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Is IPO Stock LegalZoom.com a Buy?

By Robert Izquierdo – Jul 22, 2021 at 11:42AM

Key Points

  • LegalZoom fulfills a key need for its customers, which include both individuals and small businesses.
  • Its recent performance reveals strong revenue growth, even during the pandemic.

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This 20-year-old legal services company is now public. Discover if it's a worthwhile investment.

The 2021 market for initial public offerings (IPOs) is hot with a record high of nearly $350 billion raised during the first half of 2021, according to Bloomberg.

Among the flood of recent IPOs is LegalZoom.com (LZ -1.76%). This legal services platform went public on June 30 with the IPO pricing at $28.00 per share. By the end of its first day of trading, the stock had jumped 35%.

LegalZoom was founded 20 years ago and attempted to go public in 2012 before withdrawing its offering. Now that it's publicly-traded, is the company worthy of investment? Let's dig into the business to find out.

Two business people sitting in an office reviewing info on a tablet.

Image source: Getty Images.

The business model

LegalZoom focuses on making the byzantine U.S. legal system accessible to everyday people. Its online platform provides affordable self-serve options, and if more help is needed, it can connect customers to the company's network of lawyers.

While LegalZoom's offerings are available to individual consumers, its customer base is predominantly small businesses with up to 50 employees. These customers are LegalZoom's key revenue-driving segment for good reason. Small businesses often can't afford in-house lawyers, but they still must meet many legal and regulatory requirements.

The company helps small businesses get started (referred to as business formation) and with ongoing legal needs. Its customers can pay flat fees for one-time services, called transactions, or sign up for a monthly subscription for recurring benefits such as access to lawyers. The company also collects fees for sending leads to a number of third parties -- for example, bookkeeping services. The company refers to these third parties as partners.

LegalZoom's revenue breaks down as follows:

Revenue by Type 2020 2019 YOY Change
Transactions $212.1 million $168.3 million 26.0%
Subscriptions $229.8 million $206.4 million 11.3%
Partner Fees $28.7 million $33.6 million (14.7%)

Data source: LegalZoom. YOY = year over year.

Subscriptions accounted for nearly half of the company's 2020 revenue, a positive development since they offer a predictable recurring revenue stream and deliver a higher gross margin than LegalZoom's transaction services. In the first quarter of this year, over 60% of small-business customers purchased a one-year subscription.

Partner revenue declined last year as the company decided to stop some partner arrangements that didn't align with its strategies.

Recent success

The importance of its small-business customers means LegalZoom's number of business formations is a key metric. The company had 378,000 business formation orders placed last year, up from 292,000 in 2019. Business formations accounted for over 40% of transaction volume last year.

LegalZoom's growth strategy is straightforward. It markets to small businesses to acquire new customers and to keep its business-formation numbers up. From there, it encourages these new customers to adopt a subscription plan or pay for other services, such as a tax advisor (launched last year). The company intends to expand its services into several areas important to small businesses, such as payroll, accounting, and even web hosting through partnerships.

So far, the strategy is working. LegalZoom's 2020 revenue grew 15.2%. Its first-quarter revenue increased 27.3% year over year to $134.6 million.

Free cash flow also rose 43.2% to $28.5 million during the quarter, while gross margin expanded half a percentage point to 67.3%. The company expects gross margin to continue increasing over time as it introduces greater automation into its online platform, and its share of subscription revenue expands.

While LegalZoom has reported strong results, its balance sheet is far from ideal. At the end of the first quarter, the company had $141.2 million in cash and equivalents but $514.6 million of debt. That said, management intends to use part of its IPO proceeds to pay off this debt balance.

The final verdict

LegalZoom has a lot to offer potential shareholders. It has been in business for decades, and in that time, the company has built up an ecosystem of partners and lawyers. It offers services in all U.S. states, providing a platform that can navigate the legal complexities of each state. And LegalZoom benefits from a growing U.S. online legal services market. The industry size expanded from $4.3 billion in 2011 to an estimated $8.5 billion in 2020.

But even if revenue growth is sustainable through 2021 and beyond, don't expect LegalZoom to become a top growth stock. It relies too heavily on business formations right now. If the company can continue growing subscriptions and partner revenue to reduce its dependence on that segment of its transactions business, LegalZoom can produce more reliable, higher-margin revenue. The management team is looking to do exactly that.

Small businesses will always need quality legal help, and LegalZoom is positioning itself well to serve them. For investors who can stomach the volatility that is likely to accompany a recent IPO with a rich valuation (shares trade at nearly 16 times 2020 revenue as of this writing), this IPO stock is a buy.

Robert Izquierdo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

LegalZoom.com, Inc. Stock Quote
LegalZoom.com, Inc.
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