Should Assessing a Cloud Provider’s Financials Be Part of Your Due Diligence?

In a recent post the prolific and insightful Lee Rosen suggested that a cloud provider’s market dominance shouldn’t be your sole criteria when assessing the company’s prospective longevity. Instead, Rosen suggests a lawyer should adopt the Regan-era mantra of “trust, but verify,” and assess — essentially, audit — a cloud computing provider’s financials to prove out the company’s financial health. Rosen uses his diligence on his practice’s cloud provider, Salesforce.com, as providing a high degree of financial visibility that helped him gain a level of comfort with placing his practice’s data in the company’s hands.

Rosen closes his post with a call to action where he asks cloud providers such as Clio, MyCase and Rocket Matter to disclose their financial results (disclosure: I am the CEO of Clio). This level of transparency would, Rosen states, help lawyers fulfill their due diligence obligations.

While I think Rosen puts together a compelling case, I have to disagree for the following reasons:

(Perceived) Profitability Doesn’t Imply Stability. As we know all to well from the financial collapse of 2008, massively profitable companies can go under in the blink of an eye. Past performance and solvency is not highly predictive of future success. Mismanagement or a “black swan” event can destroy a profitable and otherwise healthy company in a blink of an eye.

Acquisitions, and Shutdowns, Happen. Even if a company were profitable, they are “at risk” of being acquired and shut down by a larger company at any point in time. This could be a simple matter of a competitor acquiring a company in order to consolidate their market share, or it could be a giant company such as Google simply doing a talent acquisition with no interest in continuing to operate the acquired business.

Unaudited Financials Can’t be Trusted. Unless the disclosed financial statements were audited by a “big four” accounting firm, they would be subject to manipulation by the disclosing company to make their financial position look better than reality. Many privately held companies, however, can’t or won’t undergo the expense of such an audit, which can easily run in the tens of thousands of dollars annually. Which leads me to my final objection:

Financial Disclosure Requirements Would Stifle Innovation. Every startup starts life as a loss-making venture. If profitability and clear financial health became a prerequisite for a cloud provider being able to sell to lawyers, this would have a profoundly chilling effect on innovation in the legal space. Clio, for one, wouldn’t exist today if this requirement were in place.

Disclosing Financials is a Non-Starter for Private Companies. Salesforce is a publicly traded company, which means it must make its financial statements public. Most legal cloud computing companies, however, are privately held. Companies choose to stay private for one very clear and compelling reason: to keep their plans and their financials confidential. Even within a company, financial statements can be a closely guarded secret shared only with top executives. Simply put, no privately-held company would contemplate releasing information that could be leveraged by their competitors and potential acquirers.

So, what is one to do? In my post next week I’ll address other ways lawyers can mitigate their risk around selecting a cloud-based provider.

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