The State of Legal Tech Investment – An Interview with Investment Banker Scott Mozarsky
In this post, I interview Scott Mozarsky on the state of the legal tech investment. Scott is a Managing Director of investment bank JEGi. In that role, he focuses on legal tech investments. Some readers likely know Scott from his four-plus years as President of Bloomberg Law. Scott also practiced law at two multinational law firms and as a general counsel and head of M&A for a FTSE 100 media group earlier in his career. (See Scott’s LinkedIn profile.)
Scott and I started working on this post following a coffee meeting during Legal Week. That first week of February 2020 feels like a lifetime ago given the crisis and lockdown that has unfolded since. Scott finished answering my questions just as the scope of the crisis became clear. As he and I read the answers, we realized the world had changed. We both thought that, rather than rewrite all the answers, readers would appreciate seeing the pre and during- and post-crisis views, side by side.
How do you characterize the overall state of investment in legal tech today?
Pre-Crisis View: Investment in the Legal Tech market (and the Legal market as a whole) continues to accelerate. Despite an increase in early stage investments and M&A deals, Legal Tech has over the last few years been FinTech’s often overlooked sibling. However, the business and market attributes driving FinTech investment are very similar to the patterns that we are encountering across the legal market particularly with respect to Legal Tech and Tech Enabled Legal Services (ALSPs, online legal services, litigation support services, etc.). A meaningful number of financial sponsors and strategic players are aggressively looking to deploy capital in legal tech.
The Crisis / Post-Crisis View: Deals are slowing down and will continue to slow down during the crisis, especially for businesses that lack scale and/or subscription revenue.
Financial sponsors are focused on their existing portfolio companies and strategic investors are focused on ensuring that their day to day businesses are doing everything they can to hold their own. That said, a few legaltech funding rounds and acquisitions have closed during the last two weeks and a number of sponsors/strategics have told me they see an opportunity to make good investments during the crisis while others are distracted and company valuations are lower.
Some financial sponsors who historically have only made control/majority investments have told me they are looking for minority deals to help companies deal with the crisis and put themselves in a stronger position with those companies moving forward.
What do you think prompted the big jump in investment a couple of years ago?
Pre-Crisis View: There are literally trillions of dollars of investment capital that private equity and venture funds are sitting on. These financial players are aggressively looking for solid investments at semi-reasonable multiples. As indicated above, the FinTech market has tended to get a tremendous amount of focus from investors. The Legal Market has many similar patterns and it is not as crowded because some investors shy away from it because they perceive it to be too niche for them. Also, law firms and their clients are clearly ramping up their use of technology and data driven solutions and tech-enabled LPO and BPO services.
The Crisis / Post-Crisis View: I expect law firms and clients to accelerate their adoption of technology and data solutions. The crisis has forced lawyers and other professionals across the legal market to leverage technology ranging from workflow and collaboration tools to video conferencing. There will be a higher level of comfort with these solutions as we emerge from the crisis. Strategics and sponsors realize that these changes in behavior will drive growth for the companies that offer these solutions and this should help ensure that the investment and M&A markets continue to be highly active.
Is the current rate sustainable?
Pre-Crisis View: Yes. Tech adoption by the sell side (law firms) and the buy side (clients) in the market is going to continue to accelerate over the next few years. As the legal market continues to be disrupted by alternative legal service providers, globalization, technology, commoditization, etc. there are a number of opportunities and challenges that law firms and their clients will encounter. Technology (AI/Machine Learning) and data (analytics) enable people to seize these opportunities, better represent their internal and/or external clients and address their challenges. With transparency through data, commoditization intensifies and the need for differentiation becomes that much more important; subscribing to legal tech and data platforms enables customers to find ways to differentiate themselves and win. As legal tech companies continue to grow, investment capital and M&A deals follow.
The Crisis / Post-Crisis View: A dip this year due to the crisis and slow activity in Q2 and perhaps Q3 are inevitable, but for the reasons mentioned above, the market is likely to be very active for a number of years coming out of the crisis.
Should we expect a shake-out, that is, a large number of start-ups closing down? Why? When?
Pre-Crisis View: Nobody, and no market, pitches a perfect game. No matter how good market conditions may be, in order for a company to be successful, it needs to not only solve problems and/or create opportunities but it needs to have a strong commercial strategy and execute well and most importantly it needs to have talented people. Companies that do not possess these attributes are more likely to fail. A big red flag is a company that enters a part of the market that is already crowded with a solution that is helpful but doesn’t really solve a problem that is large enough for the bulk of the potential customers to care about. AI and Analytics are sexy and can be extremely valuable, but clients are only going to pay for them if they think that the relevant solutions will make their businesses and them more successful.
The Crisis / Post-Crisis View: For the most part, sales will slow across the market with the sales cycle lengthening. Customers will delay making decisions or changes as they conserve cash and wait for more certainty/normalcy. Companies that offer online collaboration and workflow tools, online education, video conferencing, etc. should get a short-time bump. That said, any company highly dependent on maintaining a strong sales pipeline with opportunities flowing through the funnel and closing quickly for either cash flow or continued investor backing is now at much higher risk.
What does longer term success look like for newer legal tech companies? Are there good exit strategies, e.g., IPO, acquisition, selling to private equity?
Pre-Crisis View: Longer term success involves building a sustainable business with products that are sticky and that the market will rely upon. Almost all legal tech exits will be a sale to a strategic or to private equity. Historically, legal tech companies were not large enough to consider the IPO route as an exit option. There are a few companies who have taken in a significant amount of investor capital and that are growing rapidly that could potentially consider an IPO. That said, the most straightforward exit is an acquisition by a strategic focused on bringing in talent or product functionality and/or inorganic growth or by private equity, given that there is so much capital sitting with private equity investors that are interested in investing in the legal market and who aspire to acquire a company as a platform and then do bolt on acquisitions to drive growth and gain market share.
The Crisis / Post-Crisis View: Prior to the crisis, revenue and EBITDA multiples were at high levels. I expect the market to ultimately return to these levels. Founders/owners were hesitant to sell equity or exit because in a strong economy they expected growth to continue. I think we will see more founders/owners willing to transact with realistic value expectations coming out of the crisis in order to ensure they take money off the table and mitigate future risks.
If a large law firm or law department asked you about licensing software from a company less than two years old., what would you tell them?
Pre-Crisis View: Test it first with a controlled narrow implementation and deployment that does not involve a tremendous investment of time, bandwidth and capital and does not require significant change management. Make sure during this controlled implementation that there are clear, measurable objectives that are trackable and that will determine whether the pilot is a success. Before making a larger commitment of time, capital, etc., enter into an NDA with the company and do diligence to ensure that it has sufficient capital to operate and to deliver on product and customer service.
The Crisis / Post-Crisis View: As we return to normalcy coming out of the crisis, diligence on early stage companies is that much more important.
Many in the legal tech market have opined about a move toward platforms. What are your thoughts on platforms? Is that the same question as the much older best-in-breed versus all-in-one software solution?
Pre-Crisis View: One of the biggest challenges that law firms and corporate legal groups have is “Death by Platform.” They have too many subscriptions (often 300-400) to different platforms and publications and many of these are often under-utilized. There also is a lack of single sign on which creates a number of workflow challenges. So, firms and clients are wasting time and money and not optimizing their workflows or results for their clients. Bringing as much of this as possible into one platform enables the users to save time and money because they don’t have to go from platform to platform and they don’t can cancel subscriptions that are redundant. A large part of Bloomberg Law’s value proposition and vision has been to be the Bloomberg Terminal for the Legal Market (i.e. a one-stop shop for the large majority of a firm or corporation’s practice of law and business of law needs). Startups like Theorem and Reynen Court are also focused on solving these problems. My view is that the best result for a firm or corporate legal group is to be able to do as much as possible in one platform without having to sign in multiple times and without having to invest in numerous solutions.
The Crisis / Post-Crisis View: Coming out of the crisis, law firms and their clients are likely to be even more sensitive than before to taking on additional expenses and managing their budgets. Platforms that provide single sign on and that enable customers to cancel their subscriptions of redundant solutions are well placed to seize on an opportunity here.
How does the legal tech market compare to other narrow verticals from an investment perspective?
Pre-Crisis View: Verticals like Healthcare, Technology, Marketing and Finance were at the front of the curve with respect to Tech, Analytics and Tech-Enabled Services. HR and Insurance then followed suit and the ramp up in Legal from both an investment and adoption perspective has been slower but is now accelerating. This isn’t a surprise. The Legal Industry has tended to move slower than other industries with significant obstacles such as change management and the law firm structure around the buying decision. What we are experiencing now is a similar pattern to what happened in Healthcare and Finance. Analytics, technology and data help people do their jobs better and deliver more value to their clients/customers. In the Legal Industry, the combination of technology, data and analytics ultimately provide a level of transparency that has not existed in the past, and also enable law firms and clients to make decisions grounded in science rather than art. This enables the legal industry to operate more effectively and efficiently which bodes well for legal tech providers moving forward.
The Crisis / Post-Crisis View: Subscription businesses are in a good position to remain stable during and after the crisis, but growth will be impacted for 2020 and maybe 2021. Customers are already asking providers across industries to provide them with the ability to slow down cash payments so they can protect themselves against cash flow problems. This pattern is repeating itself in all verticals.
Any final thoughts?
Despite the crisis, it is an exciting time across the legal market for M&A and capital markets. This applies to organizations in areas ranging from legal tech and tech enabled legal services to BPO and legal finance. Buy-side and sell-side behavior will continue to evolve post-crisis. In fact, as the crisis subsides, a focus on the business of law will become more and more of a priority. As we recover from the crisis, I anticipate that the market will be even more active moving forward. That will provide meaningful opportunities to investors, vendors and end clients.
I’ve been on all sides of this market over the last 25 years. I am confident that the period we are currently living in is the most exciting and active market for M&A and capital markets that the legal sector has ever experienced. And, perhaps accelerated by the crisis, the next five to ten years are likely to have the most significant impact on the evolution of how firms and their clients practice and do business than any other period during our lifetimes.
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