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Why We Bought $250,000 of LegalZoom Stock

Northwest is LegalZoom’s largest competitor, so when LegalZoom Inc went public, we paid close attention. We also invested more than $250,000 in LegalZoom stock at various buy points between $11 and $15 a share, and we keep buying.

Why? We think LegalZoom is set up to do great in the long run, so it seems like a sound investment strategy. And, since their initial public offering (IPO), LegalZoom is required to report their numbers to shareholders, so now we get to enjoy seeing regular snapshots of their inner workings.

This post is about the lessons we’ve learned so far—about the industry, about ourselves, and about why LegalZoom is such a formidable force in our shared market.

LegalZoom Stock Overview

LegalZoom first tried for a public listing in 2012, shooting to raise $100 million on a $500M valuation, but unfavorable market fluctuations (caused at least partly by Facebook’s decline in value after its IPO) simply got in the way. Instead, the private equity firm Permira pounced with an initial $200 million investment, and LegalZoom used that funding, plus another $500 million more raised in 2018 (at a $2 billion valuation), to build its brand and scale its customer base.

Fast forward to June 2021: LegalZoom did list on the public market, and the initial LegalZoom stock offering released at $28 a share with a valuation of $5.2 billion. At that share price, LegalZoom raised about $700 million that paid off existing debt and created a cash reserve to support further market expansion. The stock price peaked at $39.85 (a valuation of $7.8 billion) on August 10, 2021.

The timing of LegalZoom’s IPO proved exceptional because the broad market and more specifically tech stocks have since trended downward. Today, LegalZoom stock is priced around $12 a share (at a $2.4 billion valuation), which means investors can enter at nearly the same value as LegalZoom’s pre-IPO capital raise in 2018 with arguably better prospects given the company’s continued growth.

Why Do We Like LegalZoom as a Company?

There is a deeply-rooted culture of success at LegalZoom. We know because we used to interact with them regularly before their latest change in leadership and learned a fair bit about them (heck, we even toured their buildings). Their setup is impressive, but the human beings behind it are more impressive.

The company is filled with highly-skilled, highly-educated people with the sophistication and discipline to follow the data and act on it. From the front-line workers to leadership, Legal Zoom brews success. So, while they might make mistakes along the way, their culture of systematically solving problems and reaching high benchmarks seems to overcome whatever hurdles they encounter. That’s a hard thing to pull off with 2000+ employees.

Also, we don’t think they give a crap about Northwest (we think that’s admirable, too). Even though we’re a sizable competitor, and in areas such as registered agent service we’re even larger, they don’t reach out to us. They seem totally focused on growing shareholder value. That gives us a lot of confidence owning LegalZoom stock and going along with their leadership for the ride.

LegalZoom’s Registered Agent Market Position

LegalZoom’s market position for registered agent service isn’t as stellar as you might expect. On the one hand, they’re far and away the most visible, talked-about brand in the digital legal services market (#1, as marketers say, in “share of voice”). On the other hand, from what we can tell they’re in a distant 4th place when it comes to the size of their active client roster in the registered agent sector.

In Washington State, for example, Northwest Registered Agent (that’s us), Corporation Trust (CT Corporation), and Corporation Service Company (CSC) all maintain around 20,000 active clients, while LegalZoom maintains around 2000 clients. That’s about 1/10th of the overall market share, but with LegalZoom’s acquisition of LegalInc Corporate Services, they should sit at a pretty solid 4th place position.

Based on the available industry data, our hunch is that LegalZoom has about 350,000 active, clean-paying registered agent clients. That means clients whose accounts are paid up and who remain in good standing with the state. Northwest, CSC, and CT each sit somewhere between 1-3 million active (and paying) registered agent clients.

Why does LegalZoom’s share of the registered agent sector matter?

When you form an LLC or a corporation in the US, you’re required to appoint a registered agent in each state where you do business. So, for any business that forms companies and provides registered agent service, we would normally expect their business formation numbers and registered agent numbers to march in lockstep. However, it appears that isn’t the case for LegalZoom.

LegalZoom claims to do 10 percent of all business formations in the US. If true, they must do an insane amount of business formation filings where they don’t list the registered agent as themselves, as indicated by their probable 4th place registered agent market position.

LegalZoom’s Business Formation Market Position

LegalZoom has established their brand as the household name in business formations. In fact, they so completely dominate the public’s imagination that most people don’t even bother searching terms like “how to start an LLC in California” when doing their research in Google. They just search “legalzoom,” “legal zoom,” or “legalzoom llc.” It’s as if there’s no difference between starting a business anywhere in the US and a particular company (LegalZoom) that can help someone do it.

Let’s take a moment to appreciate that. It means LegalZoom bypassed the need to educate the market about business terms to attract web traffic and potential clients. What an accomplishment!

Establishing a brand position within a new market category is no easy feat, and it’s not for the short-term focused faint of heart. To that point, we estimate LegalZoom spent about 20 years and accumulated net losses of $750 million to create their current brand position and share of voice. If you’re looking to buy stock likely to grow in value, we believe LegalZoom stock has that potential.

Can anyone compete with the LegalZoom brand?

To compete with LegalZoom’s hold on business formations, competitors will need focus their branding, communications, and marketing on the long game. Maybe that’s 10-15 years. Maybe that’s a $750 million+ budget. In any case, it means accepting net losses all the while to build out the enormous fly-wheel they’ll need.

Of course, plenty of LegalZoom’s competitors are already trying:

Taken together, it’s clear that private equity, venture capital, and public companies are placing significant investments in this market, but the reality is that they will likely bash their heads against the wall trying to compete with LegalZoom, and they’ll face two key obstacles along the way:

  • Painfully high costs per new customer acquisition relative to the lifetime value they’ll get out the clients they acquire; and

  • Dismally low retention rates for business formation clients.

That’s right: retention for business formation clients stinks. Starting a business is hard enough, but sustaining that business is so much harder. Because of this, LegalZoom likely has a high churn rate. This means they form a ton of new business one year and likely lose a boatload of those clients the next. Their competitors should expect the same thing.

Are LegalZoom’s Services Any Good?

In our opinion, it’s almost a moot point if LegalZoom’s business formation services are any good or not when they spend $250 million a year on advertising to spur their growth. It’s been our experience that when it comes to branding, perception is reality, and LegalZoom is one more company brand that proves that people will just buy from the best known brand there is.

What about LegalZoom’s Prepaid Legal Services?

We don’t see anything game-changing in LegalZoom’s Prepaid Legal Services. Paying around $50 a month to have a client use an app or phone number that routes to a local lawyer that has been subcontracted with through the LegalZoom legal service plan aggregator isn’t, in our view, super impressive.

That’s because when the client goes to schedule something with the local lawyer, they’ll often discover that the sub-contracted local lawyer tells them their $50 a month prepaid legal plan didn’t cover what they need and their normal hourly rate is $250, and with a legal plan they get it for $200. Paying unexpectedly more simply isn’t a great client experience in our view.

It’s not really LegalZoom’s fault, and the product is gonna do what it’s gonna do: pull in some revenue. But, when it comes to being revolutionary or truly market differentiating, there’s probably nothing much here to see.

What about LegalZoom’s Accounting Plans?

Buy Buy Buy! Intuit’s product mix, including Quickbooks, TurboTax, Credit Karma and Mailchimp (among others) wasn’t built overnight.

From what we can tell, it’s not a matter of if LegalZoom will become some kind of skinned down Quickbooks. It’s a matter of when. LegalZoom’s 2020 acquisition of Purely Solutions (bookkeeping, tax preparation, and payroll) started this, and they’ve basked in their last couple investor presentations about the potential. However, in the process LegalZoom did make Quickbooks insanely more annoying for the customer and more profitable for Quickbooks.

Once they start getting traction with these products leveraging their brand position, there is potential to reach over a billion dollars of revenue for these services (that’s just about 10% of Intuit’s size today). We’re hoping to have invested over $1 million in LegalZoom shares by the time they really create scale in their Accounting Plan.

Why LegalZoom Will Remain Successful

In the end, it’s clear that the real key to LegalZoom’s success is leveraging client data. They leverage their client’s data over and over and over again to where they don’t have to worry about client retention. These deals, such as LegalZoom’s partnership with Wix to help busines clients build an online presence, are super hard to put together in a meaningful way, and LegalZoom is simply crushing it repeatedly with these deals.

LegalZoom understands that there’s only so much market penetration $250 million a year spent on marketing can do to attract people who want to form an LLC. And because of their all out marketing blitz on paid media in 2021 to impress investors for an IPO, they have subsequently raised the cost of new customer acquisition for the entire industry, which now greatly exceeds the average lifetime value of each client. (Thanks!)

But, again, for LegalZoom that doesn’t much matter. Leveraging client data is their true bread-and-butter.

Could a competitor unseat LegalZoom? Maybe someone will… and more power to them if they do. But, as to what the future will likely hold, here’s our best guess:

  • The other players, with all their money, at some point will realize they’re still about $500 million and a decade away from becoming the Chevy to LegalZoom’s Ford.
  • Maybe someone will play the long-game well and finally grab the #2 spot in brand awareness, but LegalZoom will still be #1.

None of this makes much difference to us. We don’t leverage client data. We care about client retention just because we do. And, our share of the market doesn’t depend so much on widespread brand recognition as on truly delivering on our core values year after year.

So, yeah, we invested in our biggest competitor, and we intend to keep buying LegalZoom stock. We have every reason to believe our investment will increase in value along the way.

Good luck, LegalZoom!

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