E252: Inside the Mind of a 29-Year-Old Billion-Dollar Fund Manager

0:00You dropped out of Harvard to start Legalist. It's one of the most unique stories that I've heard of a startup. Tell me about how you started Legalist. Well, I wouldn't say it's all that unique. The Harvard dropout story is sadly a little bit of a cliche at this point. But my co-founder, Christian, and I started Legalist in 2016 when we were undergrads at Harvard. We originally thought we were building a legal analytics startup. So Christian had identified the Massachusetts state court website. And at the time, legal tech was kind of a hot space. And then a bunch of those companies died. And lately, it's become a bit of a hot space again.

0:37We had this idea that we would take the Massachusetts state court website, which was this incredibly antiquated website. We would take that information, package it up into analytics and then sell it back to attorneys. And that was the premise behind the original incarnation of Legalist. And that's how we got into Y Combinator in 2016. And unfortunately, as soon as we got into Y Combinator, like the very first day, John Levy, who's the general counsel at Y Combinator, Paul's was aside after the intro meeting. And he's like, yeah, I don't like your idea very much. And Christian and I were like, well, we just got here.

1:13What exactly do you not like about our idea? And John Levy says, he's like, well, you see, lawyers already know if their cases are dogs and they don't really care. And so that's why I don't think your idea is going to work. And we were like, that is an excellent point that, to be honest, we had not really considered. So he said, how about instead of selling lawyers information they already know about whether they're cases or dogs or not, you take that information, which by then we were scraping not just Massachusetts, but state and federal courts all over the country. And we were doing it live.

1:49So we were getting information about motions that had passed often before the attorneys and the clients were even notified. So he said, if you have that kind of bird's eye view, why don't you go into a field where you can actually make money off of it, such as litigation finance. And we said, can you introduce us to anyone in litigation finance that we can talk to? And he said, I can't, but I can introduce you to someone who really hates litigation finance, i.e. someone in insurance. And we were like, all right, whatever we can get. So we get on the phone with this guy who's in insurance. And as you probably can surmise, insurance is the mirror image of litigation finance, as in the premise of litigation finance is that If you invest on the plaintiff's side of a lawsuit and the case pays out, then you get a payout.

2:38And if the case loses, then you get nothing. Insurance is the mirror image where the defendant pays in advance. And if the case settles for very little, then they make money. And if the case settles for a lot, well, then they lose a lot of money. So we get on the phone with this insurance guy and he's like, litigation finance, the bane of my existence. And we were like, sounds like a good asset class to be in. And that's how we got started. So you started the company going with a counterparty and you decided to go to the route of a fund versus a startup that serviced funds. Tell me about that decision.

3:15Was that the right decision? That's a great question. So around the time that we started, there were essentially two business models for a fintech originator. One of them was the model that we took, which was much more challenging. So when we decided to go into litigation finance, we decided to raise successive funds as an asset management company. The problem with raising successive funds as an asset management company is that it's very hard to get limited partners interested in your fund without a track record, without investment experience, etc., etc. The second route, which was much more accessible to your conventional fintech originator was the venture capital route where you raise debt facilities on top.

4:00And you actually saw a lot of unusual asset classes go this route. So in addition to litigation finance, you had every kind of alternative asset class you could think of. You had art, you had various kinds of revenue-based financing. And the problem with that model. And the reason why we decided not to take legalists down that route is that if you're operating in a capacity constrained asset class, ultimately underwriting is the most important thing because there are 50 million litigation cases out there and not very many of them which are actually going to win a significant amount. And the venture model encourages fintech originators to measure success by how much they can originate successfully.

4:45And originate successfully means they have to fund increasing amounts year after year after year. Ultimately, the hallmark of a good asset manager is not volume of origination, but rather the IRR of your investments that you actually make. And in a capacity-constrained asset class like litigation finance, it would be very easy to throw money at one of the 50 million cases out there haphazardly, but it's much more challenging to year after year make money investing in those cases. And we just didn't want the pressure of having to originate cases at an increasing caseload without knowing how large the market was before we got in.

5:28You didn't want something that started out fast and looked really sexy, but ultimately would crash and burn because there's no intrinsic value in the model. You chose to start with a$10 million fund and grow slowly in order to build something sustainable. Exactly, exactly. It's not a very popular decision here in the Valley. The way that I always explain this, which is extremely obvious in retrospect, is that in order to be a billionaire, you have to create 10 billion plus in value. In order to be a decabillionaire, you have to create$100 billion plus in value. And the only way to do that outside of, you know, ending up like SBF and being in jail is to create sustainable, enduring value that has enterprise and termination value, which means at year 10, you could sell it for some multiple.

6:11To make that in cash is extremely, if not impossible, extremely difficult. So you have to start, regardless of what it looks like in the beginning, you have to build a business that is worth something in year 10 that's compounding and that has a multiple associated with it where public investors could say, or even late stage, an acquirer could say, well, this is an enduring asset that will pay off a billion dollars a year over the next 20 years. So now it's worth$100 billion. There are really no shortcuts to that rule. Right, right, right. Well, I can think of one shortcut, which is Adam Neumann, but that requires someone being on the losing end.

6:44And I don't really think very many people want to go that route. We'll give Adam Neumann a pass. So you went out to raise a$10 million fund, probably a little bit naive in asset management. What were your first principles in pursuing that strategy? And what did you quickly learn from that experience? When we went out to raise the first$10 million fund, I think we significantly underestimated how difficult it would be. That's the thing with advisors and VC investors. So Y Combinator was like, you know what you should do? You should really go out there and try to raise a$10 million fund. And we were like, oh, OK.

7:20And it turns out like all things that people who don't have to do it themselves tell you, it's much easier said than done. So we spent a long time knocking on doors. And I have to give a lot of credit to people in the valley who are willing to take a shot on something that sounds a little bit crazy. That$10 million fund ended up doing extremely well. And as a result, we were able to raise$100 million fund, a$300 million fund. And today we manage about a billion and a half of assets under management. But I think if I were to go back in time, and, you know, I do frequently get pitched as a personal investment, kind of unlikely fintech originator first time funds today.

8:00If I were looking at my own pitch deck from back then, I'd probably be like, I don't really know about this. I don't really know if they know what they're doing. So you went from$10 million to$1.5 billion. It's an enormous increase in assets, almost unprecedented. I don't think I've had anyone in the show that's gone up 150x in AUM over any time. Maybe Electric Capital had a similar trajectory. What was the keys to that? And why were you able to do that in a relatively short order? I would not describe it as a relatively short order, unfortunately. So that first$10 million fund we raised in 2017, it took two years to deploy.

8:39And those are some of the most demoralizing years of my life. Because unfortunately, compared to everyone else we went through Y Combinator with in 2016, we had no visible signs of progress. So our compatriots, you know, three years out, they were they had increased revenue. Whereas when you raise a fund, you're kind of just flat and you're deploying that fund and you're in a waiting game. You're waiting for your first cases to return. I remember we were working out of this office on Harrison Street in San Francisco and the startup right across the hall from us, they had just started. And they were flush with cash from venture capital and they were just very high energy.

9:17And we were like in it for the long haul. We were grinding. And really, the turn came, the inflection point came when we raised Fund 2, because Fund 2 was a$100 million fund. And now all of a sudden, we were an institutional-grade litigation funder. But those early years were extremely challenging. Once we were an institutional grade litigation funder, our LPs started to notice that even though we were operating in this highly capacity constrained asset class as our primary strategy, our technology advantage, the process that we had built where you take a bird's eye view of litigation finance, you pick cases that are already primed for success, and then you invest in them at scale could be applied to additional asset classes.

10:00So we started getting approached for funds of one, for SMAs in things that were adjacent to what we were doing, which is how our bankruptcy strategy developed, which is how we started doing a little bit of mass torts, a little bit of law firm lending, and how ultimately our most recent strategy, government receivables, was born as well. I want to highlight something that you said because a lot of people are not, especially people that are starting out their first or second funds, they think LPs care a lot about alpha returns. But really what they care about is smart alpha, meaning what is the process that you're running over and over that gives you that edge every single time so that you could replicate it.

10:37LPs have seen many funds that have returned 10, 20, 30x, and then the next fund returns 1 to 2x, sometimes even loses money. So they're wary of that. A, do you agree with that? And B, how did that help shape your strategy? Yeah, I completely agree with that, although I think it differs which kind of LPs you're talking to. So family offices in particular are often much more risk takers. If it's a principal managing their own money, then they care a lot about the story. And then if you go to pension funds, OCIOs, consultants, they care a lot more about your cybersecurity policy, whether your ODD checks out, whether you have a key man provision in place that makes sure that, you know, if someone gets hit by a bus, they get their money back.

11:22So I think it really differs as you go up the chain in terms of how much dollars people are allocating. So you've used this term several times, capacity constrained asset. Double click exactly on what you mean by that and why is litigation finance capacity constrained? A capacity constrained asset class is an asset class that does not work if you put infinite money into it. Obviously, most strategies are capacity constrained to some degree, but some asset classes are more capacity constrained than others. Probably the least capacity-constrained asset class would be long-only equity. The stock market is very large.

11:58Real estate, also not super capacity-constrained. But there are a finite number of bankruptcy cases every year. There are a finite number of litigation cases per year. And even more, there is a finite number of good winning litigation cases per year. Investors who don't realize that an asset class is capacity constrained will flood money into an asset class and then be surprised when it's not a perpetual money machine that can eat any type of money. I think that a lot of strategies that generate super high alpha are capacity constrained because the purpose of a market is to erode alpha. A perfectly efficient market means that nobody makes any returns.

12:39Everybody only returns cost of capital exactly. And the reason that so many LPs are looking for capacity-constrained strategies is because that is the only area where alpha has not been eroded away. Said another way, it's the answer to why is Yale Endowment not doing this? Yale Endowment is not doing it because they can't write a large enough check in the strategy. Otherwise, they would probably be doing the desk less. You mean why is Yale not investing in litigation finance? You know, there's this thought experiment in venture, which is why did Sequoia pass? Why did Andrejan pass? Why did Benchmark pass?

13:12So what do they know that I don't know? And as a management, one of the reasons why the top investors in the world, which I categorize as single family offices, multifamily offices, obviously some pension funds are forward leaning as well. Why are they not doing this asset class? Sometimes the answer is the fund sizes are too small. Right. Capacity constraint. Yes, exactly. Exactly. Curious about online trading, but haven't taken the first step? You're not alone, and Plus 500 Futures is a great place to start. The futures market are moving fast, and with Plus 500, you could explore popular assets like oil, gold, S &P 500, Bitcoin, and more.

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14:16Plus500. It's trading with a plus. Taking a step back, tell me about the structure of litigation finance. What exactly are you buying and what does that structure look like? Litigation finance is an interesting asset class that originated about 15, 20 years ago in the UK and Australia. And in the UK and Australia, they're actually a lot less plaintiff friendly. So if you as a plaintiff start a litigation case and you lose, you're responsible for all of the costs of the defendant. And as a result, an industry popped up called ATE insurance, after the event insurance. And that was the original litigation financing.

14:53When I came over to the United States, people identified that there are certain types of cases which lawyers did not take on contingency. In the U.S., contingency lawyers are the original litigation funders where they are investing their own time plus court costs and then recouping some percentage of the case if the case is successful. So you can think of the personal injury billboards that you see as the original litigation funders. The reason that personal injury is right for contingency and other types of plaintiff's law are not is because a personal injury case is usually very small, and a personal injury lawyer can have a portfolio of hundreds of these cases and therefore have a consistent cash stream and be very diversified.

15:33Now, if you were to go to Cooley or Winston-Strong or any of the good law firms that you as a white-collar individual would go to, they do not work on contingency. They work on the billable hour. So they send you a bill. They work on the billable hour primarily because, let's say, the average partner has a$2 million a year book of business that usually comes from only a few clients. So if they were to take those three clients on contingency, those cases would last for three years and they would make no money for three years. It's just not very conducive to the model of a big law firm. It's not like a personal injury case or an employment case where, one, the plaintiffs don't have any ability to pay.

16:17And two, you can get a settlement basically any time you want from at least one of the cases and keep the lights on. So big law firms, especially white shoe law firms, just don't have the contingency built into their business model. They're also very risk-averse constitutionally, which I think you can understand from the work that they do. And that's really how litigation finance came to be. So litigation finance essentially fills that contingency gap for lawyers that don't take contingency, usually in more complex commercial litigation cases. Where's the alpha in the strategy? Why is there a premium return in litigation finance on a risk-adjusted basis?

16:54So there's not a premium return for every litigation funder, just to be clear. When we came into this space, it was sort of wave one of litigation funding. And wave one of litigation funding was characterized by top lawyers from top law firms that were leaving their firms to start litigation funders. And they were usually investing in single cases brought by their friends, their former colleagues at their old firms. They usually ran very concentrated portfolios, which had pluses and minuses, as you know, with any kind of concentrated portfolio. The plus is that some litigation funders have done extremely well.

17:34So the most famous litigation funder is probably Burford, which is a publicly traded company. And if you look at stock picker analysis, Burford's stock price has shot up in part because of or actually primarily because of one particular set of claims known as the Peterson claims. And they've done extremely well for that reason. Many litigation funders from that same vintage did not do so well because they picked a version of the Peterson claims that did not do so well. So our thesis when we came into litigation finance was that we did not need to take such extreme concentration risk when we could instead use our algorithm to identify on an algorithmic basis cases that were late stage across the country and invest small amounts in each one.

18:23So we've made over 500 investments and have had over 200 realizations. That kind of diversification is pretty unusual for a litigation funder, and it's a big part of the reason why we're successful. Many other litigation funders are successful simply because they have really good judgment and really great lawyers, and they're good at picking claims. And that's a different source of alpha than the ones that we strive for. As you started to grow, LP started coming to you and talking about government receivables. How did that come about and how did you operationalize that within your strategy? Yeah.

18:55So government receivables is our most recent and fastest growing asset class. It really started for us because in late 2021, we had a university endowment at our annual meeting pull us aside and say, I would really like to get more exposure to government receivables. I've been looking for this exposure everywhere, but it is an asset class that there are not very many people in. And I've already tried a couple of the managers and I think you guys would be really good at it. and we were a little bit more circumspect about the prospect because we said, well, you know, government receivables, it's a little different than what we do, which is usually litigation or court-related.

19:36Why do you think it would be a good fit for us? And what they explained to us is that the government makes all types of payments, primarily to contractors that do work for the government, but also to any type of policy priority that they want to incentivize more of from the private sector. And these government receivables are usually very short duration. So on average, our portfolio has disbursement durations of around 135 days. It's income generating. So for our investors, it looks like kind of a steady quarterly return stream. However, these are very hard to source. The reason they're hard to source is because any type of stable, predictable payment can be factored into underwriting by a bank.

20:21And so it's really only when people run into extreme growth or extreme decline that government receivables financing becomes attractive for them. And as a result, this LP said, you guys have the legal underwriting expertise to actually underwrite these. And I believe that with your technology, you could identify companies that are at this inflection point where they might want their government receivables monetized and you can find them at scale. And that will allow you to source and analyze government receivables and actually turn it into an asset class, which an institutional investor can invest in.

20:57So they anchored the strategy with$100 million. And initially, it was just a fund of one where we decided to see whether our tech team can actually build out an algorithm that would find these government receivables holders in any kind of predictable way. And when we found that they could, we built it out. We let in an additional 150 of new investors in early 2024. And we're on track to double the strategy size this year. One of the things that I'm very fascinated about, and I still haven't been able to crack is today, you're 29. As I mentioned, you dropped out of Harvard. You got the prestigious Teal Fellowship.

21:35We helped incubate a fun Teal Fellowship. And I constantly meet people in their late teens, early 20s that are able to be so extremely patient and build these 10, 20-year visions. some common examples, Dylan from Figma, he didn't even launch until year five and he was in his teens. What makes it so that people at such a young age can think so long term? And what is it in your disposition or your peers' dispositions that allows you to do that? I think that the Teal Fellowship selects for contrarians. When I was at Harvard, it was very obvious what the most prestigious thing to do was. And Christian, my co-founder, had an offer the summer that we did YC for literally the most prestigious thing a junior at Harvard could covet.

22:26And that was an internship at Bain Capital. And he ultimately did not do it. And every year that in the early days when we were basically making no money and working out of an office where the floors were slanted, we would think about that and Christian would be like if I were at Bain Capital right now I'd probably be making 180k oh the next year if I were at Bain Capital right now I'd probably be making 300k and every year that number would go up because when they entice you with the summer internship they basically tell you how much money you will make at every year in your tenure at Bain Capital a lot of respect to Bain Capital they were very successful at recruiting impressionable undergrads.

23:11But I think ultimately, Christian and I are renegades. We like being outside of the establishment. So there is this interview of Roland Fryer by Bari Weiss. And Bari Weiss was asking him, why is it that you are able to do research and be ostracized by your peers for doing research that they didn't agree with? And you were still, you know, having a good time and being happy. And Roland Fryer, who was one of my professors when I was at Harvard, he said, it's because I do not covet what they covet. And I think a lot of Thiel fellows have that innate difference within them, which is that they do not covet what other people covet.

23:53It would have been so easy for Christian to take that Bain Capital internship and ride that train all the way. But he decided instead, no, we're going to forge our own path. And that decides to not go the route that everybody else has gone, not necessarily because you don't like it, but because you just don't want to be like everybody else. I think that that's common among a lot of Teal Fellows that I know. And do you find it a necessary condition that you must be a missionary, not a mercenary? In other words, you must covet the mission at expense of the financial incentive?

24:35a lot of teal fellows will tell you that there is a divergence in outcomes for teal fellows some teal fellows have missions or desires that very much align with financial success and then there are other teal fellows like i know this one teal fellow that has become like a like an astrology professional and then i know another one that lives on a ranch in Montana. And those are not necessarily financial. They're just independent minded. What are you trying to say? What are you implying? I'm saying that if you're independent minded, some people will choose paths of independence that happen to have financial success associated and other people will just be independent.

25:19Different roadways to heaven. Going back to when you started at 18, you dropped out of Harvard. What is one piece of timeless advice you wish you could go back and tell that younger Eva that would have either accelerated your success or helped avoid costly mistakes? A lot of the advice that I got back then, I was too dumb to listen to or to really understand. I remember in our slanted floor office, one of our billionaire hedge fund manager advisors came and visited us. And he said, the secret to my success is to hire great people and to retain them. And I was like, oh, my God, this is the most cliche, trite piece of advice.

25:58This guy is so out of the game. He has no idea what made him successful. And it turns out that was the correct advice all along. It's just that I did not know how to listen to it at the time. Expand on that. The larger we get, the more I feel like the hiring and retention of great talent, it really is the secret to any enterprise's success, unless you're building like a consulting business that's just you personally. If you don't have team cohesion and great people on your team that are motivated to work hard. There's no way anything that's larger than just yourself can get off the ground. That's how we know that we're hiring somebody that's good is if we know even a small percentage of what they know about their domain, that's a very bad sign.