Focus on litigation valuation
While the UK is characterized by a well-established litigation funding ecosystem (total value of assets managed by UK litigation funders reached approximately £2 billion in 2021), France and the rest of Europe are in the early stages of embracing third-party litigation funding.
Litigation funding requires a very solid appraisal of the risk-return structure. Typical use cases are settlement negotiations (to assess fair offers), financial reporting (for contingent liabilities under accounting standards e.g., IFRS 37, mergers and acquisitions (to evaluate the risk of pending lawsuits in due diligence), insurance claims (for litigation funding and insurance coverage assessments).
Aether Financial Services, one of the leading financial markets valuation expert, provides a highlight of the key methodological steps in providing valuation in the context of a litigation.
1 – Understand the legal context
It all starts with a clear analysis of the type of litigation (e.g., breach of contract, intellectual property, personal injury). Jurisdictional factors come next: consider the governing law, legal precedents, and venue characteristics. Last, one needs to assess the merits of the case based on evidence, legal arguments, and procedural posture.
2 – Quantify potential outcomes
Economics of the litigation are to be carefully estimated: monetary damages (compensatory, punitive, and consequential damages, if applicable); direct costs (attorney fees, court costs, expert witness fees, and other litigation-related expenses); non-monetary outcomes (potential injunctions, reputational damage, or operational disruptions).
3 – Probability assessment
Central to the valuation is the determination of the win/loss likelihood. One needs to estimate the chances of a favorable, unfavorable, or partial outcome using historical data, expert opinions, and case analysis. It is also necessary to evaluate the settlement likelihood: the probability of settling versus going to trial and the likely settlement range.
4 – Time value of money
Paramount to the evaluation is the expected timeline: litigation can take years and expected duration needs to be incorporated into the valuation. Also, the discount rate to be applied is going to be a matter of discussion depending on the case’s risk profile.
At that point, several approaches can be developed depending on the situation to combine the above appropriately. This includes scenario analysis, sensitivity analysis, decision tree analysis and possibly Monte Carlo simulations. The determination of several parameters will also certainly rely on an analysis of comparable cases. Behavioral factors can also be incorporated into the analysis, such as the opposing party’s resources, risk appetite, and willingness to settle. Last, it is necessary to account for changes in laws or economic conditions that may influence the case.
All the factors listed above (and there are quite a few, which makes litigation valuation a challenging but exciting exercise), tend to change over time and, in practice, the analysis will have to be adjusted regularly to provide decision makers with the appropriate data.
Finally, the valuation analysis, although potentially complex, needs to present clear and defensible assumptions, data, and methodology. It must ensure transparency for use in negotiations, financial reporting, or internal decision-making.