Due diligence is a crucial aspect of M&A, but it is overdue for significant technological disruption. Before the advent of AI, the due diligence process was labour-intensive and time-consuming. Vast amounts of data—dubbed the ‘new oil of the digital era’—had to be gathered, analysed and verified by various teams. This inevitably leads to data gaps and generous helpings of human error. Time constraints made the process even more stressful, and the longer a deal runs, the more risk is involved. When it comes to due diligence, time is of the essence.
In the digital age, the amount of data that must be considered during the due diligence process continues to grow exponentially. This puts immense pressure on the individuals managing the deal process, who, at times, are grappling with more information than they can possibly handle.
AI is undoubtedly transforming due diligence. However, before firms jump head-first into incorporating AI into the due diligence process, they must be aware of both the opportunities and the threats AI brings.
AI in Due Diligence: The Opportunities
AI presents several opportunities that will improve the due diligence process:
The typical due diligence period lasts between 45 and 180 days, depending on the nature of the deal. AI can make the process faster and far more efficient by trawling through vast data sets to identify patterns and highlight crucial information relevant to the deal.
For example, natural language processing (NLP) can be utilised to scan and interpret documents, such as contracts, in a fraction of the time it would take for a human to complete. In that time, it can flag potential liabilities and risk factors that may impede deal closure. Instead of manually trawling through documents, staff can devote their time to higher-value work to improve overall productivity.
AI is particularly useful when it comes to assessing risk. A key component of due diligence is financial analysis, which includes scrutinising the target asset’s financial documentation. Here, AI can expedite the process by quickly analysing financial statements, tax returns and revenue sources to identify any discrepancies that may be present, allowing firms to identify and discuss risks before closing the deal.
AI can also predict future trends and outcomes. In the due diligence context, this involves analysing past M&A transactions and market patterns to make informed predictions about whether a deal will likely succeed. Advanced machine learning algorithms can model a range of scenarios based on historical data, helping organisations make more informed decisions. AI can also identify patterns that may not be apparent to human analysts, offering reliable predictive insights that may improve the probability of a deal’s success. AI can also forecast future cash flows, earnings and potential returns on investment, reducing the uncertainty associated with a deal.
AI in Due Diligence: The Threats
AI has the power to transform the due diligence process. However, there are also threats that must be taken into consideration:
To use AI to expedite the due diligence process, vast amounts of sensitive data must be analysed, opening the door to security concerns. If the AI implementation process is not properly managed, it poses a serious security risk.
Popular AI tools such as ChatGPT, which has set the record for the fastest-growing user base, have already set alarm bells ringing for employers over security concerns. Several companies have banned or heavily limited the use of ChatGPT, including Apple, Verizon, Samsung and Amazon until they can be sure these tools are not a security threat.
The good news is that companies do not have to rely on AI tools like ChatGPT. Instead, companies are developing their own AI tools or commissioning experts to create a custom GPT tailored to their needs. In response to this, Palladium has developed PrismGPT, a secure area we have developed for private equity clients that they can use securely.
As AI integrates into businesses, regulatory concerns are coming into focus. However, AI regulation is going to be incredibly complicated. At present, no one knows what AI regulation will look like. As a result, some businesses will worry about integrating AI into their organisations, only having to scale back once the regulation comes into being. The current uncertainty about what AI regulation will look like underscores the importance of businesses adopting a risk-based and flexible approach when integrating AI.
Another issue with AI is hallucination, where the system churns out irrelevant or factually incorrect answers. Using this information without realising that it is a hallucination could have potentially serious consequences for businesses. However, there are ways to reduce the amount of AI hallucinations that occur. Limiting the possible outcomes by providing detailed prompts and including relevant data and sources will reduce the likelihood of hallucinations.
Another risk of AI is job displacement. While AI has the potential to transform due diligence by making the process considerably faster, more accurate and more efficient, it will disrupt traditional job roles. Fleur Hicks, Chief Commercial Officer at Palladium, explained that some companies might face negative consequences if they jump head-first into AI without carefully considering the risks, especially if they get overzealous and replace people with AI systems. She said, “It’s being sold as a cheap option compared to the labour force, whereas, actually, it brings efficiencies to the labour force, not replaces it.” While AI can automate some aspects of due diligence, it cannot fully replace the critical thinking, nuanced understanding and strategic insight that humans bring to the process.
AI presents a promising future for due diligence by boosting efficiency, reducing risk and enhancing the deal-making process using predictive capabilities. However, AI also brings with it numerous threats—such as data security, regulatory concerns, hallucination and job displacement—that must be taken into consideration before the implementation process begins.
Companies must strike the right balance between leveraging AI’s benefits and mitigating the associated risks. While AI has the potential to transform the due diligence process, it is by no means a silver bullet. AI implementation must be carefully considered and expertly managed, and that’s where Palladium comes in.
The Palladium AI Impact Assessment
The Palladium AI Impact Assessment can help firms understand the potential value and impact of implementing AI on their current and future investments. The AI Impact Assessment consists of two key stages: AI Readiness and Opportunity and AI Value Estimation and Implementation Roadmap. The initial AI Readiness and Opportunity Assessment involves thoroughly evaluating the client’s portfolio companies to determine their current level of AI adoption and readiness.
The AI Value Estimation and Implementation Roadmap, the second stage of the impact assessment, involves working closely with Palladium’s team of AI experts to assess the ROI from AI projects and create a detailed roadmap outlining the steps for successful AI integration.
For more information on Palladium’s AI Impact Assessment for Private Equity