A “milestone” is a point at which a significant amount of information about the riskiness and value of an investment has been revealed. The information revealed is of three sorts: first, about the performance of the underlying asset; second, about the effectiveness of the agents developing the asset; and third, about the larger context from which the asset’s value ultimately derives. The amount of each type of information revealed at a given milestone varies depending on the milestone, but the point of designating the milestone is to recognize that material information has been revealed, creating a meaningful opportunity for funders to reassess their commitment to the investment.
As a general matter, at milestones funders either refuse further funding, “exiting” the investment, or provide an additional infusion of the capital the funders committed at the outset, either on the same terms or potentially newly negotiated ones based on a re-pricing of the asset. The re-pricing, in turn, is an outcome of the new information that has been revealed.
In a startup, a milestone might be the completion of a working prototype, which could reveal information about the basic feasibility of the company and the technical talent of the entrepreneur, but would not reveal much about either the entrepreneur’s business skills or the market’s receptivity to the product. Completion of an initial test marketing and production phase would reveal more about the entrepreneur’s business skills and the market for the product. And so on. However, mapping the milestone concept onto litigation is not straight forward because litigation is different from startups in a number of key ways. In our essay we focus on the differences in the way value is developed and the difference in risk posed by funder exit, given the fact that litigation involves opponents and given that its timeline is externally dictated, by rules of procedure and court orders. (Separately Professor Rhee noted the risks litigation’s opponents pose for funders.)
The model contract adopts a few milestones. One is similar like classical VC miletsones: the completion of discovery. Once discovery is done, funders have much more information about the merits of the claim, the talent of the lawyers bringing it, the plaintiffs’ willingness to cooperate, the receptiveness of the judge and the talent of the opponents. The contract contemplates that at the completion of discovery, funders will either exit or re-invest, likely on terms different from the initial investment and possibly negotiated in the immediate wake of the milestone.
Another type of milestone suggested in our model deviates from the traditional VC model. It is designed purely to allow funder exit, given the accelerated and supplemental investment terms to be discussed in another post. As examples for what these kinds of milestones might be, the model refers to motions to dismiss and summary judgment – dispositive motions. Those milestones allow the funder to exit if the plaintiff loses on some or all of its claims. While it might seem obvious that funding would stop if the claim in its entirety is dismissed, the accelerated and supplemental investment provisions (or similar safeguards in other deal structures that take into account the effects of having opponents and a court-driven timeline) could otherwise require a funder to fund appeals the funder believes are meritless or unreasonable.
The model contract has conditional milestones at judgment rendered at the end of a trial and at times of settlement offers. Both of these milestones reveal decisive information about the value of the claim (at least as of that moment in time). If the judgment or settlement offer reveals the claim to be worth sufficiently less than the Initial Claim Value used in pricing the investment, then a type of anti-dilution provision kicks in and the funder is given additional Litigation Proceed Rights. These re-pricing provisions will be discussed in a future post.
Finally, the contract allows exit in between milestones in recognition of the tremendous uncertainty posed by litigation. Again, this opportunity to exit is needed because of the accelerated and supplemental investment provisions. However, the destabilizing impact on the claim of exiting in between milestones is extreme – more so than in VC – and the contract requires funders to commensurately compensate exercising this right or line up acceptable replacement funding so that the plaintiff is not damaged by the funders’ decision to exit. These exit provisions will be discussed along with accelerated and supplemental investment terms.
When actually creating a contract, parties should negotiate their own milestones and the consequences of reaching them. Parties should take into account that more milestones increase transaction costs and destabilize the claim, however more milestones allow funders greater control of their risk.