When LegalZoom.com Inc. decided to forego an initial public offering this month and take $200 million in private equity money, two conclusions quickly became evident. The Glendale company still has big growth plans, but it seems to prefer to execute them outside the eye of the public markets. And with good reason. The business of providing online legal services is a nascent industry with huge growth potential, but the firm’s fortunes hinge on a thorny issue: future regulations that will largely be shaped state by state in pitched battles with vested legal interests. “The biggest obstacle is regulatory. It’s a revolution in the legal services market,” said John Grimley, an attorney in Los Angeles who works as an international business development consultant for law firms. “The bar associations are not allowing a modern regulatory regime to meet the demands of individual and corporate consumers.” Earlier this month, Glendale-based LegalZoom announced that Permira, a London investment fund best known for buying genealogy site Ancestry.com LLC for $1.7 billion, would become LegalZoom’s single largest stockholder. In conjunction with the $200 million sale, LegalZoom cancelled a public offering of its stock that had been in the works since May 2012. LegalZoom is the largest player in the online legal service sector, providing legal forms for small businesses that include LLC formations, incorporations and trademark applications. It also sells forms to individuals for wills, living trusts and powers of attorney. The company had 2011 revenue of $156 million and profits of $12 million, a turnaround from the previous two money-losing years, according to its May 2012 prospectus. Permira has the resources to give it a financial lift, with its portfolio of $30 billion in capital and an equity portfolio of 24 companies, according to the fund’s 2012 annual report, submitted under U.K. securities regulations. In its announcement of the Permira deal, LegalZoom said the money would “support LegalZoom’s continuous launch of new products and services that address an ever-widening set of customer needs.” The company did not make an executive available for interview. But Gillian Hadfield, professor at the USC Gould School of Law and a member of the legal advisory board at LegalZoom, sees huge potential for the company and the online legal market by serving people who traditionally can’t access legal services. Because a typical attorney charges about $250 an hour, only a fraction of people can afford one. By offering a low-cost alternative, LegalZoom can reach the 90-plus percent of the population that is unserved. “Currently, we see the market as document production, but there’s a lot more to it,” Hadfield said. “You could imagine processing court documents online, probate, and general legal advice on a problem with your neighbor or your kid’s private school. And that’s not fantasy. Everything I’ve mentioned is currently available in the U.K.” Regulatory restraint Still, LegalZoom has faced legal actions in a number of states accusing it of the unauthorized practice of law. And its prospectus from 2012 states that the first risk factor for its business model is “complex and evolving U.S. and foreign laws and regulations regarding the unauthorized practice of law, legal document processing and preparation, legal plans, privacy and other matters.” The company provides instructions for filling out forms, but if the questions become too complex, the company refers the customer to a local attorney. It also offers subscription plans that include lawyer consultations. Grimley said LegalZoom poses a threat to traditional law firms, which have taken a haphazard and inefficient approach to marketing their services. And the threat could involve more than just solo lawyers and small family firms. “For now they focus on the consumer market, but LegalZoom has established a platform that could diversify and reach into the competitive territory of boutique firms and mid-level corporate law firms,” Grimley said. The day may come when LegalZoom or another company finds the legal work and gives it to its attorneys who either work as employees or as subcontractors – upending the dominant business model of the legal profession. “That’s what should really scare law firms,” Grimley said. Hadfield from USC believes that economic and political pressure is mounting on regulators to change the rules in favor of low-cost alternatives to lawyers, including LegalZoom. “It’s a huge potential market, but its future in the U.S. is the future of the regulatory landscape to allow those developments,” she said. “Those who are betting on this company are betting that the regulatory landscape will shift. I think it’s already starting to shift.” In its prospectus, LegalZoom outlined two strategies to grow the company: a switch to subscription services and geographic expansion beyond the United States. Nellie Akalp is chief executive of CorpNet.com, a Westlake Village company that provides document and legal services similar to LegalZoom, but focuses exclusively on small-business clients. She said the online legal market is a rising tide that’s lifting her company, but thinks that most of LegalZoom’s growth will depend on moving from one-off document sales to subscriptions. “In the online legal industry, documents have become a commoditized service,” she said. “The subscription model is really the one that’s going to work to grow the company and build a residual income.” For example, CorpNet offers a compliance service that alerts business owners of tax, legal and other regulatory deadlines, and then offers to help them meet their obligations. LegalZoom also has subscription packages that include free attorney consultations on new legal matters, review of LegalZoom interactive documents, and “registered agent” service for corporations that are required to have a lawyer in their state of formation. U.K. partner As for international expansion, LegalZoom plans to replicate its U.S. model abroad by targeting small businesses and consumers in other countries, according to the prospectus. Hadfield said it takes capital to create valid legal document formats in other countries, but LegalZoom can spread the investment cost over a large customer base. “There are costs associated with adaptation, but they aren’t prohibitive,” she said. But that may be another reason why LegalZoom chose a U.K. partner rather than the U.S. public markets. Permira has deep pockets and typically holds an investment for five to seven years, which should be enough time for LegalZoom to at least make headway in the U.K. and possibly Europe. Permira did not make an executive available for interview, but a source familiar with the firm who requested anonymity said the fund usually takes a controlling interest in companies with potential for international expansion. In 2012 it invested in four companies and divested eight. The prospectus valued LegalZoom at about $484 million, meaning that Permira’s $200 million stock purchase should give the fund slightly less than half the equity. LegalZoom’s management team will maintain ownership as will the previous investors, including venture capital funds Polaris Venture Partners and Institutional Venture Partners. It is unclear whether Robert Shapiro – the well-known lawyer, co-founder, shareholder and public spokesman for the company – will retain ownership in the company. He did not return calls for comment. Permira plans to keep LegalZoom in Glendale and doesn’t foresee any staff cuts. “This is a growth story,” the source said. Akalp, the competitor at CorpNet, said she sees the potential for more private equity deals in the industry. “In general, sales volume continues to rise,” she said. However, LegalZoom and Corpnet are not operating in a vacuum and the pressure will be on to expand fast as other companies try to get a piece of the action. For example, Grimley pointed to LawKick, an online lawyer referral site based in Los Angeles. “There are a lot of potential competitors and the market will become saturated,” he said.
LegalZoom Pulls Back IPO
