History tells us most VC backed legal tech companies will fail

Jason Fried, the co-founder and CEO of Basecamp and widely respected business commenter blogged this on Friday.

SILICON VALLEY HAS BECOME ESPECIALLY GOOD AT TURNING SOFTWARE, THE HIGHEST MARGIN PRODUCT EVER, INTO MANY OF THE WORST PERFORMING BUSINESSES IMAGINABLE. WITH FEW EXCEPTIONS, THE AMOUNT OF MONEY BEING LOST BY THE LEADERS OF THE NEW SCHOOL IS ABSOLUTELY STAGGERING.

That’s it, and in all caps.

This sounds early similar to the the year 2000 when the rug was pulled out from under Internet companies, including many in the legal industry, chasing page views and market share, as opposed to revenue and profits, as a measure of valuation.

The corrections in valuation in 2000 weren’t 30 or 60 percent. Valuations of venture backed Internet companies dropped 90 to 100 percent. Venture capitalists which had committed to put in millions of dollars in traunches of money over time wouldn’t put in another dime – unless it was to bridge a sale. 

Harvard Business School senior lecturer Shikhar Ghosh found that as many as 75 percent of venture-backed companies never return cash to investors, with 30 to 40 percent of those liquidating assets where investors lose all of their money. 

The legal tech industry has seen a huge increase in venture capital investment. One billion dollars was invested last year and from the looks of it, we’re on pace to do it again. 

Venture capitalists are betting on growing valuation quickly, no matter the losses, and liquidating their investment by selling the company to another company or private equity firm. 

That’s a good bet in some cases based on the inefficiencies in the delivery of legal services and the ability for technology and innovation to reinvent the delivery of legal services and the processes behind this delivery.

But the problem for most venture-backed legal tech companies is that they are going to fail. The millions of dollars in venture capital investment announced in press releases won’t be delivered by venture capitalists with a decline in the economy, continuing losses or a concern that the company will not dominate their market. 

Some will then sell, some will sell at a fire sale and some will go out of businesses. Some may continue on like a dead man walking trying to stay alive to catch lightening in a bottle at a later date. 

Losing money as a startup or emerging growth company is common, and there is nothing wrong with it. It’s the model for venture-backed companies which can sustain losses longer than self funded companies. 

The problem comes when the funding stops – for the company, its employees and its customers – if revenues do not exceed expenses. 

Assuming legal tech venture-backed companies are not exempt from history, we could unfortunately see the majority of them fail.