The business case for medico-legal funding

26 Aug 2019

Scenario: You know for certain (100% probability) that a company’s stock price would increase in value 60% per year for the next 3 years.

Questions: How much stock should you buy? Should you borrow funds to buy more? At what cost would it make sense to borrow?

The above hypothetical investment scenario is the exact predicament faced by many attorneys litigating personal injury and medical negligence cases on a contingency basis.

While it costs money in the short-term to fund the litigation, the financial rewards in the long term can be large.

In this article we discuss a financial methodology to make better decisions in sourcing additional capital to help grow your pipeline and litigation of new matters on contingency.

RETURN ON INVESTMENT

Return on Investment, also known as ROI, is a financial measure of a company’s profitability, and the efficiency with which its capital is utilised. It is a key ratio to measure how well a venture, project, or initiative is generating profits relative to capital invested.

In personal injury litigation there are various expenses and revenues generated at different stages in the process, but their timing can be months or even years between cash-flow events. Therefore, you need a tool which can calculate a single rate of return for the investment decision to take on a new contingent matter.

The financial metric we use is known as the Internal Rate of Return (IRR) which calculates the return on investments on an annualized basis. This return is then compared to the cost of funding the opportunity in order to decide whether to invest in more cases or not.

To calculate IRR we need to consider both the various cash inflows and outflows throughout the litigation process, and their timing. These are summarized in the timeline below and expounded thereafter.

 

CASH OUTFLOW

• Marketing expenses – Costs incurred upfront to attract new cases
• Initial paperwork
• Hospital records;
• Police records;
• RAF 1 application (paperwork required to open a case with the Road Accident Fund)
• Merits trial (± Month 18)
• Expert report disbursements – Certain expert reports are required prior to merits trial, depending on the nature of the accident. These may include accident reconstruction experts as well as some medical experts;
• Advocate fees to represent the claimant’s case in court for merits trial.
• Quantum trial (±Month 24)
• Expert report disbursements – Certain expert reports are required prior to quantum trial, depending on the nature of the injuries. These may include medical experts as well as actuaries;
• Advocate fees to represent the claimant’s case in court for quantum trial.

CASH INFLOW

• Fees owing to the legal representatives in term of the Contingency Fees Act are, unfortunately, not paid after the litigant obtains the court order. Due to the cashflow inefficiencies of the RAF, they are on an average of 6 months later.
• Refund for advanced disbursements are paid together with the taxed bill of costs (which may also include monies owing to the attorney for fees or a shortfall on the disbursement recovery from the party and party costs) on an average of 9 months after court order is obtained.

PUTTING IT ALL TOGETHER

The Internal Rate of Return formula take the various cash outflows and calculates the investment return given the resultant cash inflows. The IRR is presented as an annualized rate for comparative purposes.

The Taurus Capital Personal Injury Contingent Litigation Calculator can do this for you automatically. It is available for free download here.

COST OF CAPITAL

Calculating your firm’s Return on Investment for litigating new personal injury matter is only half of the equation. Once you know the IRR, this then needs to be compared relative to your cost of capital. If the return is greater than the cost, then financial logic dictates that you should proceed to invest in additional cases for your firm on a growth trajectory.

One thing to be aware of is that capital is never free. Even if you are using your own money, there is an opportunity cost of having this money locked up where it could be earning dividends or rental income.

It is also important to use the after-tax cost of capital in the calculation, as certain funding structures allow for tax benefits which effectively lower the net cost of funds.

INVESTMENT CASE STUDY

ABC Law currently run a medium size personal injury firm. The managing partner, David Davids, is considering borrowing money from a specialist lender at 25% per annum to bring on a book of additional cases which will allow his firm to grow to the next level. David wants to know if this is worthwhile or if the interest charge will erode any incremental value generated by bringing on these new cases.

David collects the details for an average personal injury litigation at his firm. These are captured on the Taurus Capital Personal Injury Contingent Litigation Calculator as described and shown below:

CASH OUTFLOW

• Marketing expenses – Average R25,000 per case
• Initial paperwork
• Hospital records – Average R1,000 per case
• Police records – Average R1,000 per case
• RAF 1 application – Average R1,000 per case
• Merits trial (± Month 18)
• Expert reports – Average R50,000 per case
• Advocate fees to represent the claimant’s case in court for merits trial – Average R50,000 per case
• Quantum trial (±Month 24)
• Expert reports – Average R50,000 per case
• Advocate fees to represent the claimant’s case in court for quantum trial. – Average R200,000 per case

CASH INFLOW

• Fees as per the Contingency Fees Act. Average claim R1.2 million. 25% contingency fee of R300,000 per case.
• Refund for advanced disbursements paid together with the taxed bill of costs (which include monies owing to the attorney for fees and/or a shortfall on the disbursement recovery from the party and party costs) Average R400,000 per case.

DECISION

Based on the calculator ABC Law’s IRR is 62.3% per annum. Davids should proceed with the finance and onboarding of new matters since his cost of capital is only 25% per annum.

David explains the decision to his co-director with an analogy to the stock market. Looking at the book of litigation cases as an investment portfolio, imagine you knew for certain that a certain stock price would increase 62% over the next year. It would be completely logical to borrow funds at 25% to invest in this opportunity. Even though you will pay away some of your gains to the funder at the end of the year, these were returns you would not otherwise have had due to lack of sufficient funds. The IRR is excellent.

CONCLUSION

In this article we introduced a financial methodology for deciding whether or not to grow your contingent personal injury litigation practice given a determinable cost of capital.

The three steps required are as follows:

• Calculate the IRR for your specific law firm (calculator available here)
• Identify your after-tax cost of capital (ask your banker or specialist lender)
• Make a decision:

If IRR > Cost of Capital then proceed to invest in more cases.
If IRR < Cost of Capital then do not proceed to invest in more cases.

Taurus Capital are a specialist funder to the legal fraternity and understand law firm finance. Due to our specialist skill we are able to place value on your personal injury book of matters and advance you funds to help grow your practice.

If you are serious about growing your Personal Injury firm or Medical Malpractice firm in South Africa then contact to us today at [email protected] (or via the “Send a legal query” button on the article) to discuss a bespoke solution for your firm.

See also: The history of litigation funding

(This article is provided for informational purposes only and not for the purpose of providing legal advice. For more information on the topic, please contact the author/s or the relevant provider.)