The Beginners Guide to Investing In LegalTech

enture investors get pitched by startups across a wide variety of sectors. You see your fair share of startups in the bigger sectors like B2B, healthcare, and fintech, which regularly attract the most VC dollars. But you’ll also come across plenty of startups in niche categories such as ClimateTech and InsurTech.

These may not seem as attractive at first glance but being an investor is all about getting in early. If you fund startups in these niche sectors early and become an expert then who knows, you might become the go-to investor in the space right before it blows up.

One of these newer, more niche startup sectors that might be worth looking into is called LegalTech. Here’s a beginner’s guide to the sector.

What is LegalTech? 

Pretty much exactly what it sounds like.

LegalTech is a sector that focuses on disrupting the legal industry from big law firms to the actual judicial system. Now, as you might suspect, this space might turn a lot of investors away because you’re likely going to be dealing with lots of regulations and reasons why certain technology can’t be used.

Have you ever been in a clerk’s office inside a courthouse? It feels antiquated, like you are in a movie from the 1990s. But that doesn’t mean there isn’t opportunity in the space. According to the company Lexfusion, the size of the LegalTech market in 2021 was about $14 billion when you include regulatory technology and contracting technology.

Furthermore, funding for LegalTech hit a record $1.4 billion in 2021. Since then, however, and due to all of the struggles in the public and private markets, funding has slowed in the space. There were only 62 LegalTech deals in the third quarter of this year, according to data from Legal Complex, the lowest seen since 2019. Through the first half of the year funding for LegalTech dropped by 40%. In general, conditions are less than ideal for venture investing and seem to have hit the sector hard. 

Opportunities for disruption

There’s certainly no shortage of areas for disruption in the legal space. The biggest issue that comes to mind is the opportunity for digitization when you consider all of the paper running through courthouses and law firms. The opportunity is even more apparent now as the pandemic has led to more remote work in the industry. 

Securely and more efficiently managing documents is another idea that comes to mind because of the sheer amount of documents and how sensitive information can be in many cases. While lawyers have been fearful to take some of these steps many in the industry were able to overcome these fears simply because they had to during the pandemic.

Another opportunity is automation. While being a lawyer can seem quite dramatic on TV before all of that happens there is usually a bunch of paralegals and lawyers in cubicles spending hours scanning through thousands of documents in search of pertinent information. Technology and artificial intelligence can empower people to do this much more quickly.

For court systems, one longer-term opportunity could be the idea of going virtual. Even with how ingrained technology is in our society, it’s still a bit odd to picture what a virtual court hearing might look like. Can you imagine dealing with connection issues during a dramatic court proceeding or people showing up in sweatpants or a lawyer motioning that their client pleads not guilty through a click of the mouse?

But some court proceedings will likely go virtual in the future. After all, if you could perform jury duty remotely, wouldn’t you? Virtual court hearings are certainly not widespread but they actually are happening in some parts of the world. The British Columbia Civil Resolution Tribunal in Canada has been doing virtual hearings for six years now. 

First, the court only dealt with condominium claims but now deals with all small claims concerning matters under $5,000 Canadian dollars. The court also uses some software solutions to help people get more information about their situation and figure out ways to resolve a dispute.

Biggest LegalTech Startups 

1. LegalZoom went public in 2021 at more than a $5 billion valuation. The stock jumped out of the gate but has since fallen significantly like most tech stocks and trades at a roughly $1.7 billion valuation. The company helps customers create legal documents without having to hire a lawyer. Documents it can help create include wills, living trusts, business formation documents, copyright registrations, trademark applications, and more.

2. Dye & Durham went public in late 2020 at about an $800 million valuation and currently trades around a $630 million market cap. The Canadian company that has created software solutions to help with workflow, property settlement, regulatory information, and support in the real estate sector. 

3. CS DISCO went public in 2021 at a $1.8 billion market cap and currently trades at about $451 million market cap. The cloud artificial intelligence company has built solutions that can speed up the tedious process of reviewing large bundles of legal documents to help lawyers find the info they are looking for more quickly. The company’s AI models continuously learn as they are used so they get more helpful each time.

4. There have also been some big prospects brewing in the private markets. Checkr, which helps companies with background checks, raised a $250 million series E round in September of 2021, valuing the company at about $4.6 billion. Rocket Lawyer also raised a large $223 million round in April of 2021. There’s of course the question of whether or not these companies have gone through down or structured rounds but it will be interesting to see where they eventually land.

Biggest LegalTech Funds

Considering LegalTech is in the early innings, It’s hard to know how many funds have really started to significantly focus on LegalTech. But according to Business Insider,  the fund 500 Startups had done the most deals in the space at around 13 in 2020. Ulu Ventures, which was co-founded by Google’s former deputy General Counsel Miriam Rivera, had done 8 deals that year.

There are also a few funds exclusively focusing on LegalTech. One of those is NextLaw Ventures, which is led by a number of executives from Dentons, the largest law firm in the world. The CEO is Dan Janson, a serial entrepreneur that also led the global media business for Boston Consulting Group. The company’s investments include ProFinda, Hire an Esquire, Qualmet, and Doxly, just to name a few.

Another fund solely dedicated to LegalTech is simply called the LegalTech Fund, which is being run by Rich Banks, a Stanford law professor, Sam Elhag, a former entrepreneur, and Erez Kalir, who formerly worked for Tiger Management and McKinsey. The early-stage fund has actually made a whopping 34 investments in LegalTech startups including CapGains, Cloverleaf AI, FlyTech, Josef, and OneNotary. Earlier this year, the LegalTech Fund raised $28.5 million.

Important considerations when evaluating LegalTech startups

Evaluating new startups in any new sector is not going to be easy because there are fewer success stories and therefore fewer examples of a winning roadmap. 

But investors really need to be sure that whatever LegalTech startup they are examining has good product market fit, even more so than other more developed sectors. The reason for this is because the business model for many law firms is the billable hour, meaning the more hours they work the more they get paid. So why would a law firm want to become more efficient with its time if it might lead to less money? Obviously, there are plenty of reasons that firms might still want to get more efficient but just make sure there is real interest in the product or service the startup is selling because efficiency isn’t always a winning formula in law.

Law firms also aren’t super focused on technology. That’s not to say they don’t want it to be better but much of their time is focused on winning cases or locking down new deals. And at some of these bigger law firms, you could really be looking at long sales cycles. Not only are you pitching an industry incredibly focused on detail but also one in which there can be a lot of bureaucracy.

Still, this shouldn’t discourage you from the space because every other sector has faced this before. I mean do you think it was easy for past startups to get their technology into these old and highly-regulated industries like banking and healthcare? Absolutely not and it’s still a struggle. But if you can solve a real problem in any industry then there’s going to be demand. Given the world we now live in, expect demand for LegalTech to ramp up.