For large law firms, funding innovation isn’t the problem. Committing to innovation is.
You can call me a legal industry specialist, and as such I pay close attention to start-up and investment activity in that space. As reported by my friend and colleague Josh Kubicki and others, there is a clear trend of increased legal start-up activity over the last few years. In particular, I’ve noticed the increased number and variety of investors placing bets in this vertical. From angels to PE firms, all seem to paying more attention to the opportunities brewing in and around the rapidly evolving legal sector.
As an adviser to large law firms on business and technology matters for more than 15 years, it also hasn’t escaped me how little these firms invest in strategic technology, new product development or R&D. I understand it can be difficult for a professional service business to think in terms of “products” and strategic technology. But I believe that this, much to the dismay of many law firms, creates an innovation imbalance that a growing list of start-ups are clearly capitalizing on — and investors are betting on.
So what can law firms do? Why don’t they invest more in innovation and technology, or in new products/services that better serve their current and future clients?
One oft-cited challenge to law firm innovation is the restriction placed on law firm business and financial structures by bar associations, the groups responsible for the regulation of the legal profession. The American Bar Association’s controversial Model Rule 5.4, which acts as a guideline for state and local bar associations across the US, effectively limits how lawyers and non-lawyers work together. This includes a restriction on outside investment in or ownership of a law firm’s business. Thus law firms usually rely on bank loans to smooth cash flow or fund special projects, but these come with strict terms and conditions (see Dewey or Howrey).
How is it possible for law firms to innovate and compete with smart, nimble legal start-ups who have access to a deep pool of flexible capital and resources? Before you write off these helpless and capital-starved firms, let’s consider some numbers:
CrunchBase lists 96 funded legal industry start-ups since 2009. The average seed round raised was $480k USD, and follow-on rounds ranged from $700k to more than $10m in A & B venture rounds. Even more if you happen to be LegalZoom.
Now let’s look at the top law firms in the country. The AmLaw 100 rankings, published annually by the American Lawyer, represent the top 100 US firms by revenue and other metrics. In 2013 these 100 firms brought in a reported total of $77.4B in revenue. The average revenue per lawyer in these firms was $841k, and profits per equity partner increased slightly from 2012 to $1.47m per partner. To be clear, each of the average equity owning partners at these AmLaw 100 firms earned $1.47m a year.
Stretching our imagination and using some simple math, if a small firm with 30 of these equity partners invested a mere 1% of one year’s individual profits they could fund their own legal start-up. If they were aggressive, at 2.5% they could easily finance a $1 million business. Theoretical, yes. Or is it?
There is no regulation that I know of which prevents a law firm from investing in itself. Or a spin-off organization, or captive team charged with innovation, creating new products and competitive advantage. Traditionalists say “law is a profession, not a business”. That’s bullshit, a firm is a business. For the many of largest firms, a highly-profitable billion dollar business.
So why aren’t we seeing more of these businesses invest in themselves, especially at a time when many law firms are struggling to compete and survive? Despite the bad rap “big law” gets when it comes to innovation, established law firms have competitive advantages that most start-ups do not have: clients, credibility, expertise…and cash. Operating year-to-year and focusing on partner profits is short-sighted. Yet those who choose to play the long-game may just have all the necessary ingredients to give these new competitors a run for their money.
Access to capital isn’t the problem. Most law firms can afford to invest in their future. Very few actually are. But if they fail to do so, I’m afraid there are a growing number competitors ready to eat their lunch.