Unlike sharks, killer whales hunt collaboratively. Is this the right approach to the legal tech vertical?
Why aren’t more law firms investing in startups and/or launching corporate venture arms? Is corporate venture capital (CVC) a good fit for the legal industry? If not, is there a better model? And then, finally, what does all of this have to do with killer whales?
In this essay, I’m going to attempt to answer each of these questions. I will start by giving a brief introduction to CVC and then I will outline the current models of law firm venture investments, highlighting both strengths and shortcomings. In the second half of this essay, I’ll suggest an alternative model, a collaborative industry-wide approach which I have dubbed “Investing like Killer Whales.” This is the strategy we used when we syndicated an investment in AI-based contract benchmarking startup TermScout. See Abramowitz, “As Promised, Our Second #Legaltech Investment Announcement This Week,” Zach of Legal Disruption, May 5, 2022 (describing collaborative syndicate approach and why worked well for TermScout).
In sum, this essay reflects many of our learnings from that experience, my experience investing in LegalMation back in 2019 (without a formal syndicate), as well as opportunities that our team has been working on in 2022. Like the other models I’m describing, I will highlight both pros and cons.
I. Corporate Venture Capital and Law Firms
A. CVC rationale
Corporate Venture Capital (CVC) has grown exponentially over the past decade. The rationale behind CVC is fairly straightforward: big companies want to keep an eye on smaller companies and trends that could be disruptive, invest where synergies exist, and gain a competitive edge over competitors. This used to be accomplished through R&D and M&A. However, since 2010, CVCs have grown exponentially. See Nicolas Sauvage, Claudia Zeisberger, & Monisha Varadan, “Is Corporate Venture Capital Right for Your Startup?,” Harv Bus Rev, July 28, 2022 (citing statistics showing tha CVC is “an increasingly prevalent alternative to traditional funding options such as VCs and angel investors”).
The graphic below shows the trend, including the records for both deals and total funding set in 2021 (admittedly an outlier, milestone year for venture investment generally).
Each of the above rationales should apply to law firms, especially given the growth of artificial intelligence and natural language processing. And, in fact, many at the highest ranks of law firm leadership at top firms, do pay attention to disruptive technology and invest resources in order to stay ahead.
For example, in 2018, Mishcon de Reya invested in Thirdfort, a property conveyance platform, which was a participant in MDR Lab. See “Mishcon Invests in Thirdfort, MDR Lab 2018 Member,” Artificial Lawyer, Nov 19, 2018. At the time of the investment, Mishcon de Reya’s Chief Strategy Officer Nick West explained, “We created MDR LAB so that we could work with, develop and learn from businesses like Thirdfort to identify the gaps and opportunities in the legal market and use technology to address them.”
Similarly, Zach Posner, founder of The Legaltech Fund said of his LPs (two of them law firms), “The reason that they invested in us is because they want to get an understanding for what’s kind of coming around the corner.” Cassandre Coyer, “LegalTech Fund Founder Talks Investing in Current Economic Climate, Supporting Startups,” Law.com, June 17, 2022 (discussing raising $28.5 million, which included investments from Orrick and McDermott Will & Emery).
There may be individual lawyers who think tech will not affect them. And in some cases they are right. However, I am not personally aware of global law firms that are not monitoring the legal technology ecosystem closely. The dissenting perspective is important to keep in mind. I’ll come back to it when discussing the killer whale model.
That said, monitoring legal tech is different that parting with money. For the most part, AmLaw 200 has shied away from CVC or investing in startups. By comparison, nearly 20% of the S&P 500 have a venture arm, and the $70 billion invested by CVC in 2020 accounted for 25% of all venture deals that year. See Brian Rinker, “A Peek Inside the Hidden, Messy World of Corporate Venture Capital,” Insights by Stanford Business, Jan 20, 2022 (providing industry data and noting effective CVC approach requires “making a serious commitment to a long-term investment”).
Further, not just corporations, but consulting firms like McKinsey (a people business just like a law firm) have made significant investments in startups.
https://twitter.com/RomeenSheth/status/1443375302336471040?s=20&t=myZLFSEiyphkrdDjizVjlg
B. Three models of law firm startup investment
There are some notable exceptions of which I am aware. And, like CVC, law firm investment in startups comes in different shapes and sizes. Per the graphic below, I group them into three different categories.
One-off opportunities: The best example here is the investment made by Clifford Chance and Latham & Watkins in Reynen Court. As far as I know, neither firm has dedicated capital to deploy regularly into promising legal startups, but they saw an opportunity in Reynen Court and committed serious capital. A similar example is Cleary’s investment in 10BE5, a new technology that automates the work traditionally performed by attorneys when drafting capital markets disclosures (disclosure: I am an investor in 10BE5). Wilson’s investment in Lexion is not exactly the same as the prior two examples, because Wilson has funds that make many investments in startups (not just legal tech), a core part of the firm’s strategy. See Wilson Sonsini on Crunchbase.
Captive Funds: It seems to be something of an open secret, but Kirkland has a fund through corporate venture partners Touchdown Ventures that has invested in Casetext, LinkSquares, and Lawgeex. Touchdown Ventures partners with leading corporations to manage their venture capital funds, or what they call “venture capital as a service.” MDR LAB, which according to Crunchbase has made four investments in companies that have gone through its program, is perhaps the truest form of captive fund both because of its branding and because of how closely the firm works and aligns with their portfolios.
Independent Funds: Both Orrick and McDermott as well as Docusign and Carta have invested as LPs in the Legaltech Fund, started by serial entrepreneur Zach Posner. The Legaltech Fund has invested in 13 startups and was even the lead investor in Proof, a platform for service of process in all 50 states. This model exists in other industries as well. Fifth Wall is a property tech investment fund whose LPs are all large real estate companies that can provide expert vetting, financing, and early customer revenue, all of which significantly derisks the portfolio.
I will repeat my qualification above: these are the models of which I am aware. It would not surprise me to find that certain law firms are investing clandestinely or are one that I have not yet come across
C. Pros and cons of the different approaches
There are, naturally, strengths and weaknesses to each of these approaches. Having a fund that makes multiple investments in different companies benefits from diversification. Additionally, not having a dedicated fund probably means the firm will miss opportunities because they cannot move fast enough getting buy-in from the partnership. I have seen more than one instance in which a firm showed real interest in investing in a startup but could not persuade the necessary parties quickly enough. Cf Post 008 (collective decision-making significantly hinders the rate of innovation adoption). This is even more pronounced at law firms than it is at Fortune 500 companies because often the most senior lawyers at the firm will have the most pull but the least incentive to invest their money in the future of their profession.
And, yet, there is very sound reasoning behind passing on a dedicated fund. VCs have a hard enough time as it is generating returns. A VC needs at least one unicorn exit (a company with a billion dollar valuation) that will, on its own, return the entire fund. Although 2021 saw a record number of unicorns, those were likely inflated values. See Abramowitz, “Was #CLOC22 CLM’s First and Last Hurrah?,” Zach on Legal Disruption, May 26, 2022 (reviewing various factors, including a “54x valuation” for one CLM provider). Confining investment to a specific vertical, especially one that is not considered “hot,” can remove some of the benefits of diversification.
As an extreme example of how VCs operate, I shared an opportunity recently with a top Israeli fund and they refused to even take a meeting with the founders because they already had made an investment in a different legal tech startup within the last five years. Even The Legaltech Fund looks for startups with adjacencies to legal—a very sound strategy. Legal technology may be promising, but it is not hot.
The other challenge with creating a venture arm at a law firm is persuading the partners to commit capital. And if it’s hard to get the partnership to invest in a one-off opportunity, it is even more difficult getting a firm to establish a fund. As an example, 2021 was a watershed year for law firms, but how many firms used extra profits to set up a captive VC or invest in one-off opportunities for that matter? Likely zero.
Furthermore, having a law firm on the cap table can theoretically frighten off other firms from engaging with the company. In practice, this may not be a real concern. As an example, 10BE5’s relationship with Cleary has not affected their ability to gain traction with other competing firms. But this may be the reason why Kirkland does not actively advertise its relationship with Touchdown Ventures. Fifth Wall overcomes this challenge by having many strategic LPs, and perhaps this is an advantage of having an independent fund like The Legaltech Fund, although at the moment they have only two law firm LPs.
II. A new approach: Investing like Killer Whales
Last year my partner and I syndicated an investment in TermScout. As far as I know, this was the first legal industry syndicate in a legal tech company. We plan to form other syndicates and we expect that others will likely use our playbook, the mechanics of which I will now describe.
First, we put in our own money, but we also allowed other accredited investors to participate. Like a traditional VC, we receive a 20% success fee assuming TermScout is able to execute on its vision, but, unlike a fund, there is no management fee. To set up the syndicate, we used AngelList, which charges a small set-up fee shared pari passu between all the investors. This mechanism is advantageous to us because it allows us to invest with leverage plus it allows ordinary lawyers the ability to invest in venture deals to which they normally might not have access. (On the growth of solo capitalists and syndicates see “Ep 26: State of Venture Capital,” All In Podcast, Mar 19, 2021.
Our primary qualification for creating a syndicate is that other professional investors be part of the round. So, while we were willing to invest our own money in TermScout regardless of who else was joining, once we recruited two top-flight funds, GroundUp and NFX, we were then ready to open up the opportunity to wider participation. It was not the first time I have recruited others to join me in an investment. In 2019, I persuaded Relativity and several strategic angels to invest in LegalMation, but there was no formal syndicate or success fee.
I term this method “investing like killer whales,” because of its collaborative approach. This is very different than traditional venture capital investing.
As anyone who has watched Shark Tank knows, VCs have earned the label of being sharks. On Shark Tank, the entrepreneurs will often play the sharks off of one another. They can do this because sharks operate alone. Multiple sharks may be circling in the water, but each is concerned only with their own outcome. By contrast, BBC Earth has showcased the ingenious ways in which killer whales hunt collaboratively. Whether it is herding herring in Norway, hiding in the waves on the beaches of Patagonia, or knocking a sea lion off the ice, killer whales are always working together. See “Best of Killer Whales: Top 5,” BBC Earth, Mar 23, 2021. See also “Adam Smith Needs Revision,” A Beautiful Mind, Sept 12, 2015 (applying benefits of collaboration to successful romantic hookups via John Nash game theory).
Startups need all the help they can get to scale and succeed. Syndicates help by adopting the “it takes a village” approach. Executed correctly, a syndicate allows multiple parties from different organizations to collaborate in order to help a startup achieve success, both with their wallets and through their ability to open doors and add other strategic value.
This killer whale investment model has many of the advantages of a captive fund as well as one-off opportunities. On the one hand, by syndicating instead of raising a fund, there is no artificial pressure to find opportunities and deploy capital. We have the liberty to invest only when we find opportunities we truly love. On the other hand, the syndicate should be able to move fast because rather than convincing a firm to invest all of the partnership’s money, we only have to convince individuals to write smaller checks.
While an established fund should be able to move faster than forming individual syndicates, funds have their own internal approval mechanisms like investment committees. (On the politics of fund investments, see “Oren Zeev on Why Diversification Is Overrated,” VC20, June 29, 2020 (Zeev discussing how internal deliberations in his prior funds were a primary driver for him going solo as VC).
The killer whale model enables interested individuals to participate without forcing uninterested parties (i.e., partners in a law or VC firm) to put their hard-earned money into legal tech. Earlier, I mentioned that some lawyers have zero interest in using or investing in tech (“the dissenting perspective”). Specifically, this is why I think that CVC may not be a good fit within the legal industry. Corporations have to innovate because they have shareholders to answer to who want them to innovate. In contrast, law firms answer to partners, many of whom have zero incentive to invest in innovation.
If firms are indeed trying to use investment as a way to push technology inside their own organization, it may ultimately be better to adopt a bottom-up approach where individual attorneys with skin in the game push the adoption of technology in which they themselves have invested rather than a top-down approach where the organization is trying to mandate certain tech to their lawyers.
In my mind, the greatest advantage of the syndicate model is that it does not just get lawyers or a law firm on board, it has the flexibility to get specific experts on board. Could it be useful for a startup to have McDermott on the cap table? I assume so. But, I believe it is more useful to target specific individuals who have an appetite for legal tech plus relevant domain expertise.
For example, a startup that targets general counsels should consider pitching a career GC like Bradley Gayton as an investor. On the other hand, a startup targeting law firms and specifically law firm management probably wants to engage someone like Ralph Baxter, who was the Chairman and CEO of Orrick and now sits on the board of InTapp.
This is the same advice I give to startups selling to law firms and knowledge professionals trying to push the adoption of tech inside their organization: don’t sell to an “organization,” sell to specific people. This is true even at corporations, which are ultimately a collection of individual people with their own incentives. But, it is even more pronounced in law firms, where every partner is a profit center that can move with little friction to a competitor law firm. See Post 051 (Jae Um discussing the partner dynamics that make legal innovation an extreme sport).
Sure, legal tech can benefit a law firm. But in almost every case, a handful of partners (and their clients) would benefit the most. CVC exists for a reason: to keep an eye on disruptors, to benefit from synergies, and to edge out competitors. In most cases, the rationale for CVC applies with greater force to individual practice areas than the BigLaw model. The Killer Whale method enables this more concentrated alignment of interests.
The killer whale method, however, is not without its own shortcomings. Indeed, it is worth highlighting three particular drawbacks:
- Founder Reluctance: The best founders still want legacy funds like Andreessen and Sequoia on their cap table, not necessarily the Killer Whale Strategies Syndicate or any crowdfunding group. This places a real burden on us to demonstrate our strategic value and persuade entrepreneurs to do something different. In the case of TermScout, we were able to demonstrate our value by virtue of the fact that we brought two blue-chip funds to the table.
- Success Fee: Strategic investors do not always like paying a success fee. As an example, none of the angels who invested in LegalMation joined the TermScout syndicate, and I suspect the success fee was the primary issue. If the idea of a syndicate is to find the very best strategic investors, then ideally there should be no obstacles to getting those individuals on board.
- Diversification Challenge: Because each syndicate is tailored to provide the maximum value for each specific startup, the investors in each syndicate will likely be different. While our syndicate is derisking through diversification, the individual investors (assuming again that they only invest in one deal) are exposed to the risk of investing in one-off opportunities.
Now, it could very well be that, over time, more firms will engage in CVC, but the question remains: is CVC a good fit for law firms? The stakes are high, not just for law firms (not to mention ALSPs and Big 4), but for disruptive legal startups in general.
The success of a startup ecosystem improves as financing sources become smarter. Y Combinator’s dazzling product-market fit as an early-stage funding vehicle has certainly contributed to the growth of startups over the past fifteen years. Ultimately, the track record of the models I outlined above as well as the killer whale method will determine which avenues firms and startups ultimately choose.
This essay was my attempt to open source our method so that others may adopt it and improve on it, ultimately for the benefit of the legal tech startup ecosystem and, hopefully, an improved legal profession. What I have not touched upon is why Killer Whale Strategies, ostensibly a consulting firm, is doubling as an investment vehicle. This is a topic I will cover soon in my newsletter, which you can subscribe to here.