Some advice for Legal AI startups

What most outsiders just don't get about the legal industry

Legal AI is definitely overhyped right now. Startups are getting absurd valuations left and right, with minimal revenue. Why’s that happening? Well, it all seems to be driven by investor demand. Venture capitalists are super excited about the possibility that generative AI could replace lawyers. As a result they’re posting bad takes like this:

Any startup focused on legal AI needs to recognize that the legal ecosystem is very unique. It’s made up of a bunch of different players with no analog in other industries. It’s not just licensing/bar exam requirements, or the profession’s obsession with gatekeeping work via unauthorized practice of law rules. It’s also a combination of industry quirks that make it impossible for outsiders to disrupt all in one go.

Don’t get me wrong: There will be plenty of disruption in minor pockets of the legal industry. The move to the cloud was not the sexiest of trends (compared to this wave of AI hype) but it definitely transformed a lot of the way lawyers handle contracts, e-discovery, and more. Historical examples abound, like when email or legal research databases came on the scene.

There is no question that legal will be disrupted by tech.

Having said that, my sense is that investors and tech startup founders dramatically overestimate their grasp of how the legal ecosystem operates. Any time a VC/founder has a bad experience with a law firm, they suddenly become motivated to disrupt legal. In fact, that’s Atrium’s founding story.

As a “power user” of legal services over a decade in the startup industry, through the foundation and fundraising of startups like Justin.tv as well as the work he’s done as an investor and advisor to companies through Y Combinator, Kan says he was frustrated by how little technology was being used in the process of interacting with various law firms. (Source)

And as we all know, Atrium—despite it’s huge backing from VC investors, ended up flaming out spectacularly.

Why did that happen? There are a lot of reasons, some of them generalizable, some of them not. But overall the Atrium story does illustrate a common phenomenon in tech circles: Outsiders dramatically underestimate the difficulty of transforming the legal industry’s workflows, and overestimate their own ability to replace lawyers.

In today’s article I’m going to share a few truths that most industry insiders are already aware of but outsiders might not be.

1. High hourly rates are not as big of a problem as they appear

So many legal tech startups are founded under the premise that law firms are too expensive. Most of the discussion revolves around absurdly high hourly rates charged by the largest firms. This is usually presented as the market opportunity: If some $30k/year tech subscription can potentially handle 90% of the work a $1,000/hr second year associate can handle—what client wouldn’t immediately jump on board?

Quote from the TechCrunch article covering my first legal tech startup’s Series A:

The company charges per user, and a small law firm can expect to pay $15k-$30k per year. Expensive yes, but not if the alternative is paying hundreds of extra hours in legal fees at $600 per hour.

Without getting into the specific reasons why law firm services are uniquely valuable in the ecosystem (more on that below) there’s a simpler reason why this is not a problem. Clients generally *do not* have a problem paying those rates. If they’re paying a junior $1,000/hour, they’re likely also paying for a $3,000/hour partner who’s worth far more than that rate.¹

Clients aren’t dumb. They look at the whole bill. And when you have a $2 billion matter, you find the best damn law firm you can and pay them whatever they want. Because at that point, paying $20 million or $30 million doesn’t matter; it’s just a rounding error. How the firm decides to allocate the cost is irrelevant—the real question is how much did the whole thing cost relative to the legal exposure involved?

Now it’s true that not all firms get asked to handle these types of matters. Only a select few are tasked with handling bet the company litigation or high stakes M&A. However—all other firms, the ones who handle more routine matters—are *not* in fact charging absurd rates. There, the story is reversed, where clients are pushing back hard on rates.

Doesn’t matter if it’s $300/hour for a junior or $600/hour for a partner. These rates may seem crazy high when hiring an attorney for ourselves—but that’s not the right comparison to make. For corporate clients, that’s not a lot—in fact it may translate to $30k-$100k in legal fees, which is completely fine for routine matters involving millions in potential legal exposure.

Key takeaway is that the absolute amount of legal fees doesn’t matter. The only thing that matters is how much that is relative to the total potential legal exposure. How much you’re paying per hour for each individual lawyer matters even less.

Example of a bill from Wachtell Lipton. These are big numbers and they look crazy—until you realize it was for a multi billion dollar case.

2. Law firms hold a unique position within the legal ecosystem

Another reason why corporate clients are willing to pay outside lawyers so much is because law firms provide more than just the work. They provide the imprimatur of a professional services organization with a gold standard reputation that’s been around for decades if not centuries. It’s similar to why companies will pay consulting firms like McKinsey a heavy premium—it’s not just for the work product itself.

I think most people who lack familiarity with the legal industry are totally unaware of this dynamic. They view law firms similarly to say, a marketing agency that processes work. They think that if technology can replicate 90% of what the outside agency (or law firm) does, at a fraction of the cost, clients will throw themselves at the tech.

That’s just not how things work in the legal industry. Law firms are incredibly unique players in the legal ecosystem because:

• First, law firms solve highly ambiguous problems. To use the earlier example, marketing agencies often operate in relatively unambiguous environments. They run ad campaigns or create landing pages. These are not novel problems that require novel solutions. The work is straightforward. They either solved the problem and did a good job, or they didn’t.

  
  Law firms, on the other hand, don’t have such clear cut standards. It’s often hard to tell whether the firm’s lawyers made the right decision. When the client settles a case—could it have been settled for more or less? When the client receives a memo suggesting a well thought out course of action—how can you be sure that there’s a better alternative?
  
  This ambiguity is why the legal industry also focuses so heavily on signals or proxies for quality. It’s why we, as lawyers, are so obsessed with law school and law firm pedigree. We can’t really *tell* how good something is, so we look at the surrounding qualities. It’s why big firms focus maniacally on the details. If you can’t get the little things right, the thinking goes, how can you convince your clients that you can be trusted on the big things?

• Second, corporate legal buyers by and large come from law firms. Every big shot Chief Legal Officer or General Counsel likely started off their career at a large fancy law firm. These firms spend a lot of resources and branding efforts to convince their employees and clients that they are top notch. See, e.g. the existence of summer associate classes, which are less about recruiting and more about brand marketing.
  
  Could you imagine what it would be like if Chief Marketing Officers all went to marketing school and started their careers at a handful of top marketing agencies that spent millions of dollars every year convincing themselves that the agency’s full of amazing marketers? I’d be willing to bet that those agencies would hold a special spot in the marketing ecosystem.

Add up both of these factors, and you start to understand why law firms have such a stranglehold on corporate clients. And to be completely fair to the law firms—it’s often completely justified. Law firms are full of extremely talented lawyers who aren’t just good at the work itself—they also have strong decades-old reputations. Which means there’s a level of accountability that a hot new AI startup doesn’t have.

Which leads me to my final point.

3. Trust matters a lot more than efficiency

This is the one thing that startups could really learn from law firms. Because of the nature of the work, law firms have to be trusted by their clients. Trusted not to merely do good work, but to also do right by them. There are all sorts of professional standards, ethics, and rules that govern the interactions between lawyers and their clients.

The startup world, on the other hand, is like the wild west. I don’t mean that in a purely bad way—in fact, I’ve found that personally, I fit in much better at startups. However, there are some things about the wild west I don’t particularly like—and I suspect corporate clients don’t like either.

There is far less accountability to clients/customers in startupland. People who run and work at typical startups often view themselves as outsiders to the industries they serve. They feel like they belong to the founder community, or the venture capital community, or the tech sales / customer success community. They are often more interested in building long term relationships with their own industry peers—as opposed to building those relationships with their clients.

Now this is definitely not always the case. Many founders and employees are legal professionals themselves, and feel a strong connection with the legal ecosystem. Many founders and investors are lawyers as well. Plenty of successful startups have built strong long term relationships with the community they serve.

However, I’ve seen a lot of bad behavior over time. Like overstating product features to buyers just to get the deal done. Or lying to prospects about the product roadmaps. I have seen this bad behavior from startup people who are lawyers and non-lawyers alike. I think at the end of the day, these people do not care, because they believe that these customers/clients are not people they have to do business with in the future.

So when you have startups engaging in this kind of behavior, legal buyers naturally exercise a ton of skepticism. Whether it’s a law firm buyer or an in-house legal department buyer—everyone’s been burned enough times to know you have to keep your eyes wide open. Or as one potential client said to me at a legal conference last week: “I know you’re going to tell me how great you are—let’s see if your clients say the same thing.” ²

For startups that do want to do right by their buyers—I would recommend this: Tone down on the talk tracks around efficiency, and ramp up the talking points around trust and accountability. Legal buyers will find your candor refreshing—and who knows? You might be able to convince them to sign on the dotted line faster than you otherwise would.

Conclusion

If you’re a legal AI startup founder, employee, or investor—sorry if I’ve offended you! My hope with this article is to convey what legal buyers care about, and why this space is unique and different from other industries. Starting and running a company, or working on the front lines of a startup, all while creating new technology is a tough job. Please don’t get swept up in the disruption talk and make your own job even harder.

Personally, I truly believe AI will change the legal industry for the better. I’m already starting to see it in a lot of places. Usually from technologies focused on solving real problems and products that appeal to law firms/legal departments instead of investors. Sometimes the startups that take this route have a longer journey, with a lot more bumps on the road.

But in the legal industry, longevity matters. Trust and reputation matters. So as long as you do right by your clients, you will end up just fine. Even if it takes a little bit longer than you expected.³

1. Charging clients based on time worked can both overstate and understate your value. You can imagine how a quick phone call with a true subject matter expert can be worth far more than the $3,000/hour she charges.

2. I’m paraphrasing but this was the gist of it. And it wasn’t the first time a lawyer has said something like this to me.

3. The principles in this article serve as the hiring philosophy behind my company, Latitude Legal. We are hiring for sales, but if you look at the job description or my LinkedIn post describing the role—you’ll find that it probably looks very different than most legal sales jobs.