Expect strong M&A activity within the LegalTech market says DAI Magister

05
Dec
2023

Adam Aziz

Recent years have seen significant advancements in Natural Language Processing (NLP), particularly with the development of Large Language Models (LLMs) like GPT. These advancements, coupled with continuous improvements in data accessibility and computational resources, have markedly enhanced the capacity of LegalTech companies to automate complex text analysis. According to Goldman Sachs, Artificial Intelligence could replace as much as 40% of legal work.

Amid this technological evolution, AI-powered workflow solutions are emerging as more than a trend — they are poised to become indispensable for law firms under increasing pressure to balance quality of service with pricing and cost efficiency, and for legal departments who risk falling behind in terms of efficiency if they fail to implement these technologies. Solutions that can enhance quality and save time will crucially lead to improved client outcomes. 

While the promise of LegalTech is substantial, the funding landscape tells a story of its own. Despite a significant surge in funding, reaching $2 billion in 2021 from a mere $500 million in 2017, momentum stagnated in 2022. This year, funding has declined by over 50% YTD. The initial funding excitement experienced during previous years has resulted in a crowded market, intensifying the competition among LegalTech companies.

The challenges of fundraising in this environment, increased awareness of AI solutions combined with a group of consolidators that may favour acquisition over internal development, and a large cohort of companies reaching scale, create a compelling backdrop for an active M&A market in 2024/25. We still see opportunities for investing in LegalTech as in most cases, the market is yet to reach maturity, but expect the window to close over the next few years as the consolidation trend becomes dominant.

The workflow solutions landscape

The market for attorney workflow solutions spans diverse software products designed to enhance the efficiency and effectiveness of lawyers and legal departments. Covering a broad spectrum that includes legal research and litigation management software, eDiscovery, AI-driven legal assistants, and collaborative platforms equipped with data repositories, these solutions cater to the diverse requirements of legal professionals. They achieve this by automating routine tasks, providing real-time insights, and fostering smooth collaboration among team members.

eDiscovery

eDiscovery involves identifying, collecting, and analysing electronic information, including emails, documents, and databases to support legal proceedings. It plays a pivotal role in assembling pertinent digital evidence during the discovery phase of litigation, serving as an integral element within the broader context of litigation management. 

Specialised platforms streamline the discovery and review of documents, enabling lawyers to analyse large data sets efficiently. eDiscovery is the most mature segment in workflow solutions, with established leaders backed by significant funding from prominent investors.

Looking ahead, we anticipate a relatively subdued level of transactional activity in the eDiscovery space, given its mature nature. An exception could arise if one of the significant consolidators opts to expand its market share through acquisitions.

Contract analysis & automation

Contract analysis and automation tools play a pivotal role in streamlining the multifaceted tasks undertaken by lawyers and legal teams on a daily basis. These tools often leverage advanced technologies such as AI, ML, and NLP to extract critical information, identify potential risks, and automate repetitive tasks, enhancing efficiency and reducing the burden on legal teams and removing human error from the equation. Many players in this sector focus on serving law firms while concurrently extending their services to corporate legal teams. They can reach this broader customer base because their solutions can increase the efficiency of any department dealing with contracts, from sales and procurement to legal operations.

Legal AI assistants

The Legal AI assistants’ market is becoming crowded. The assistants harness the power of artificial intelligence and conversational interfaces facilitated by the LLMs, on which they are commonly built to automate and support lawyers in various tasks. 

Incumbents & rising challengers as consolidating forces

Incumbent legal software providers offer a wide variety of practice management tools and workflow solutions designed for law firms, while others have ventured into leveraging LLMs for legal research, issue summaries, and document drafting.

This innovative offering is designed to answer legal research questions, provide summaries of legal issues, and generate document drafts. Industry leaders serve as gateways for large clients, enabling cross-selling of additional tools based on specific needs.

Ultimately, incumbent providers and well-financed challengers have the resources and incentive to acquire companies with advanced capabilities that would otherwise prove challenging and costly to develop internally. This will likely further drive competition and M&A in the coming years ahead.

The scene is set for a robust M&A market

We have seen that LegalTech is not immune to the broader cooling off in the fundraising market and expect this environment to persist into 2024. This does not mean investing into areas like contract analysis and AI assistants is no longer attractive. Considering the total funding raised by eDiscovery leaders, often in excess of $200m, there is still an opportunity to back the winners in their upcoming funding rounds but expect a competitive environment for investors who will require companies to demonstrate a clear ability emerge as market leaders.

We also anticipate strong M&A activity in the coming years: the market, saturated with well-funded contenders, sees companies vying for dominance by expanding their product portfolios beyond their initial domains, mirroring the consolidation witnessed in the eDiscovery sector during its maturation. We anticipate 250+ M&A deals across contract analytics & AI legal assistants over the next 3 years and expect a significant number of deals over $100m as challengers continue to mature.

As growth-stage companies gear up for a year of potential deal-making, the key to success lies in establishing differentiation within the crowded marketplace. Three fundamental pillars underpin this strategy:

• Technological prowess & unique functionality - Investors & acquirers alike will demand that LegalTech companies have exceptional ability and expertise in leveraging technology and distinctive features or capabilities that set their solution apart from others in the market. A unique technological differentiator is a key way in which companies can signal their potential to emerge as a market leader to investors and acquirers.
• Strong repeat customer base - Companies that can demonstrate a sizeable base of repeat customers set themselves apart in two fundamental ways. Firstly, this demonstrates market demand for their solution, and proves they have an edge over the competition – recurring customers also signal a quality product. Secondly, it makes them attractive to potential acquirers as in addition to the acquisition of the underlying technology, they are also unlocking a cross-selling opportunity. 
• Convenience - In a setting where switching costs can be high, it is crucial to prioritise ease of adoption and provide a solution that is convenient to implement. One way of doing so is by building solutions that can integrate directly with other standard elements in a company’s tech stack. An alternative to providing integrations is servicing multiple business units. This way, you can find your internal champion in the legal, sales, or procurement departments of a customer and proliferate throughout the organisation from there.

In conclusion, whilst there are clear headwinds in the fundraising market, we still see an opportunity for investors to back the winners if they act quickly. Companies can expect thorough diligence processes and must demonstrate they can win in a highly competitive and crowded market. We also expect an uptick in M&A across the contract automation and AI assistant segments, similar to the trend observed in eDiscovery as it reached a similar stage of maturity. The competitive landscape will be mapped out over the next 2-3 years and those who have not reached a certain scale by then risk falling by the wayside.