Practice Innovations: How can legal tech companies benefit from everything going bad?

The latest market cycle has been nothing less than a joyride for the legal tech industry. Every year was a record year. The market was over-flowing with easy money, and legal tech founders were stockpiling cash.

In 2018, $1.2 billion poured into the legal tech industry. In 2021, just three years later, a new record was set at $2.5 billion. Between 2016 and 2022, it’s estimated that there were more than 1,800 legal tech funding rounds totaling more than $13 billion in raised capital. If that doesn’t justify a rocket ship emoji or three, then what will?

However, that was the old market cycle. New, we’ve just entered a new one, and it looks a lot grimmer for tech companies worldwide.

The latest tech boom — like some in the past — was primarily funded by venture capital. Low interest made money cheap, and most asset managers we’re ready to allocate capital to risky investments. And a tech startup is one such risky investment.

While the pay-off is potentially massive, the likelihood of losing all your money is high. In past years, money poured into tech like there was no end to it, especially during the beginning of the pandemic when people had money to spare, and the situation favored digital technologies.

Since then, the tides have turned. Inflation is sky-high and the interest rates are rising, which means that money has become more expensive. Now, investors are more likely to beat inflation in the least risky fashion by allocating capital to something like public equity instead of VC firms. Smaller pools of capital for venture capitalists mean that startups and scale-ups that are dependent on venture capital have a hard time raising new capital in the current market cycle. And those who can raise new funds must accept lower valuations.

How can legal tech best adapt?

So what does this macro-economic development mean for the legal tech industry?

First of all, it’s clear that the legal tech industry will not go unaffected by this. We will see layoffs and a general hiring freeze. Like other VC-backed startups, legal tech companies are looking to cut costs and increase their runway. Further, we can expect some legal tech companies to die off, and even those with money enough to operate over the next eight quarters will have to be conservative with their spending.

This is a crisis. It’s going to be painful. Yet, it’s also important to remember that the legal tech movement is still in a good position overall. It didn’t become a bad idea to digitize and automate mundane legal processes just because the market may be cooling. The legal tech market continues to mature, and people are becoming more aware of legal technologies’ benefits.

In fact, and a bit counterintuitively, there might also be some positive side effects for the legal tech movement during this downturn. Some of those benefits may include:

• • • We will see more realism — In this market, numbers beat narrative. Only real products adding real benefits to real clients will make it through. Slideware, crypto projects with no use case, and immature AI solutions all will suffer. That might make us less fixated on emerging technologies and fancy flash-ware; but with a new, more realistic perspective, we can finally go back to basics. Talk less, innovate more, please!
    • There will be consolidation — A few companies won’t make it; however, those that do, will come out stronger. You cannot overtake 15 cars in sunny weather, as Ayrton Senna once said, but you can when it’s raining. This crisis is also an opportunity for some companies to win market share.
    • Companies may be able to buy some time — When you’re on the VC treadmill, you’re under heavy pressure to perform. In some way, performance will be even more important as the competition for funding increases. At the same time, those companies raising money on step targets or those still struggling to find their product-market fit will get a quarter or two more of additional time to figure things out. Such companies can cut costs, focus on their foundation, and build something that scales better.
    • This is an opportunity for legal tech — A legal tech company doesn’t just compete with other legal tech companies in regard to raising new funds — it competes with all kinds of tech companies. Cynically speaking, many legal tech companies are fit for this kind of environment. Legal is not expendable when things go sideways; on the contrary, legal tech products quickly become business critical during a recession. For example, taking the opportunity to find out what’s in your contracts and how to get out of them is incredibly useful in times like these.

There is no doubt that this is a difficult time for venture-backed legal tech companies. The record-breaking days are probably not coming back anytime soon, however, it is equally true to see that there is nothing to gain from panicking. The legal tech movement must adjust expectations, be a bit more disciplined, and then start looking for opportunities.