From zero to hero – how investors are driving the LegalTech market
With the LegalTech industry growing in participant numbers and influence in the Australian market, researchers Eric Chin, Ben Armstrong and David Bushby explain the growth of the market, how it is being funded and what we can expect next.
LegalTech has moved into the mainstream consciousness of the legal sector.
But what exactly is it? We classify LegalTech firms as businesses that use technology arbitrage in the delivery of legal services. Solutions can focus on the efficiency of the legal business, or the efficiency of the lawyer. The underlying technology can be app-based, web-based, or use artificial intelligence, blockchain, data analytics, predictive analytics and so forth.
What is clear is that LegalTech is on the rise, with LegalTech adoption by BigLaw firms fuelling the explosion of LegalTech firms in the $23 billion Australian legal industry. However, Catalyst, a US-based venture capital firm, estimates that LegalTech adoption currently sits at about 20 per cent, suggesting there is clearly opportunity for growth which will continue to help shape the changing legal services ecosystem.
The Australian market
LegalTech in Australia can trace its origins back to 1985 when TALaw, an online barrister briefing service for solicitors and corporate counsels, was founded. It wasn’t until cloud computing became mainstream in the 2010s, though, that we saw LegalTech startups mushrooming in Australia.
Australia’s LegalTech market is unique in the Asia-Pacific region in that we have a strong grassroots movement of technologists, lawyers and entrepreneurs bringing new solutions to life. There is also the potential for Australia to become a vibrant exporter of LegalTech solutions.
Overall, there are now 124 LegalTech firms in Australia. Our research reveals that the business to business (B2B) sector is the most mature, while the business to consumer market (B2C) is nascent (this trend can also be observed in the United Kingdom). Unsurprisingly, the majority of Australia’s LegalTech solutions are focused on the B2B market of law firms (64) and corporate legal departments (41) as their primary customer segment. Only 18 LegalTech firms are focused on the B2C market.
Funding our LegalTech firms
Australian LegalTech firms have access to a range of funding options, including grants, accelerators, crowdfunding, angels, venture capital (VC) funds, private equity, debt and corporations. Each form of funding comes with its own benefits and disadvantages, however there is usually a certain progression:
At different stages of the journey, different attributes are important to attract capital.
1. In the early stages – before a company has a battle-tested product or big customer following – the founder and founding team, its vision and supporter network is critical.
2. Once the business has some customers and a first version of the product in market, the focus is more on the ability of the team to engage the market, sell effectively and build a team.
3. As the business is growing in scale, the unit economics, the strength of the product and the competitive environment tend to weigh more on the minds of investors.
We gauged funding to LegalTech firms in Australia by researching publicly reported funding deals. The research traced $412.45 million in funding raised through 55 funding deals. Predictably, most of these were raised in the United States and UK markets, where more willing investors and investment capital are readily available. Unlike these markets, funding for LegalTech in Australia has historically been modest.
A breakdown of the funding data reveals the biggest raises have been supported by venture capital ($295.90 million), private equity ($75.2 million) and debt funding ($24 million). The solutions that have raised the most funds are e-Discovery ($139.6 million), document automation ($61.87 million) and collaboration ($51.5 million). These are segments of the LegalTech market that are mature (read: e-Discovery), big (read: document automation) or scalable (read: collaboration).
The funding data also reveals that solutions which are tailored to law firms attracted the most capital ($330 million), but solutions tailored to corporate legal departments attracted the most funding deals (27).
A capital idea
Attracting early-stage funding can appear to be a dark art, however more start-ups are navigating that maze and beginning to catch the eye of later-stage funders. This is partly a function of more available capital in the Australian market and partly the result of an increasingly sophisticated support network that provides encouragement and networking, and which can lower the cost of launching a company.
There are some common barriers to attracting capital for a LegalTech business:
- LegalTech is a relatively unknown sector and, as such, companies have to spend time bringing potential investors up to speed on the market dynamics and opportunity;
- like other verticals, it helps if the founder has a deep understanding of the industry based on experience. The legal market prefers to deal with people who have a first-hand appreciation of the problems and don’t make rookie mistakes about the existing market dynamics;
- sales cycles can be long, particularly when selling to the government, BigLaw firms and corporate legal departments;
- there are relatively few exits in LegalTech overseas or in Australia. This limitation is most pronounced in the largest market in the world, the US, where ownership of legal practices is limited to legal practitioners only. While non-lawyer ownership is allowed in the UK and Australia, most of the exits have come in the form of IPO. In Australia, we have seen the IPO of legal service providers starting in the personal injury space and spreading into the intellectual property arena.
Drivers of LegalTech valuation
To achieve a high valuation, generally a range of factors have to be present:
- a significantly differentiated product/technology;
- a superb team that attracts the right talent and conveys a compelling vision to the market;
- strong customer growth and a good pipeline;
- a track record of delivering on promises;
- strong visibility in the market (e.g. wining elite customers and industry awards);
- proof, ideally, that the founder knows what it takes to get a significant exit for investors;
- exposure not only to Australian markets but customers in and a desire to take on larger overseas markets;
- competition on the deal;
- strong month-on-month user and/or revenue growth.
Market opportunities in Australia
The fact that much of Australia’s LegalTech sector has developed without a dedicated ecosystem (e.g. LegalTech-focused events, organisations, accelerators, or angel/VC funds) points to an opportunity for both those who can provide that infrastructure and, more importantly, the founders of the future who can benefit as those support structures develop.
ALTA, The Legal Forecast, Legal Hackers (Australian chapter), The College of Law Centre for Legal Innovation are recent examples that have been established during the past two years. There still lies a significant gap for an Australian LegalTech accelerator (the Mills Oakley accelerator took one cohort only in 2016-17), while the recent call for applications for the Lander & Rogers LawTech Hub is a promising development. Also missing is a specific LegalTech-focused fund or angel network.
Outside legal document automation and legal marketplaces, Australian LegalTech firms face very little local competition, especially from next-generation, emerging LegalTech firms. Practice management, legal analytics and knowledge management are a few examples where a large market potential exists with very few, new local entrants.
Launchpad to global markets
Australia’s cultural alignment to significant, English-speaking markets such as the US and the UK gives us a competitive advantage in the region when exporting home-proven LegalTech to those markets. An expansion to the UK, for example, requires little (if any) product or operational changes to cater to that market, given the almost identical legal systems, market dynamics and culture. While the US legal system and regulatory regimes are different, market dynamics are similar and a more mature, entrepreneurial culture can provide a less-resistive path to accessing and acquiring a larger pool of clients who are more experienced buyers of emerging technologies.
Market challenges in Australia
There are significant hurdles to clear for the LegalTech market in Australia, including:
- a small market size (the total addressable market within Australia for LegalTech firms is likely to be too small to attract significant, follow-on VC funding);
- a talent shortage (Australia’s IT talent shortage is a widespread issue across all sectors, and LegalTech firms will continue to find it challenging, at least in the short to medium term, to source the technical skills required); and
- innovation policy (policies, incentives and pathways to promote the growth of Australian startups, including emerging LegalTech firms, have fallen behind our international peers in some areas).
Peak bodies such as ALTA have an opportunity to represent the collective voice of Australian LegalTech and join forces with other associations such as StartupAus and FinTech Australia to advocate on such issues on behalf of their members.
Like other professional services areas, software will continue to reshape the world and new business models will disrupt traditional practices and relationships. The legal services market is not immune to the broader changes in the market or forces such as globalisation, digitisation, automation, the changing nature of work and employment, and artificial intelligence.
The legal market will survive these changes, but will be transformed. The opportunity is to get ahead of those changes, understand them and become early masters of the tools to drive competitive advantage and efficiency. One is reminded of the old Latin proverb: Audaces fortuna iuvat (Fortune favours the brave).
This article is an abridged and updated version of a research paper, entitled 0 to 111: Funding Australia’s LegalTech market, by Eric Chin (Alpha Creates), Ben Armstrong (Earendil) and David Bushby (InCounsel). The research is based on publicly available data of Australian home-grown and overseas LegalTech firms with an Australian office presence.