Gabrielle Orum Hernández, Legaltech News
While legal technology is still a
nascent market rife with challenges, venture capitalists are hopeful about
start-up prospects.
Credit: Rawpixel.com/Shutterstock.com
There is no greater marker of Silicon Valley success
than venture capital funding. But while enterprise technology in other
information governance-heavy industries like communications, finance, and
healthcare draw billions of dollars in venture funding, early investments to
legal technology start-ups have yet to reach this scale, despite the fact that
the legal industry is worth
hundreds of billions of dollars.
Venture capitalist
research group CB Insights looked into the market earlier this summer. Although
the group did not respond to requests for comment about survey methodology, it found
that over the last five years, the legal technology sector
has received $739 million in venture capital funding globally, a figure that pales
in comparison to the growth of technology serving the finance industry, for example. The same report found that only two
legal tech start-ups, Avvo and kCura, have received more than $100 million in
total disclosed venture funding.
That level of investment
over just five years can demonstrate serious interest in at least some areas of
a burgeoning legal tech market, but it may also demonstrate some trepidation
from investors. Where investments in technology serving financial and
healthcare services have grown consistently, legal technology investment has
stagnated somewhat this year, with financing activity in the
first half of 2016 dropping 74 percent as compared to the same period last year.
In many industries,
first-hand knowledge of a field can be a great way to connect investors to
projects. For instance, Domain Associates, one of the biggest funders of
biotech, is comprised exclusively by VCs with backgrounds in healthcare. Many
of Silicon Valley’s biggest investors have previous experience in engineering
and financial services, but at least a handful have legal training. High
profile investors like Peter Thiel and David Lee have graduated from top law
schools and have gone on to clerk or work at law firms and corporate law
departments.
However, investors with
legal backgrounds don’t flock to the legal industry with as much enthusiasm as
other investors do to their respective fields of expertise. Patrick Chung, a
graduate of Harvard’s joint JD/MBA program, has worked in venture capital for
over 10 years. He launched his own investment fund Xfund in 2012 and is a
current investor in court aggregator technology Ravel Law. He says investors
with legal training sometimes steer clear of the legal tech market precisely
because they’re so familiar with it.
“One of the most telling
or depressing things is that generally people who have been lawyers understand
the market, and therefore they don’t invest in it,” he says.
However, some of legal
technology’s biggest investors to date have been those with legal training. AJ
Shankar, founder of e-discovery platform Everlaw, says that in seeking
investments for his start-up in 2011, he thought it wise to seek out the people
in venture funds who would have first-hand knowledge of the pain points in the
legal field.
“If there’s a VC fund
and one person has a legal background, you absolutely want to be talking to
that person,” Shankar says.
Miriam Rivera is founder
and managing partner at Ulu Ventures, but before that, she spent five years as
deputy general counsel for Silicon Valley behemoth Google. She estimates that
about 10 percent of her investment portfolio at Ulu is in legal technology.
From her experience, she says that most legal technology start-ups she knows
find their biggest investments and support from those with legal
backgrounds.
“My sense is that the
typical investor has firsthand knowledge of the challenges that law firms face
in managing law firm matters and cost. Almost everyone I know [investing in
legal technology] has some sort of relationship to the law previously,” she
says.
Rivera and Xfund’s Chung
both point to a key tension in legal technology’s traction within the venture
capital market—investors with the deepest connections to the legal industry are
keenly aware of both the power and problems with pitching new technology to the
legal industry.
Challenges to Big VC Investment
Start-ups, especially in
enterprise-facing technology, live and die by the sales cycle. The sales cycle
reflects the amount of time it takes between opening a dialogue with a
potential buyer of a service or product and the closure of the sale.
“With any kind of large
enterprise sale, you’re always looking at long sales cycles, a great deal of
bureaucracy and some decision-making dispersed, so that’s par for the course
for any large enterprise sale,” Chung explains. But while other industries have
fairly uniform sales cycles, selling new technology to law firms tends to be
long, arduous, and often unfruitful.
Ron Dolin, senior research
fellow at Harvard Law’s Center on the Legal Profession, is an angel investor in
legal technology, meaning that his contributions come from his own personal
finances rather than a venture fund.
Dolin, who also teaches a course on legal
technology and informatics at Notre Dame Law School, invests exclusively in
legal technology but notes that law firms can be some of the most difficult
buyers of start-up technology.
“The issue that has come
up with selling to law firms is that they have a really slow sales cycle, and
every law firm has a different mechanism of contact for who to talk to buy
something,” he explains.
Further, he notes, law
firms tend to make decisions about their technology investments by committee,
making it difficult to get uniform decisions with any degree of speed or
consistency.
The sales-cycle length
can put legal tech start-up founders at a key disadvantage—venture funds
looking to invest in growing companies see less progress than they might like,
and funders are forced to either self-fund or seek greater investments from
angel-level investors.
Shankar notes that
getting early investment can make or break a start-up’s ability to expand into
the market. “Getting that kind of investment can be crucial to scaling that
success,” he says.
Because venture funders
tend to look to other funders for confirmation that a start-up has traction in
a market, seeing a lack of investment from venture capital can be a red flag
for other potential investors. David Hornik, a partner at August Capital and a
former practicing attorney, points out that venture funds are looking to invest
in start-ups with the potential for a “big exit,” essentially a giant revenue
stream that can be parlayed into a major sale.
“As a VC, one who is
managing hundreds of millions of dollars, I can only invest in companies that
have the capacity to make hundreds of millions of dollars,” Hornik says.
Chung says that there
haven’t really been any of these major sales in legal tech yet.
“One of the greatest
difficulties for both the supply and the demand is that you can’t really point
yet to a giant exit in the space. There isn’t a legal tech company that has
been sold for billions of dollars recently,” Chung says.
While it’s true that the
more recent legal tech start-ups haven’t yet sold for billions, there have been
some major acquisitions in the legal tech space. OMERS
Private Equity acquired e-discovery giant Epiq Systems for an estimated $1 billion overall in July. While not
a “start-up” by any means—the company was
founded in its original form in the 1960s—the acquisition arguably demonstrates the potential
for such a sale from newer entries to the market.
But the potential some
investors are looking for has not been fulfilled—not yet, anyway. “When
that happens, you’ll see a huge flood of people come in, investors and
entrepreneurs,” Chung adds.
Breaking Barriers to Successful Investment
Despite its challenges,
legal technology has made significant inroads in venture capital investments
and will likely lead to more deals in the future. The initially-cited CB
Insights’ report found that the number of investment deals surrounding legal
technology has expanded from 14 in 2011, worth about $91 million, to 65 in
2015, worth about $292 million. Chung, Hornik, Dolin and Rivera have all made
investments in the area in hopes of big returns.
Chung finds that looking
a little more closely at the perceived obstacles to investment in the field can
reveal some strong reasons to invest in legal technology. For example, Chung
notes that many investors are turned off by the loyalty that firms show to
incumbent tech vendors, notably WestLaw and LexisNexis, presuming this means
that new start-ups will have little to no chance of breaking into the market.
But flipping the commitment that Big Law firms typically demonstrate to their
vendors on its head, Chung says, can be an attractive trait for investment in
the legal market.
“Customer loyalty is
very high. You just have to look at the things law firms buy today to see
that’s the case—they buy the same things they’ve bought for decades,” Chung
says.
If new start-ups can
break into the ranks of law firm buying, they may be able to capitalize on the
staying power of law firm loyalty. “Once you open the market, exit costs are
very high,” Chung adds.
Rivera has focused
investments with Ulu Ventures largely on making complex practices accessible,
both for attorneys and consumers. Ravel Law, Lex Machina, Everlaw and Bridge US
have all received investment funding from the venture fund. Though big data is
a trending topic in legal technology aimed at law firms, Rivera cautions that
attorneys are really looking for deeper understandings, not just more metrics
and data. Her investments look to simplify data, not just aggregate it.
“We want to find
insights from the data that actually help us make decisions. To the extent
software allows us to do that, we think it’s very valuable,” she says.
Rivera finds that
start-ups trying to mitigate pain points while demystifying the legal system
draw her attention. “I like things that try to help the law be more accessible
to ordinary people affected by the legal system,” she says.
Dolin agreed that
start-ups in the legal technology space can ameliorate key pain points, but
they need to think carefully about their strategy for monetization. As an
investor, he finds it difficult to justify pouring money into a project that
doesn’t have a clear path to a revenue stream.
“I’ve seen a lot of
start-ups in the legal space explain how they’re going to help people without
any clear type of monetization, and I don’t want anything to do with it when I
have my investor hat on,” Dolin says.
While the start-up
community is known for its desire to fix social ills through technology, Dolin
says legal technology won’t be able to attract greater funding without
clarifying how money will eventually come back to the investor.
“You don’t go to a VC
and say, ‘I want to help people, so let’s do this.’ You say, ‘I can make a lot
of money by solving this problem that people have and that’s worthwhile,’”
Dolin says.
With this kind of
monetization in place, investors with and without legal backgrounds may be
poised to push past these obstacles and venture into the field.
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