LegalZoom Stock: Investing in Small Business Growth

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Everyone’s a wantrepreneur. They have some great idea in their head that they’ll tell you if you’ll promise not to tell anyone. These are the sort of folks who would ask a venture capital firm to sign a non-disclosure agreement (amateur hour move). Then there are those who take a few more steps. They design a logo, throw up a splash page, and create some business cards. They’ll then promote themselves for several years winning “awards” and perhaps some paltry checks from an incubator before the whole thing finally fizzles out. Then, there are those who have the tenacity to succeed – the select few.

Regardless of which category of entrepreneur you fall into, there’s a company that has what you need to start your business. And they’re counting on a whole lot more businesses to be created to fuel future growth.

About LegalZoom Stock

The last time we looked at LegalZoom (LZ) was late last year in a piece titled 6 LegalTech Startups Disrupting the Legal Industry. Now, we can dig into their S-1 IPO filing to learn about business model specifics. LegalZoom attracts customers at the time of business formation, and then continues to serve their legal and compliance needs for life with a mix of transaction and subscription services. Over 60% of small business customers purchased one year of a subscription service at the time of their initial formation purchase (a transaction), and over half of their small business customers purchased at least one third-party solution at that time. The latter represents affiliate revenues or what LegalZoom calls “Partner” revenues which make up a small percentage of overall revenues.

Credit: LegalZoom

Transaction revenues represent a single purchase made by a customer, while subscription revenues represent yearly subscriptions to products or services. As for retention rate, that sits at around 68%, a number that may sound bad until you consider that 20% of all businesses fail within one year of forming. Around 60% of their subscriptions are for a “registered agent service,” a subscription service that most states require for businesses to receive legal notices and critical mail. In the fourth quarter of 2020, they began providing tax, bookkeeping and payroll subscription services. This business model works well, just as long as Americans are starting new businesses.

While we usually focus on revenue growth above all else, it’s comforting to see a company that’s generated a profit for two years in a row. That fiscal responsibility is also evident in their use of IPO proceeds to completely erase about $560 million in debt. The question is, just how much of an opportunity is there in America’s small business operators?

LegalZoom’s SAM

In 2020, 10% of new limited liability companies, or LLCs, and 5% of new corporations in the United States were formed via LegalZoom. With around 4.4 million new business formations annually, LegalZoom has captured about 8.6%% market share (378,000 new businesses formed in 2020 used LegalZoom). That total number of new businesses is also growing, with the number of business formations in the United States having grown for 26 of the past 30 years on a year-over-year basis. In this respect, there’s a lot of upside for the firm, but perhaps not as much as they think.

Remember how we talked about total addressable market (TAM) vs. serviceable addressable market (SAM)? The former is the total opportunity, while the latter is what a company in it’s current state can actually capture. Here’s how LegalZoom views their SAM which they calculate to be a whopping $48 billion.

Credit: LegalZoom

These numbers include the 31.7 million existing small businesses in America with 50 or fewer employees (LegalZoom’s target demographic) that they hope to sell services to. That’s not exactly blue ocean, because all these businesses currently have vendors they’re using. In order for LegalZoom to capture $37 billion of that SAM, they’ll need to steal it from other competitors, of which there are plenty.

Competition

Offering canned legal services to consumers and businesses isn’t a novel idea, and LegalZoom lists a number of competitors in their S-1 filing that compete with them on the new business formation aspects of their business:

  • Rocket Lawyer – With total disclosed funding around $269 million, Rocket Lawyer is the most formidable of LegalZoom’s competitors.
  • BizFilings – Small firm that’s been around since 1996 with no mention of funding in Crunchbase. Provides rush business incorporation services to entrepreneurs.
  • LegalShield – Around since 1972, LegalShield could hardly be considered a startup. The firm provides access to legal services offered by a network of provider law firms to members and their family members.
  • MyCorporation – Acquired by the owner of Quickbooks, Intuit, back in 2005.

In addition to these names, other competitors come into play as LegalZoom expands their business offering beyond business formation to include consumer legal needs such as estate planning.

Brand Recognition

Back before we found our way, we were putting food on the table by selling other people’s products. That led us to publish articles like The Cheapest Way to Get a Divorce Online, a piece in which we talked about how LegalZoom was using a service called Wevorce for do-it-yourself divorces. It’s just one of many consumer legal needs that LegalZoom can fulfill by being in the right place at the right time.

Throughout their S-1 filing, LegalZoom emphasizes the strength of their brand and the high levels of customer satisfaction (also referred to as “net promoter score” or NPS). LegalZoom can leverage the power of that brand to expand into other areas of business, whether that’s organically or through acquisitions. Every business has an owner who has personal taxes to file, or a will that needs to be written. So do all their employees. Some areas that LegalZoom dabbles in currently that could provide further expansion opportunities include:

Credit: LegalZoom

LegalZoom estimates estate planning to be an $8.8 billion a year business which seems quite high. Their estate planning bundle costs $179, so that means 49 million people will write a will every year? Doesn’t seem likely, but it’s still an opportunity to be captured. As for taxes, that’s one ultra-competitive space that they’ll need lots of marketing dollars to capture, even with their strong brand name.

To Buy or Not to Buy

While there’s plenty of gas in the tank for growth, we think LegalZoom’s SAM estimates are a bit far-fetched. Just how many marketing dollars will they need to steal tax services away from well-entrenched companies like Quickbooks or Xero? We’re also wary of the transactional aspects of their business and their overreliance on America’s youth for future growth. When a regulatory filing spells out how many divisive D&I clubs have been formed internally, it paints a picture of a firm that’s not focused enough on what really matters – execution. If you compare LegalZoom to DocuSign (DOCU), it’s a no-brainer as to which legaltech stock risk-averse investors ought to be holding.

Conclusion

One thing the Americans have always brought to the table is their girth – and entrepreneurial spirit. That’s literally what you’re betting on here. Having such a strong dependency on a single country is a risk. So is having 45% of revenues coming from transactions as opposed to subscriptions. LegalZoom is a decent legaltech stock for anyone looking for an easy-to-understand business that’s entirely dependent on the continuing ability for Americans to innovate.

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