The last decade saw a sustained uptick in funding into the legal vertical. So what is all that capital accomplishing? Quite a lot, actually.
The legal industry is full of opinions – and so it is full of noise. In 2019, 🤦♂️ facepalming and 🙄 eyerolling at innovation hype is still very much in vogue, and so a lot of the noise is 😒 negative 😠 in tone.
Amidst all the noise, though, I see very clear signals of meaningful change. (And I have data to back up that claim. 🤓 Because of course I do.) But first, some context.
A Call for Patience (and Some Perspective)
Almost exactly a year ago, I published a post about capital investments into the legal services sector. See Post 062. To write today’s post, I revisited some of the observations made in that post — but today, I’ll be going a bit further back in time.
Why? Because big, meaningful, structural change (the kind we all agree that the legal industry needs) happens over long periods of time (sometimes much, much longer than we realize or want). Living as we do in the age of hot takes and the 24-hour news cycle, our perceptions are inundated every single day with more discrete pieces of information than we can really handle. Making sense of the world is now more difficult than ever, for all of us.
Against that backdrop, maintaining a shared view of reality based on objective facts is even harder. Our narratives are shaped more by our own individual experiences and feelings, and all people gravitate toward narratives that confirm, rather than challenge, their pre-existing notions.
We are all susceptible to biases of many kinds. In short, we lean on biases because objective thinking 🤔 is… hard work 😫.
(Hat tip to Jason Barnwell for the link above — I highly recommend the source post, which explains why we are susceptible to cognitive biases and covers the most common types.)
It’s much easier to weave narratives that feel true. And narratives about how legal innovation is slow, painful, or #fakenews often feel very true to those living in the trenches.
Today, my goal is to provide a data-informed narrative. My hope is that this narrative will give everyone a reason to be a bit more optimistic about the trajectory of legal evolution. On whether I succeed, you be the judge.
A 10-Year Retrospective: Real Change Takes Time, and Innovation Happens in Waves
This publication is grounded in the theory behind the Rogers Diffusion Curve, which posits that the adoption of new ideas flows through a social system in a specific order. See Post 004 (introducing diffusion curve). We’ve established, more than once, that the adoption of a specific idea occurs over time.
When we complain about the slow pace of innovation in the legal industry, we are really complaining about the aggregated pace at which a whole bunch of new ideas are spreading through a very complex and very fragmented system. See Post 051 (legal markets are balkanized and opaque).
The overall pace of innovation in the legal industry, of course, is nearly impossible to measure objectively — although not for lack of trying. While we see an ever-increasing number of surveys in the legal vertical, most of them largely fail to provide the meaningful interpretation we all crave. One reason is because nearly all of these studies measure respondent sentiment rather than actual industry activity. Even when the surveys include self-reported data on concrete specifics, such as tech adoption and use or experimentation with innovation methodology, most commentary that accompany these survey findings analyze only a specific point in time. When longitudinal analysis is provided, we often struggle with very real data sufficiency issues. The most common issues are that the respondent samples are neither homogenous nor stable over time. Often, the survey results on the actual pace of progress are inconclusive, and the sentiments appear to be, on the whole, overwhelmingly underwhelmed.
The result is that we often regurgitate the same old headlines, and these often reinforce the same old narratives.
Money isn’t everything. Capital investment does not automatically translate to actual breakthrough solutions, and taking a solution to market certainly does not guarantee meaningful uptake. See Post 063 (most legal innovations struggle due to inefficient access to buyers and users). However, a closer look at the texture and patterns of capital flow, particularly when analyzed over time, does provide a useful proxy measure of innovation activity for the industry.
More Deals with More Money for More Startups
You’ve all seen the headlines, and you’ve all heard the story: 2018 was a watershed year for legal startup funding. Yes, I absolutely agree it was — but I’m not sure we are putting that story in proper context.
In 2014, a search on AngelList for companies identifying as legal startups would return somewhere in the neighborhood of 400 companies. Today, that number is 2,282. On its own, this isn’t conclusive proof that legal innovation is exploding, but it is a signal.
Crunchbase reports over 600 venture deals in the past decade for 372 companies, with a total deal value of $2.5b.
The above chart is based on that funding data from Crunchbase, and it provides several points of interest.
- Unlike most charts about the legal industry that span a decade, it does not show a curve screaming upward to the right. Instead, there is a discernible sawtooth pattern marking three distinct waves in this 10-year period, although it is clearer for average deal value (green bars) than for the deal count (blue lines). This bears closer examination, and we will take a closer look in just a bit.
- Since 2013, the legal vertical has sustained a materially higher volume of deal flow as compared to the period from 2009 to 2012.
- As many predicted, 2018 was indeed a watershed year for investment in legal startups — at least with respect to deal size.
Let’s take the last part first and break down some of the biggest deals from 2018.
These are eleven of the largest deals from 2018. While most of these fall short of the staggering sums we see in some private equity-backed transactions for more mature companies, these eleven deals alone add up to $398m.
The deals that attracted the most interest at the time were the unusually large sums for early rounds. Larger Series A rounds are in step with broader trends in VC funding, but they are quite new to the legal vertical. Last year, PitchBook reported 1,165 Series A deals in 2017 with a total deal value of $12.7b and a median deal value of $6.1m. Compare this to 2012, when PitchBook reported comparable deal flow (1,192 deals) but at less than half the total value ($5.7b) and with a median deal value of $2.8m.
Even against that backdrop, Kira’s $50m Series A and Atrium’s $65m Series B are unusually high, particularly when considering the implied valuations. Some have speculated that this portends a frothy funding scene with inflated valuations. While that may be true, I think painting the entire group with that brush is a bit unfair. Kira, for instance, bootstrapped for a long haul — almost 8 years — before taking outside funding. Atrium’s funding performance is due in some part to the deep Silicon Valley connections of its founder Justin Kan, who founded and ran streaming site Twitch until its sale to Amazon for $970m. However, the better explanation is that Atrium’s brand promise deeply resonated with the VCs who all threw into the $65m round: a new kind of firm that would provide the type of legal services that startups need to grow.
However, I think the real story here are the later-stage deals: that’s what explains the sharp uptick in average deal size in 2018. We are seeing more later-stage deals with large sums. Of the eleven deals I featured in the above graphic, four are Series D, and all four of these companies are at least 5 years old: Icertis was founded in 2009, Disco and Carta in 2012, and FiscalNote in 2013. Not featured above are Checkr, a global background check company, and Exterro, a well-established eDiscovery player, raised $100m apiece in 2018.
Here, it’s worth tracing back the funding activity for some of the largest deals in the preceding three years. In the right hand column, you can trace back the earlier rounds of most of the later stage deals that clocked in large sums. The $80m Series D for Carta was its third round in four years. The 2018 raises for Everlaw, Logickcull and Disco were all preceded by an earlier round in 2016, and Atrium’s 2018 Series B was a relatively quick follow-on to its 2017 Series A. What this suggests, at least to me, is that the legal vertical is getting better at producing proven winners — viable businesses that serve real validated market needs and for sizable recurring revenues.
So let’s take that hypothesis for a drive by looking at historical funding data a different way.
The Real Story from 2018 Isn’t Written Yet
Understandably, the big deals dominated the headlines in 2018, but I think there is another and even more interesting story under the surface.
The below chart breaks down the total deal value from 2014 to 2018, but by deal stage. “Early Stage” is comprised of Series A and Series B deals; “Late Stage” includes Series C through E. There are always some anomalies that don’t fit neatly into these categories, like much older companies seeking capital infusions in private deals, and for the purposes of this analysis, those deals were excluded.
If (like the vast majority of people) you consume news as it breaks, you might have ended 2018 feeling like there was an usual amount of coverage of legal startup funding — and you’d be right. The above chart actually didn’t prove out my initial hypothesis (that 2018 saw an unusual proportion of late-stage deals, though it doesn’t really disprove it either.) What THIS chart suggests, at least to me, is that 2018 was an unusual year in more ways than one.
Deal Count by Stage, 2014 – 2018
In fact, 2018 saw an enormous uptick in early stage deal flow relative to 2017, and if you take Seed and Early Stage rounds together, the Crunchbase data suggests higher values for both categories in 2018 relative to 2017. What this data point suggests is that 2018 may have produced a bumper crop of early stage startups. How these particular startups actually fare remains to be seen, but I tend to think these industry-wide trends are, on the whole, positive for the legal vertical.
Why? To answer that question, we must now return to the first chart and the sawtooth pattern in average deal value. Let’s look at it again:
We are venturing into the murky area of inference and pattern recognition, but I think this hypothesis is worth considering. Last year WAS a watershed for legal startup activity, but the later stage rounds were years in the making. The startups that scored big Series D rounds in 2018 toiled for years to refine their products and build their sales channels. Many of them did that hard work on the runway provided by earlier rounds in preceding years. I would guess that the peak average deal values in 2015 and in 2012 followed a similar pattern — that the deals near the top end of the value spectrum were later stage deals of companies seeded three to five years earlier.
Here’s hoping that the 42 companies scoring early stage deals from 2018 will take that capital to develop solutions that solve real problems and to build products that law firms, law departments, and individuals will buy. If so, I think there is a better-than-even chance that we will see another watershed year in 2020 or 2021 and on an even greater scale than 2018.
Looking Back 👀 to Look Forward 👀: A New Hope, Always 💖
Below is a table of some of the household names in legal tech, along with the year of their founding. Do you notice a pattern?
With the exception of Elevate, all of them are 15 years old or older. Because it really does take that long to build a company from nothing but an idea to a self-sustaining operation. (The exception in the bunch Elevate may have had an unfair advantage: its founder Liam Brown had a leg up from his experience founding and running Integreon. This also should give us hope — that the ex-founders and alumni from previous startups, leveraging the lessons they learned along the way, can accelerate the pace of industry-wide innovation when they go on to new endeavors.)
Of the companies on this list, most have taken capital infusions in one form or another. Mitratech, Integreon, DTI, Axiom, Intapp, kCura and Consilio are all PE-backed. Perhaps because these names are so familiar, they occupy segments in the legal vertical that lack the novelty factor (eDiscovery/LPO or law firm back- and middle-office tech). Maybe that’s why they don’t get as much ink as the AI or analytics startups, but believe me when I say these companies are making products and providing services that have materially changed the practice and business of law.
Their PE funders would agree, and recent funding activity signals that they see room for even more growth and impact. In turn, that PE funding positions these once-insurgent companies as real challengers to the established order: they are the next generation of consolidators that will drive waves of strategic acquisitions:
- In 2017, Singapore-based fund Temasek invested an undisclosed sum in InTapp. Since then, InTapp has put that capital to work with a string of strategic acquisitions (DealCloud, OnePlace and gwabbit) in an ambitious play to become the platform solution of choice for large law firm operations. See Press Release.
- After a 2015 spinout following a tumultuous run with Hewlett-Packard, iManage made waves with its 2017 acquisition of AI startup RAVN Systems. See Press Release. This is consistent with industry-wide trends in DMS innovation. Following its 2016 acquisition of Recommind to bolster search, OpenText has been on an buying spree to facilitate transition to the cloud and to extend its feature set into practice-specific use cases. Expect this trend to continue as staid, established DMS companies race to meet the rising expectation of law firms in their own race to modernize their operations in both the front and back office.
- Even in the headline-heavy year of 2018, the PE-backed consolidation of Consilio and Advanced Discovery made waves. See Press Release. The post-merger entity is now the second-largest provider, globally, of document review services in eDiscovery. Consider that at its peak about 15 years ago, eDiscovery and associated LPO providers numbered in the hundreds. Size and scale give the consolidator competitors in this space the edge they need to continue innovating as the component technologies in natural language processing (NLP) and technology-assisted review (TAR) continue to advance in sophistication.
- Most interestingly, Intralinks has done multiple rounds on the PE circuit over the years, culminating in a 2018 exit, when FinTech SaaS platform SS&C Technologies acquired them for $1b in cash and $500m in SS&C stock. See Press Release. The big sums involved here are consistent with PE interest coalescing around DealTech, where the overall size of the prize is heavily influenced by increasing demands placed on transactional practices to execute deals faster while providing a more seamless client experience.
If DMS, eDiscovery, and data rooms 😴 bore 😴 you, they shouldn’t. These are core technologies that lawyers use every day, and just because these categories have been around a long time, we shouldn’t ignore the fact that they make the lawyer experience and client experience in 2019 very different — and much better — than it was in 1999.
Even if the capital flow in 2018 did fund a bumper crop of promising startups, the reality is that most of them will fail. Because most startups fail. But if even a quarter of the 42 startups raising Series A and B rounds make it to later rounds in the next couple of years, a handful of winners might put that capital to work and emerge as winners. Imagine what they could accomplish and what positive change they might bring to the legal industry by 2030.
That sounds like it’s a long ways off — but that long of a view might be just the 🌈 antidote 🌤 we need for the pessimism that seems to persist in the legal industry.
The State of Play in 2019: the Caravan Keeps Moving
We are almost 2/3rd of the way through 2019, and we are seeing enough movement to confirm that the frantic pace of activity from 2018 isn’t slowing down.
Startup Funding on Pace to Hit 2018 Highs
According to the same Crunchbase data set, venture deal flow for the first half of the year is on pace to match 2018, and the average deal value shows a slight uptick, pushing past $8m. The monster Series E for Disco, hot on the heels of their 2018 raise, probably pulls this number up.
Aside from the raw numbers though, my quick run through some of the marquee deals revealed a few other interesting trends:
- LegalTech is global: Of the nine deals highlighted above, at least four are based out of the US. Red Points is Barcelona-based, LegalStart is Paris-based, Farewill hails from the UK, and 164 is based in Hainan, China.
- Startups target diverse segments: While Farewill is the only startup in the above nine that is B2C, LegalStart is a one-stop operational platform for entrepreneurs and small businesses, Litify offers a full-stack platform solution for Small Law, and Nivaura is a end-to-end workflow solution for investment banks.
- Legal looking SaaSy: Red Points provides a platform solution for IP infringement detection and removal, while Litify is built on SalesForce.
ALSPs Making Big Waves with Big Deals
Startup funding takes a backseat, however, to the massive news of structural shifts in the ALSP space.
- In February, Axiom announced the spin-off of two of its business lines (Axiom Managed Solutions, its managed services arm, and Knowable, its enterprise contracts analytics business), followed by the filing of a draft registration statement with the SEC for a proposed IPO of its common stock. See Press Release. The texture of this announcement hinted at an imminent sale of one or both of these businesses, and in April Lawyers on Demand announced it was in talks to buy the managed services business. See “LOD in talks to buy Axiom spin-off,” The Lawyer, April 23, 2019. Most recently, LexisNexis and Knowable announced a joint venture to apply Knowable’s machine learning and contract intelligence capabilities to the growing suite of analytics under the LexisNexis umbrella. See “LexisNexis Forms Contract Analytics Joint Venture with Axiom Spinoff Knowable,” Law.com, July 18, 2019.
- In June, EY announced the completion of its previously announced acquisition of Pangea3 Legal Managed Services from Thomson Reuters. See Press Release. This marquee deal represents a critical turning point for the legal vertical as ALSP and Big 4 threats converge — likely shrinking the protective moat around incumbent law firms and shortening the time they have to formulate a competitive response. Pangea3 brings more than 1,100 professionals to EY’s Global Law platform, along with a well-established distribution channel into some of the largest corporate law departments in the world. While ALSPs still play primarily in the lower end of the value/complexity spectrum, the EY platform and its deep resources could offer an accelerator for the well-established tech enablement approach that has kept Pangea3 at the forefront for over a decade.
- The sale of Pangea3 raised questions about Thomson Reuters’ strategic direction — chief among these being their massive stockpile of dry powder following its sell-off of its majority share of the Financial & Risk unit to Blackstone in 2018 for $17b. See “Blackstone strikes $17bn deal for Thomson Reuters data unit,” Financial Times, January 30, 2018. Just last month, we got our first peek with the announcement of TR’s acquisition of HighQ for a reported price exceeding $300m. See “Thomson Reuters the platform: The post HighQ acquisition analysis,” Legal IT Insider, July 19, 2019. The HighQ acquisition appears to be the centerpiece in TR’s catch-up strategy to compete in the platform era.
- Elevate adds to its war chest with a $25m sale of a minority stake to Kayne Partners. See Press Release. This capital infusion follows a 2018 round of growth financing from Morgan Stanley, which Elevate has put to active work with acquisitions of LexPredict, Sumati, Halebury, Yerra Solutions and Cognatio Law, all in a three-month period between November 2018 and January 2019. Liam Brown, the founder of Elevate, explained these acquisitions here on Legal Evolution. See Post 088.
PE Cash Keeps on Flowing
PE funding continues to churn through legal. K1 and Onit kicked off 2019 with news of a $200m investment. This was followed by the May announcement that hG is taking Litera Microsystems off K1’s books, adding to its legal and compliance portfolio that includes Mitratech and Citation. See Press Release.
While Onit has been quiet on the deal front, Litera has moved quickly, snapping up Workshare just two months after the hG investment. See Press Release. The Litera-Workshare deal continues a broader trend of core document tech platforms buying up fit-for-purpose point solutions. Last year, Chapman and Cutler made news by actually selling software baked inside a law firm to NetDocuments, and Donnelly Financial Solutions acquired eBrevia to add AI-based data extraction and analytics to its data room suite. Expect this DealTech consolidation trend to continue as the world’s most prestigious deal firms push to modernize their transactions practices.
There’s an old adage that has stuck in my mind since I first encountered it while reading Gone with the Wind about 20 years ago: “the dogs bark, but the caravan marches on.” (Apparently, this saying is Arabic in origin and some version of is found in many languages across the Middle East.)
The legal evolution caravan keeps marching forward. Sometimes the pace may seem glacial, and there is plenty of chatter from opinionated observers. Still, progress is happening, and the change we are seeing is structural in nature. The change that has already happened is embedded and meaningful.
Keep hope alive, take a longer view, and let’s all try for a little bit more patience.