On Jan. 6, D.C. investment firms The Carlyle Group and Revolution Growth acquired Virginia-based e-discovery solutions provider LDiscovery. On its face, this is nothing new—outside financing occurs all the time in business. But the price tag—a reported $150 million—perhaps is.
Perhaps that figure shouldn’t be too surprising, though. The International Data Corporation (IDC) found that the global e-discovery market surpassed $10 billion for the first time in 2015, with more than $2 billion of that total coming from e-discovery software alone. Moreover, IDC estimated a 9.8 percent compound annual growth rate, meaning that services and software will total over $14.7 billion by 2019.
It’s safe to say that those numbers are attracting the sharks. “How many 10 billion dollar, growing markets are there? Very few,” says Andy Howard, a partner at Shamrock Capital Advisors and lead advisor on the firm’s investment in e-discovery provider Consilio. “That’s why there’s money being attracted to the vendors, but you’ve got to play it in a smart way.”
So what constitutes a smart investment in the current e-discovery market? The Carlyle Group’s reasoning for the LDiscovery acquisition is instructive.
William Darman, managing director of the U.S. middle markets group at Carlyle, explains, “The management team is tremendously strong; the industry macrodynamics are certainly attractive; the company offers a service model that is differentiated from its peers and very much enabled by a world class technology platform; and significantly, this is a business that we think has tremendous growth potential organically but also as an acquisition platform.”
The Acquisition Situation
While discovery has been a part of the American legal system since its inception, the concept of e-discovery as a business is less than two decades old. From an outside perspective, one may think that this means e-discovery businesses are inherently more risky because they haven’t had enough time to stabilize. However, many investors instead view the market’s lack of maturity as an opportunity.
“That’s right up the alley of private equity and professional investors,” says Andy Macdonald, CEO of Consilio. “It gives them a chance to buy organizations, consolidate, pick up scale which should juice margins, and deliver pretty good returns from an equity investor standpoint.”
Consilio has put this action plan to work. In August 2015, it closed a deal to be funded by Shamrock rather than the operationally-focused Vista Capital Partners. By December, it had already made a number of acquisitions, most notably the $112 million purchase of Huron Legal from Huron Consulting Group.
“We went out and spoke to about a dozen PE firms, with the thought process of, the e-discovery business itself on a macro level is growing ridiculously fast. It’s about a $10 billion marketplace, growth is above 10 percent, with no real dominant player, and a lot of smaller or medium-sized companies that are getting squeezed from the standpoint of compliance and infrastructure where it’s ripe for consolidation,” Macdonald explains. “Our thesis was, pick a platform like Consilio, put some capital behind it, let’s get four, five, six investments, consolidate, pick up some synergies, and it should be a wonderful return for the shareholders.”
In October 2015, Mitratech received a strategic investment from TA Associates, a move which the company said at the time was primarily to further future acquisitions and global expansion. Looking back, Mitratech CEO Jason Parkman tells Legaltech News that TA Associates had been pursuing Mitratech for an extended period of time, specifically looking for a legal technology company that had “very clear growth paths and growth expectations.”
“The business has been running really well, and TA was really looking to say, ‘We see a business that can really be not just a strong and growing business, but can really be a continued area of investment in this growing area of legal technology for the future,’” Parkman says.
And these acquisitions aren’t likely to slow down, Macdonald adds: “The consolidation opportunities will begin to accelerate, because as more people like Shamrock and Carlyle and Revolution and others enter the space, they have money that they need to put to work from an investment standpoint. So these will drive acquisitions.”
Becoming Ol’ Reliable
Investors and e-discovery executives also note that the legal department is becoming increasingly integral to the success of the business as a whole. And when added to the fact that new technologies are being added to business functions with increasing regularity, the business prospects for legal technology companies are compounded.
“The legal aspect of the business world today has become so material to even the survival of a company. There’s so much risk, so much litigation spend, so much regulatory and compliance pressure that the legal area within a corporation and relationships with outside counsel have become absolutely material to the survival of companies,” Parkman explains. “So all those things that software does in general become that much more important when you look at it through a legal lens.”
He adds, “All those things are coming together so that people who may not have paid much attention to legal from an outside investment standpoint before are realizing now that it’s actually a pretty exciting place.”
With this increased reliance on legal software comes increased reliability for investors, Macdonald says. He notes that the first wave of e-discovery investment happened between 2005 and 2007, but investors may not have seen the returns they were looking for. When Consilio was previously part of a larger company as First Advantage Litigation Services, for example, the team would receive a massive influx of funds for one quarter (such as working discovery on the Siemens FCPA case) that it could not subsequently maintain.
Given the current legal climate, however, Consilio now has agreements directly with many corporations rather than individual law firms on an as-needed basis. And that change has made all the difference when talking with investors.
“The world of e-discovery has changed a bit where the revenue sources are now coming from corporations where we have master service agreements in place. While it’s not a guarantee of a constant stream of revenue, it creates a vision of a bit more predictability. I think that allows the professional investor to be willing to place a bet,” Macdonald says.
With Consilio’s investor Shamrock, Howard agrees: “Smaller companies, when I look at it, can have one or two or three big clients which is fantastic, but you run a lot of risk with them, because you’re dependent upon those big companies.” He also adds that although these companies often come with a smaller price tag for investors, “It’s not about pricing at the end of the day. It’s about providing the best services and enabling us to get the best resolutions.”
The next wave of investment cash may not be headed to companies that exclusively work the American market, though. Howard says that when striking a deal with Consilio, he looked at three main attributes: the management team, the growing e-discovery market as a whole, and finally, international expertise.
“There are a lot of players here, but only a few have the international capabilities with global corporations handling their most sensitive matters. … It’s one thing to have expats in a market; it’s another to actually have in-market personnel who know the laws, who know the people, who know the matters,” Howard says.
The IDC e-discovery figures back up this assertion. By 2019, Europe will be almost 23 percent of the global e-discovery market, the study found, and Asia will be over 7 percent.
And don’t think this fact is lost on investors. Evan Morgan, a partner at Revolution, told Legaltech News that one of the firm’s motivations for the LDiscovery acquisition is “expanding the current customer base both domestically and internationally.” Similarly, Parkman says that international expansion was a consideration as well for TA Associates’ acquisition of Mitratech as well.
“What we’re seeing now though is not just the importance of litigation, but the importance of the broader legal environment, including compliance and regulatory issues,” Parkman says. “Those are global issues that could exist for companies anywhere in the world, regardless of how litigious their particular country is. Because of that, that’s one reason you’re seeing the expansion of technologies globally, because these issues are truly global in their scope.”
“When folks look at where the e-discovery market is going today, certainly there’s a growth in stored information, but we see significant growth that is outpacing U.S. growth outside the country,” Macdonald adds. “The growth of opportunities and the growth of revenue in Europe and Asia far outstrips the growth rate in the U.S.”
These factors mean that, moving forward, investors will likely continue to flock to the e-discovery space. “It’s still not 100 percent a business where you can sit back and say, ‘I know what’s going to happen a year from now,’” Macdonald says. “But as we get bigger and other companies get bigger and there’s a bit more scale and a little more diversity of client types, I do think private equity investors have enough of a sense of where revenue is coming from that they can actually put their money to work.”