“The legal tech space has become explosive. Investors are pouring millions into legal innovation as founders excitedly plan to disrupt the legal space.”

The Lawyerist, June 25, 2014

It goes without saying that over the course of the past 12-24 months, a lot of attention has been focused (at least amongst lawyers) on the increasing amount of investment capital going to fund legal technology startups.  The Lawyerist reported last week that there are 101 legal startups and that funding of legal startups in just the first 5 months of 2014 is estimated to be in the range of $77M.  Tech Cocktail reported in February of this year that $458M was invested in legal technology startups in 2013, which was a huge increase over the $66M invested in 2012.

Clearly something is afoot.  The question for practicing lawyers is whether these newly funded companies are working to lessen the role of lawyers in society, supplement the role of lawyers in society, and/or provide lawyers with the tools desperately needed to improve their practices, increase their efficiencies and lower their costs of services?  

A high level perusal of the legal technology startup landscape has led me to the conclusion that, by and large, they fall into one or more of the three groups shown in the below graphic:

Technology and Legal Services

Group 1 companies are those focused on offering basic legal information and documents via the web, but in a lawyer-less way.  LegalZoom is the best known of these companies, but it is closely followed by RocketLawyer, Law Guru, Law Depot and others. These companies all seem to be addressing “non-unique” areas of law (wills, powers of attorney, landlord tenant, basic incorporations, etc.) and then fulfill a host of basic consumer needs in this regard. They often get challenged for the “unauthorized practice of law” (UPL), but have deep pockets and strong economic interests to fight these issues out.

Group 2 companies are those that are primarily focused on providing free legal advice through licensed lawyers in moderated forums and the like.  Avvo, Lawyers.com, LawGuru and JustAnswer are examples.  Given the involvement of lawyers, they seem to be avoiding most of the UPL issues. Many of these companies make their complete history of free legal advice searchable such that the general public can use these historical discussion threads in a self-help sort of way. Almost all of these companies also offer a “Match.com” type of function, in that they showcase potential clients the lawyers they could hire for their particular problem or need. A number of these companies (e.g., RocketLawyer and Law Guru) are offering services in both Groups 1 and 2 which might be an indication that these two groups are coalescing in terms of the functions they offer.

Group 3 companies are companies that are seeking to provide tools to improve how lawyers and law firms work on a daily basis, such that they become more efficient, affordable and effective for their clients. These companies include e-discovery companies, document and knowledge management providers, law firm billing systems, etc.  Examples include MetaJure (the company Kevin and I co-founded), Clio, Attenex (now called Ringtail), and Recommind to name a few.

From a non-scientific examination of the funding data, it seems that the overwhelming majority of institutional money (VC’s, etc.) is going to investments in Group 1 and 2 companies. For example, LegalZoom recently received a $200M tender offer to buy out shares from early investors after having earlier received a host of VC funding, RocketLawyer raised $15M in May of 2013 to bring its funding total to well over $50M, and Avvo recently announced it had received $37.5M in a Series D financing.

VC Dollars

There probably are a number of reasons “big money” investors are primarily putting their money into companies in Groups 1 and 2.  First, is plain market size. U.S. legal services in 2013 was a $275B market. Capturing just a small share of this market through non-lawyer generated legal forms, ad-supported legal answers, and/or lawyer match-making services can lead to big annual revenues for startups in this space.  If you add in the amount of the legal services market that is not being served at all by the practicing bar due to cost issues, the real size of the U.S. legal services market is most likely significantly bigger than the $275B number.  A small indication of the potential size of this market was gained when LegalZoom filed for its IPO in 2012 (later withdrawn) and declared that it had $156M in annual revenues. 

A second reason investment capital may be seeking out these companies is that the huge, unmet and growing need for legal services is at the “low end” of the market, not the top.  Almost all of Group 1 and 2 companies are focused in addressing this low-end of the legal services market given that the majority of US law firms and lawyers have not figured out a way to effectively address this market. Accordingly, well funded startups in this space have an open field of opportunity in front of them, especially if they figure out ways around the UPL issues.

Third, investments in Groups 1 and 2 are as much a consumer play as a legal play. Most VCs are far more comfortable in this market rather than in the market of creating tools to be sold to legal service providers (i.e., Group 3).

Fourth and finally, the market for technology sold to law firms and lawyers is probably at best a $10B market — if you apply the metric that the average law firm spends around 3% of its gross income on technology related items. As much of this spending is for generic technology such as PCs, smartphones and the like, the percentage spent on e-discovery tools, e-billing systems, Client Information Systems, Document Management Systems and the like is probably half of that amount at best. It is probably no surprise that $300B markets grab far more attention than $5B markets.

One way to think about how professional investors are approaching the legal startup space is to think about how they approached the travel services industry, the insurance brokerage industry and the stock brokerage industry. Rather than invest in technology to make “old school”, store-front, travel agents more efficient, VCs focused their investments on companies like Travelocity, Expedia, Kayak, Hotels.com, TripAdvisor and the like that sought to supplement or to outright displace traditional travel agents.

A similar scene played out in insurance sales (Esurance, Progressive, etc.) and in the stock brokerage business (Etrade, ScottTrade, etc.).   It goes without saying that these new technologies and web-based services dramatically disrupted those industries and the traditional providers of those services.  The question for lawyers and law firms is how these new legal startups will impact the legal service industry, law firm business models, pricing for legal services and even the legal regulatory scheme itself.

Effect of VCs

If these new startups increase access to legal services and/or cause the legal profession to get more efficient and cost effective in how they deliver their services, it should be all for the good.  My main concern, however, is what appears to be a lack of focus on the Group 3 companies as these are the ones that will give lawyers the tools to respond to the changes being driven by Group 1 and 2 companies. If VCs and other professional investors are not putting much if any of their money to work with Group 3 companies, who will?

I know in the case of MetaJure, we have a lot of lawyer/angels as investors who understand the importance of funding legal startups in this space.  Encouraging more lawyer angels around the country would be a good thing to do.  The profession (perhaps through the ABA?) might also think about soliciting a group of high net worth lawyers who made their fortunes by being GCs of well known startups to create a dedicated investment fund that targets investments in this area, both for the social reason of keeping the profession healthy and with good tools as well as from a return on investment perspective.

Finally, could law firms consider forming an investment consortium that would fund one or more legal startups building tools that those firms need, in exchange for royalty-free licenses to the resulting technology as well as the equity upside?  This is how we funded Attenex through the Preston Gates & Ellis law firm.  There is probably no end of ideas of how to get some key funding to Group 3 companies, but if we don’t pay attention to this issue, we might find ourselves like the travel agents and insurance salesmen of old.

The Need

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