Strategy How Legalist grew from humble roots

The couch picture is a tradition at asset management firm Legalist, writes Andy Thomson. It’s a reminder of the early days of the firm when it was run out of a garage covered in graffiti in one of San Francisco’s less glamorous districts. As the garage “was about to be torn down”, says the firm’s co-founder and chief executive officer Eva Shang, the couch was being moved across the road to a new office. That is when the team decided to pose for a picture – a picture which included cars coming to a sudden halt behind it.

The concept of the office is now in Legalist’s past – still technically based in San Francisco, Shang says that everyone in the firm works remotely. But the team will occasionally come together, including every July for the couch shot.

The word ‘unconventional’ is easily applied to Legalist, and to Shang herself. The firm was launched in 2016 when Shang dropped out of Harvard University as a 20-year-old to develop a business with the help of Y Combinator, a Silicon Valley technology accelerator.

The firm that emerged was based on proprietary technology that trawls public government databases to search for investment opportunities that meet certain pre-specified criteria. Today, it has around $700 million in AUM across three strategies – debtor-in-possession financing, litigation finance and government receivables lending – all run by portfolio managers but based on the technology.

Shang says the firm’s approach is based on being ‘top-down’ rather than ‘bottom-up’. The latter is where firms are typically brought opportunities by the likes of brokers and bankers and will choose their deals from what comes across their desks. Legalist has what Shang calls “a very intentional approach. One of our investors calls it ‘portfolio by design’. We decide in advance what the ideal opportunity looks like and then we go out there and source it”.

She adds: “That’s the reason why our strategies centre around government proceedings. Anything that touches the government in some way creates a public record, which then gives us a bird’s eye view of the entire world of credit opportunities in that space.”

Further differentiation is provided by a focus on niche areas, or what Shang describes as “hyper-specific buckets”. While debtor-in-possession (DIP) financing is often a part of the toolkit for distressed investors, Shang says that most LPs she speaks with have never come across a DIP financing-specific fund. Legalist is currently in the market with its second such vehicle. Shang says the strategy is favoured because it’s high up in the capital stack and the firm dodges competition by avoiding the larger deals that the mega-sized distressed funds tend to chase – focusing instead on tickets of around $10 million-$20 million.

PE-like returns

When it comes to litigation finance, Legalist – as with DIP financing – uses its database to identify target cases that best fit its criteria. It backs single cases and targets private equity-like returns of 20 percent or more. The newest strategy, government receivables lending, involves providing financing to government contractors that may need extra finance to support the costs of a contract during the period before the government pays them. “It’s like factoring but we’re not buying the receivable – just lending working capital against approved government payments,” says Shang.

Reflecting on the early days of the firm, Shang says she and co-founder Christian Haigh (now the chief investment officer) had little idea of the future shape of the business. The early motivation, says Shang, was Haigh’s obsession with data. Beyond that, not a great deal was clear, and she compares the business plan with one formulated by the cartoon South Park: one, collect underpants; two, question mark; three, profit. The Legalist plan was near identical, she jokes, with the only difference being that step one was to collect data.

She says a coherent plan started to come together with the help of an adviser at Y Combinator, who pointed out that with an overview of a sufficient amount of data it was possible to search in real time for things you wanted to invest in and create your own market. This was the inspiration behind the litigation finance strategy, for which Legalist scraped together a $10 million first fund in 2017 before managing to close a much more substantial $100 million fund a couple of years later.

Shang stresses that plenty of blood, sweat and tears separated the first and second funds. Amazed by the ability of some brand-name spinouts to raise $1 billion “right off the bat”, she reflects: “At 20, I spent a year doing the first fundraise. If I went back in time and told myself how difficult it would be to raise that first $10 million, I would probably have packed up and gone home. That’s why so few firms are built from the ground up.”

She says the capital mostly came from high-net-worth individuals and concedes that she hadn’t quite thought through the fund economics, which meant that the $10 million raised translated to just $250,000 in management fees for a firm developing its own proprietary technology and seeking to build a team. It wasn’t until the $100 million fund was raised two years later that the firm made its “real start as an asset manager”.

Since then the fundraising has accelerated. Six months ago, AUM was around $200 million. This has since risen to $700 million and is expected to reach $1 billion once the firm reaches a final close of its second DIP fund, which is aiming for $300 million. The third litigation fund is also pegged at $300 million, while the first government receivables fund, launched earlier this year, has a $100 million target.