Private Credit Investing with a Focus on Legal Assets & Litigation Finance

Joe Siprut:

Thanks for having me. I appreciate it.

EMS:

Absolutely. So to kick off the conversation, tell us a little about the firm and how you got to where you are today?

JS:

Sure. So Kerberos is an alternative investment manager with a focus on credit strategies. As you mentioned, the main thing that we do is investing in legal assets and direct lending to law firms. So we have a sort of credit-oriented strategy or approach to the litigation finance asset class, which is a very interesting, I think, intersection. And we can talk a little bit about that today.

And I myself was a lawyer for many years before I founded Kerberos five years ago. I spent about nearly 20 years as a practicing lawyer before generating our initial lending strategy. And it seems like a lifetime ago, but over the last five years, we've built up the Kerberos platform quite substantially and have really, I think, found success with this sweet spot in direct lending to law firms with complete cross-collateralization of their entire portfolio.

EMS:

So Joe, as a follow-up, I'd love to hear more about your firm's core strategy. Should we think of it as private credit or more as litigation finance?

JS:

The short answer is both. I think that we are in the litigation finance asset class and we are competing with other various different litigation finance strategies to provide capital to participants in the asset class. But fundamentally, what we're really doing is just providing capital to law firms, direct lending to businesses like other more familiar private credit type strategies, but the difference with ours is that because of the complexity of the collateral, we're able to charge a complexity premium. And so the way that we think of ourselves is that on a risk-adjusted basis, we're getting a return that is not proportionate to the actual risk being taken. And that's the sweet spot that we have really come to occupy over the last five years, and it's where we like to live on a risk-adjusted basis.

So the way that we do that is we cross-collateralize hundreds or thousands of cases with every single loan that we bring. Oftentimes law firms that work on contingency, for example, bringing personal injury or mass tort cases, they have to wait an awful long time to get paid, and that's the nature of the game for them. What we do is instead of taking single-case risk on those specific cases, we'll cross-collateralize the whole pool and provide essentially a loan with equity-like metrics, and we feel like on a risk-adjusted basis, that's a better alternative.

EMS:

Joe, given the current economic environment, what challenges and opportunities has this created for a niche alternative strategy such as Kerberos?

JS:

Yeah, it's interesting because I think on the one hand, the current return on cash is very relevant to alternative managers, right? Because with cash sitting in a bank account effectively generating 5% or 6%, as a manager you have to be able to demonstrate real alpha, otherwise why get out of bed? So if you're a private credit-type strategy where you're generating 9% returns, in a different market that might be a great value proposition for your investors. But in the world we're living in now where cash is at 5% or 6%, that's probably not going to be enough to justify the hassle and the risk associated with investing in that kind of strategy.

So there has to be real alpha, but the good news is for Kerberos and for I think maybe other niche managers with higher return strategies, this is our chance to shine because we can deliver that alpha. And historically, for example, Kerberos is generating 20% plus gross returns. So if cash is at 5%, yes, it may be the case that a traditional private credit strategy generating 9% or 10% is going to have an existential crisis. But a strategy that generates 20% is going to be positioned actually quite nicely to capture some of those allocations. So I think depending on who you are and where you fit in the ecosystem, this is actually quite an interesting and maybe even opportunistic market in terms of capital raising.

EMS:

Joe, to shift gears a little bit, ESG has been top of mind for the investment industry and wanted to hear how your firm is addressing this important topic?

JS:

So for us, the way that we treat ESG, at a minimum, we have a negative ESG screener, right? For all of our cases. And so it definitely comes into play at the underwriting stage. We also have an ESG linked debt product with ESG KPIs that allow us to ratchet the margin by 50 to 100 basis points depending on the firm's ability to hit various ESG type metrics that we prescribe in our loan document. So that's a very popular program that we think allows us to demonstrate a real commitment to ESG.

The most important thing that we do, we think, is that we provide concrete analytics on our ESG exposures just like we do for all of our other investments. So I think that for a manager, simply having a brochure with a picture of a tree on it or something like that, is not really checking the box in a meaningful way for ESG. What investors expect and what you have to give them is meaningful tangible metrics on what are the ESG analytics in your fund, in your portfolio specifically, how are you defining it, right?

So for Kerberos, for example, we say we define ESG by getting exposure to cases that advance claims on behalf of victims of discrimination, sexual abuse, pro-environmental causes, cases on behalf of combat veterans, for example. We specifically define ESG in that way, and then we track those metrics so that our investors can report to their constituents. If you're not doing it in a concrete way, then you're not really doing it at all as far as we're concerned.

EMS:

Joe, you've had a lot of success in your five years building the firm as an emerging manager and would love for you to impart some advice on how other emerging managers can be successful?

JS:

Yeah, I think that the best strategy for an emerging manager, particularly in this environment, is to put stock in quasi separate managed account type relationships where you can have programmatic, if not quite discretionary capital to anchor your pursuit of deals. So if you're out there as a fundless sponsor and you're trying to raise money for deals but you have no real credible way of financing them, short of just running a process, eventually the market's going to figure out that that's what you're doing, and it's going to be harder to get good deals that way, right? It's just not a good way to do business because there's factors beyond your control.

But if you can get an SMA with a couple of larger, maybe multi-strategy credit funds that aren't necessarily going to give you discretion over the capital, but you're going to have a programmatic buy box where you can invest and have credibility behind the term sheets you put out. If you're doing those things, then I think that you're distinguishing yourselves and you're going to give yourself a good shot at building a real track record to then grow into a commingled vehicle and raise real discretionary capital. And the SMAs may still play a role alongside your fund even at that point, right? Because it gives you more dry powder and more capacity, more of a buy box in terms of ticket sizes for your deals.

So I think the key for someone just starting out is to really focus on a couple of anchor investors that maybe are just looking to outsource their diligence and deal flow, frankly. But that's fine because you can still have that programmatic, incredible capital behind you as an emerging manager, and you can go out and get deals done that way, build that track record, and then for your next vehicle, maybe it ends up being a discretionary commingle fund.

EMS:

Joe, we've covered a lot of ground today and want to see if you have any final thoughts or future plans you'd like to share with us?

JS:

Well, Kerberos, speaking of which, Kerberos is in the market right now for a new commingle vehicle, and we're anticipating a first close next month, which we're excited about. Very good mix of institutional investors like pension funds, endowments, and then also multifamily offices, single-family offices, IRAs, high net worths, really good cross-section of folks that we've managed to attract.

So our focus for the near future, I'd say over the next 12 months is in continuing to raise that fund and managing our pipeline. We've got hundreds of millions of dollars of deals right now that we're working on at Kerberos. The demand for our product continues to be very strong, which tells us that we're really onto something and our goal is just to keep doing what we're doing and keep generating great returns for our investors.

EMS:

Joe, I want to thank you so much for sharing your perspective with our listeners.

JS:

My pleasure, and thanks for having me.

EMS:

And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics, and join us for our next EisnerAmper podcast when we get down to business.

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