worrying about making a profit today, and instead getting the largest share of the market and hope that in the future it will turn into profit. We have not done that at all because we are employee owners of this business. We use a conservative leverage structure and insist the business be profitable and only invest moderately in growth instead of explosively. Those are the ways to mitigate the unpredictability of cash flows.

Some investors say Burford is driven by YPF but that is simply from an accounting perspective, whereas on a cash basis it is completely different?

That is exactly right.

There is a weird dynamic where the accounting you have to follow makes it seem like Burford is driven by one asset but it is completely the opposite.

That is right and is no different from private equity. I am invested in many private equity funds and receive statements from private equity firms showing the value of my investment increasing because they mark those investments but have not sold any of them yet. The fact the statement is up is all very good but I am waiting for the cash, which is how I manage Burford.

Burford might get some stick for doing fair value accounting but the private equity funds have been doing that for years.

It is simply how the world works. Imagine a fund manager being told they cannot change the value of their mutual fund portfolio until they sell the stock. That is not how we go about reporting performance.

How could IRR’s change in the next five years as the capital flowing into the industry grows?

The law industry has had many ways of dealing with litigation economics for a while. This is particularly noticeable in the United States where there have been contingency fee lawyers who operate on a no-fee no-win basis since the beginning of time. Those levels of contingency fees in the legal industry have not varied widely and, as a result, you have a world with a benchmark for risk-based asset pricing set not only by litigation finance firms like Burford but also by an enormous volume of contingency fee litigation. The fundamental reason is that these are binary risk assets.

We can and will lose money in several of our investments. Theoretically, we could lose all our capital in every investment, which you simply do not see in most financial assets. Investors quite rightly demand a premium for that level of risk associated with the assets. If you had a choice of investing in Burford's assets or some distressed debt pool with the same returns, you would choose to invest in the distressed debt pool which has some underlying asset value. Investors will continue to require a risk premium on their capital to invest in this asset class, which means managers and investors in this asset class need to continue to produce returns which generate those risk premiums.

There's a widespread understanding in this industry that the better way to compete is by growing market size as opposed to competing for share on price. The market is not static and over $800 billion a year is spent globally on legal fees; more on judgments and awards. That is not all addressable to legal finance, but for Burford to have the largest portfolio by far in the industry at $4.5 billion shows you the gap between where adoption is today and where it might be in future. Entry and competition in this market tends to expand the market size as opposed to being involved in a tussle for share. That state of affairs will persist for quite some time.

Could more commoditized smaller cases in the industry pressure IRRs?

Pricing pressure is not particularly different. In a capital provision business, the ultimate basis for pricing pressure are clients, who always prefer paying less for their capital. When a capital user enters the market to borrow debt, they will push for the lowest price possible. Our clients have always done that but you accept the reality of pricing for the risk. If a client brings us a single high-risk case, we will charge considerably more for the capital than a client who brings us a 10-case portfolio which significantly mitigates the risk. The solution with clients is not to end up in a downward spiraling approach to pricing, but to enlarge the market instead.

Is that why larger more direct cases almost protect the IRR from the smaller end where private capital hedge fund money could simply serve as a source of capital?

I see it as opportunistic as opposed to defensive, but it is dangerous to try to commoditize these cases, and litigation finance is no different to any other specialty finance play. There has been wreckage from non-expert investors dabbling in what they thought was attractive. There are specialist players who made and continue to make good returns and there are those who came in to do one deal because they thought they could master that specialist area, and it typically does not go that well. And I think litigation finance is no different than that. If a hedge fund does a small deal on its own in a side pocket, that takes an enormous amount of risk. The only way to invest in this industry is on a large diversified basis. Other players simply will not last.

If in 2030 we look back and IRRs have declined to 15%, why could that be?

I do not think you will see that with respect to binary risk litigation as that is not an appropriate level of pricing for the risk. We have 50 years of data of contingency fee price levels and lawyers do not take on risk for those kinds of returns. That, I believe, will be the dumb money. What you might see however, is appropriate pricing for risk by market enlargement. I have this conversation regularly with corporate clients and law firms and this is why we end up doing so many of our deals as larger multi-case portfolios. When I was the general counsel at Time Warner, I am not sure I would have found the pricing attractive to do a single case for litigation finance.

But I have many cases and the solution I offer people when they dislike the pricing levels is not to reduce the price but to diversify the risk. If Time Warner are willing to bear some of the tail risk across a 10-case portfolio, I can get the same net returns on capital and offer them a lower headline number. That point is not well understood. This capital is expensive because of the binary risk element which, if reduced, I can keep the same net returns while reducing gross price.

If you then play this forward you get a more securitized asset class?

That is correct and also one of our long-term goals.

Is there a reason why that could not happen?

The principal reason revolves around information asymmetry. Most litigation is confidential but the underlying substance of the case is generally protected by legal privilege. Companies do not want privileged facts broadly known and they run the risk of losing the protection if that information comes out in the public domain. It is difficult today to give the market enough information about cases to enable them to make investment decisions. We have been building a secondary market and Petersen is the most prominent example of our success in effectively securitizing our position in litigation but we have also done it in other cases. The cases where it is working today are cases where there is enough information in the public domain that investors can make their own investing decisions, without needing privileged material.

What I would like to see going forward, and we are still far from this happening, is a world in which we can build a large and diversified portfolio with a sufficient track record that investors will buy on the track record instead of feeling the need to diligence the underlying cases.

Could Burford become the Goldman of legal finance?

That is a very realistic goal for us, but in the confines of our own smaller industry. We have a strong ability to originate deal flow and make it accessible in different forms. We already do that today in several ways. You can buy the equity or public debt, or participate in our partner funds. We will continue to expand the number of capital opportunities to participate in.

Is there any correlation in return profile of smaller versus larger cases?

No, the correlation is more to underlying litigation risk than to investment size.

Looking through the numbers you provided, it is clear that the actual zeros which Burford has are typically sub $1 million investments. Why is that?

Litigation is a process that tries to get adverse parties to better understand the strengths and weaknesses of their positions. Companies do not get into litigation out of the blue; they had a prior course of dealing where something went wrong and the relationship fell apart. Each of them believes they are right because nobody goes to litigation thinking they will lose. You are starting off with two parties who both believe they are right, but one misjudged their position. We do not take those cases and send them to trial the next day because we prefer a process which lets people figure that out on their own.

Litigation goes through those stages so that parties exchange their information under a mandated process and can recalibrate their own positions and revisit whether their original assessment was right. In several cases, you can rapidly figure out that in you were wrong. The other side has the stronger case and it no longer makes sense to prolong the litigation. That is a case which might well resolve rapidly and for very little money. That is why you see some of those small dollar losses, because the case did not get anywhere close to the end of its life.

That creates a risk/reward for you if you can cut your losses very early?

In some cases yes, but in others it does not result in a change of assessment. Those cases end up going to trial because the parties are too far apart to resolve them on their own. A decision maker makes the decision and sometimes we are on the wrong side.

For larger cases, is there a situation where you can add to your winners?

Yes, and you saw an example of this last year. In 2020, we had great success in a pool of related cases, but that did not come all at once. We started investing in that pool some years earlier with just one case. We watched that case and as our conviction level grew, we added to the position over several years by bringing other clients and doing related cases, until we ended up building a significant position which was ultimately successful.

How do you look at the tradeoffs between growing or allocating capital via balance sheet versus with third party capital?

That goes back to one of the very earliest premises; we are an employee-owned business in several ways. At the end of the day, we think about maximizing public equity value. You do that by allocating capital in the most sensible way that drives the highest return on ROE, although you should look at that on a long-term rather than a short-term basis. We also have an eye to wanting Burford's product offerings to be as broad as possible to meet our client's needs. We use a mix of balance sheet and limited partner fund capital across client and investor demand. Just as a public company has separate pools of stakeholders, who buy equity on one hand and debt on the other and are obviously looking for something very different, so is the case in private funds.

So we have private funds that are oriented at the LP version of a debt investor where we are providing a low-risk short duration and comparatively lower return and product to those investors, which is also attractive to corporate clients and law firms. We think of this as a spectrum where we go up to higher returning, traditional litigation finance style investment. We think about the funds business in that way as an important adjunct to what we do on the balance sheet and as a way of both having access to additional capital but also having brand extensions which are attractive to investors and clients. Given the returns we make in traditional litigation finance in the core business, it is more profitable for us to make those investments on balance sheet with debt capital than in a 2 and 20 style fund. There are many things to be done in the funds business which are not simply copycat 2 and 20 funds of the balance sheet.

Is it about extending the product range of Burford with third party capital but also trying to optimize the higher return items on your balance sheet?

It is also dealing with the interests of the various capital provider constituencies. We continue to make capital available in high returning items to our partners because we value both the public and private capital sides.

How do LPs view litigation in their portfolios relative to other asset classes?

They view it as a desirable uncorrelated investment which has a place in their alternatives mixture. There is a widespread realization that it is an interesting asset class to pursue.

Are there any challenges, given the difference in the duration or the uncalled commitment nature compared with more traditional alternative asset classes?

No, we manage that carefully. The challenges for private investors are private LPs are accustomed to a high level of involvement in the investments they make and a greater level of transparency than most public company investors have. The challenge this asset class presents is the more people know information about the investments, the more risk and stress you put on the legal privilege analysis. We are not in a position to share client data about individual litigation investments with LPs, so they are not getting any more information from us than public company investors do. That is not the norm in private fund investing, making it hard for LPs to invest in this asset class.

Is there any reason Burford could not reach a $50 or $100 billion AUM, third party capital under management, in 10 years?

Given we are only 10 years old, my crystal ball does not extend that far, but we believe there is market opportunity for us, which we have been saying publicly for a long time. We have been building the business to take advantage of what we see as future market opportunity.

Is there any challenge in growing third party asset AUM?

The challenges are only those we have discussed. On the one hand, we are sensitive to the economics of the returns we generate. We make significantly more money on balance sheet than we do in a 2 and 20 fund for the identical high returning asset, making us fairly resistant to fee or price pressure from LPs, who are increasingly fee focused, to the point of irrationality where the fee levels can drive the discussion somewhat more than the return levels. We are disciplined, just as we are in our use of leverage, in how we address fee levels from LPs. If we do not find the overall offering attractive to equity shareholders, we will not pursue it. That is a very significant distinction compared to many private fund managers.

I do not put the management fees from private funds we raise in my pocket. Those management fees go to public shareholders. We view all our private fund activity through the lens of equity value creation, and not how much money can be taken from the fund this year.

If the asset management fees and income cover operating costs and the interest on the balance sheet, then all the IRR from the balance sheet will simply flow to the bottom line for shareholders?

Yes, that is right.

You used to use the cash NAV back in 2010, and some people say you should not use book value in this business because it is a book of options with binary risks. How do you suggest we frame the business?

I completely agree you should not value this business on book value. This is a high growth business with a track record of success generating high uncorrelated returns. It is entirely inappropriate to use book value as a metric. To your cash NAV point, I can offer historical context. Burford started life as an externally managed fund. The public vehicle was a fund which Jon Molot and I owned and in 2010 that was the structure. It changed in 2012 to be a unitary operating business and so we dissolved the fund structure. The reason for the cash NAV structure was to ensure we were not paid performance fees until we generated the actual cash.

That was the sole purpose for cash NAV. That was a time when, back to the accounting point we made earlier, just as I do not want my private equity managers to be paid on their paper gains, public shareholders should not have wanted Jon and I to be paid on paper gains. That was the reason we had that metric in place but it was not used since we dissolved in 2012.

If you would not use book value, how would you look at it?

This business is appropriately looked at on a PEG (price to earnings growth) basis.

A very simplistic way we look at it is the two-year deployments, times the IRR minus OPEX and interest to get cash receipts; is that a high-level way of looking at P&L?

You can certainly start there but, by doing that, several things are happening. You are getting both the growth and the existing portfolio, including Petersen, for free.

Petersen is simply a free option on top of that?

Yes, but if you are going to talk valuation, arguably it should not be a free option, and certainly the growth should not be a free option either. The business has been growing rapidly. I know of no businesses with these kinds of growth characteristics whose market value should not include some allowance for future growth.

So if we look at this purely on a book value basis this could really miss the value of the manager or your expertise and the future growth in the business.

Yes, I completely agree with that approach.

Why is Burford always innovating or at the forefront of industry change?

It is simply around our scale and depth of experience. We have assembled the leading team in the business and have many smart people here. We cover the entire waterfront of the industry, and do every kind of case globally with our law firm and corporate partners. That means we see an enormous amount of stuff, which allows us to sit back, talk to clients and think about where this industry is heading. We can do a better job of serving our client's needs and introducing products and services they want and value. You saw that when we went into the insurance and asset recovery business or when we launched diversified law firm portfolios. Those were all first-mover items by Burford and not only have they all transformed the industry, but they are regularly copied by everybody else.