Why AI for due diligence beckons a new era of strategic insight

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Due diligence (DD) is the cornerstone of private equity and high-stakes acquisitions. It involves investigating a potential investment, verifying its financial health, operational efficiency, legal compliance and more. Naturally, this demand for precision and objectivity makes AI for due diligence an intriguing possibility, which just 24% of private equity firms are leveraging.

AI for due diligence is poised to unlock unprecedented efficiency, accuracy and insight, transforming how private equity firms assess potential investments. This is because, over and above everything, due diligence is a labour-intensive undertaking. Each DD exercise requires large teams of analysts to sift through mountains of documents, build complex financial models and interview countless stakeholders. This translates to weeks, if not months, of work and significant financial outlay.

AI has the potential to revolutionise private equity by automating data analysis, risk assessment and document review. This allows for efficient identification of anomalies, potential fraud and high-risk investments. AI-powered tools streamline the audit process, saving time and resources while providing deeper insights into portfolio companies, ultimately enhancing decision-making and risk management.

An AI-powered due diligence platform

One of its more intriguing propositions is an AI-powered DD platform. But what is an AI-powered due diligence platform? What might this technology look like? Imagine an AI-powered DD platform that can scan an entire data room, instantly categorising and mapping its contents. Computer vision algorithms could even analyse images and videos, identifying inconsistencies or anomalies that might otherwise go unnoticed.

AI tools for private equity could also transform financial modelling, a cornerstone of due diligence. By analysing historical data and identifying patterns, AI algorithms could build sophisticated financial models and generate forecasts with remarkable accuracy. This would enable private equity firms to make investments based on a deeper understanding of a target company’s financial performance and prospects.

Perhaps most notably, AI is emerging as a powerful analytical tool in its own right. Natural language processing (NLP) enables AI-powered solutions to comprehend complex questions and produce insightful analysis. A private equity partner could simply type a question into an interface, and AI would produce slides and analysis based on the client’s needs. This capability effectively provides PE professionals with a virtual expert capable of answering intricate queries about a company’s operations, market position, or competitive landscape. 

These possibilities aren’t entirely science fiction. Prominent consulting firms are already leveraging AI to enhance their capabilities. McKinsey & Company’s AI-powered research assistant, Lilli, has been deployed to unify the company’s expertise into a single, highly searchable database. This enables McKinsey consultants to rapidly synthesise information and generate insights by simply asking Lilli a question. Similarly, KPMG’s CLARA, an AI platform explicitly designed for auditing, has proven invaluable in identifying risks and opportunities embedded within legal documents. 

As AI for due diligence advances, its impact is expected to grow. AI can automate routine tasks, generate deeper insights, accelerate the overall process, and radically streamline day-to-day tasks. According to a recent KPMG study, AI can free up 40% of employees’ time – even without training. In turn, AI enables private equity firms to make more informed, strategic investment decisions. 

However, it’s crucial to remember that AI is a powerful assistant, not a complete replacement for human expertise. The ability to analyse complex information, fact-check findings, and offer insightful interpretations remains firmly within the human domain.

The potential drawbacks of AI for due diligence

While the transformative potential of AI for due diligence is undeniable, it’s crucial to acknowledge the inherent limitations and challenges accompanying this technological advancement. These are primarily related to the requirement for human supervision and a rapidly evolving (and highly nuanced) legal environment. 

A key concern is the potential for bias to infiltrate AI algorithms. These algorithms are often trained on historical data, which may contain inherent biases, leading to skewed results and flawed conclusions. This can be particularly problematic when assessing sensitive issues such as diversity and inclusion within a target company. Ensuring fairness and mitigating biases in AI algorithms is essential to avoid perpetuating inequalities and discrimination in decision-making.

Another significant challenge arises from the phenomenon known as “hallucination.” In their quest to generate information, AI models may sometimes produce outputs that are not grounded in factual evidence. This can manifest as fabricated details in financial reports, misleading statements about a company’s operations, or even erroneous risk assessments. The potential for such misinformation to misguide investment decisions underscores the importance of human oversight and critical evaluation of AI-generated outputs. 

Equally, the black-box nature of many AI algorithms can make understanding the reasoning behind their decisions challenging, raising concerns about transparency and accountability. This issue renders the development and adoption of explainable AI (XAI) crucial. XAI models provide transparent explanations for their decisions, making it easier for human experts to understand and validate their findings.

Data privacy and legal considerations further complicate the use of AI for due diligence. The sensitive nature of the information involved necessitates robust security measures to prevent unauthorised access and potential breaches. Moreover, using AI raises questions about intellectual property rights, ownership of AI-generated insights, and the possible liability of AI developers in case of errors or omissions.

While these challenges are substantial, they are not insurmountable. By acknowledging the limitations of AI, investing in ongoing research and development, and implementing robust ethical guidelines, the private equity industry can harness the power of AI while mitigating its potential risks. The key lies in striking a balance between technological innovation and human expertise, ensuring that AI is a powerful tool to augment, rather than replace, human judgment and decision-making.

AI as a force multiplier

This cautionary tale leads us to where AI truly shines – as a force multiplier for human expertise. Imagine a scenario where senior freelance consultants, armed with the ability to program AI tools and interpret their findings, can go toe-to-toe with established firms. This could fundamentally reshape the competitive due diligence landscape, levelling the playing field and empowering independent experts.

Private equity funds, in turn, might begin prioritising consultants who possess a deep understanding of due diligence and are adept at harnessing the power of AI-driven software. This would mark a significant shift in the skills and expertise demanded of due diligence professionals, emphasising adaptability and technological fluency.

It’s important to note that this does not signal the demise of large consultancies. Instead, AI gives these firms the tools to operate more efficiently with a leaner structure. By automating routine tasks, AI for due diligence can redirect resources towards strategic analysis and value creation, ultimately delivering more impactful client results. This shift could also democratise the market. In the current landscape, the reputation of a consultancy often holds immense sway. However, with the rise of AI, the spotlight could shift towards the underlying AI software itself, with consultancies acting as facilitators rather than sole providers of expertise.

This new paradigm presents an opportunity for both individual consultants and established firms to thrive. For independent experts, AI offers a chance to expand their reach and compete on a larger stage. For consultancies, AI presents a tool to enhance efficiency, deliver greater value, and adapt to a rapidly evolving industry. Ultimately, the integration of AI into due diligence stands to benefit all stakeholders by driving innovation, improving outcomes, and creating a more competitive and accessible market.

Tapping into AI expertise will be crucial

However, successfully integrating AI into due diligence requires specialised expertise. To navigate the complexities of this evolving landscape, it is crucial to partner with experts who possess a deep understanding of both due diligence and AI. These professionals ensure that the power of AI is harnessed effectively and ethically, aligning with your firm’s strategic goals and ethical standards. 

By embracing this transformative technology and collaborating with commercial due diligence experts who can guide its implementation, private equity firms can unlock a new era of efficiency, accuracy and strategic decision-making. The journey has just begun, and the possibilities are limitless.

P.S. While AI is transforming the due diligence landscape, the post-merger integration phase remains crucial for realising the full value of your M&A deal. Download this free guide, “Drivers of Post-Merger Integration Success,” penned by yours truly. I discuss how meticulous planning and expert guidance can ensure a smooth transition and set the stage for long-term growth, outlining the critical steps to take in the first 100 days after closing and presenting real-world case studies.