Due diligence is conducting a series of investigative acts to ensure the counter party’s bona fides before conducting a transaction. But not everyone is doing it right. McKinsey reports that 40% of the mergers and acquisition (M&A) deals fail due to inadequate due diligence.
In this article, we discuss what due diligence is, what an automated due diligence process looks like, and its benefits.
What is due diligence?
The concept of due diligence was born out of the Great Depression. To force all investors to conduct a “reasonable” amount of investigation – i.e., due diligence – prior to investing in a security, the US government passed the Securities Act of 1933.
Thenceforth, the borrower was obligated to provide as many financial documents as possible for the lender to review before a deal was agreed upon.
What is due diligence automation?
Due diligence automation is using software robots to, at least partially, automate the due diligence processes. The idea is that bots will enhance the due diligence efforts by reviewing documents faster, more efficiently, and without human error.
What are tools are used to automate due diligence?
Optical character recognition (OCR) can scan documents and extract useful info.
Natural language processing tools extract meaning from the data and structure it into a machine-readable format.
Robotic process automation (RPA) bots take the data, compare it to rule-based inputs, and reach a conclusion. They could also transport the output into a standardized report.
4. Web scrapers
Web scrapers scrape the Internet to gather all publicly available data about people and organizations. Having as much info as possible about who you’re doing business with is a critical foundation of due diligence.
The aforementioned tools are congregated to power end-to-end due diligence solutions, such as:
- Tofler: A solution provider in India that provides the financial records of Indian companies.
- LexisNexis: To identify potential risks, users can access a company’s financial records, politically exposed persons (PEPs), etc.
What are the benefits of automated due diligence?
1. Identify risks accurately
Annual financial statements can range between 120-180 pages. Moreover, due diligence isn’t only confined to financial documents, but also checking the:
- corporate documents
- customers, sales, and marketing materials
- intellectual property, and more.
Having bots assess the data and the fine print eliminates human error and reduce the risk of unseen red flags.
2. Ensure compliance
The company you are investing in should be regulatory compliant. Due diligence tools have built-in functions that compare the company’s data collection with governmentally-sanctioned templates.
3. Save valuable time
Going through all the documents, looking up the business executives and decision-makers, and comparing whether the company meets the investment criteria can be time-consuming. So due diligence can take between 30-60 days. Having an automated end-to-end process speeds up the due diligence program.
4. Communicate with disparate team members
The due diligence process involves the financial, legal, risk management, operational, and other departments. If done manually, trying to know which stage each department is at takes time.
Automating the due diligence processes means all team members can instantly look at the stage at which others are.
5. Reduce post-acquisition costs
Leveraging artificial intelligence in the due diligence process might seem expensive and difficult at first. But it’s similar to purchasing an insurance policy in the case of disaster.
For instance, in 2011, HP bought Autonomy in 2-11 for $11.7B. A year later, they figured out Autonomy had overstated its income statements, balance sheet, cash flow forecasts, and other financial aspects. So HP had to write off $8.8B of the valuation.
6. Increase your information reach
One of the main benefits of the Internet is democratizing information and making it accessible. Due diligence tools use web scrapers and public data to gather a comprehensive overlook of the companies in question.
7. Valuate the company justifiably
In ’94, Quaker purchased Snapple for $1.7B. Less than three years later, they sold Snapple for $300M. Inaccurate valuation is a result of
- Overlooking the risk profile of the company
- Not asking the related questions
- Poor analysis of financial data
- Poor insight into the current processes of the organization, etc.
Automating the due diligence processes can remedy these challenges by having bots automate tasks that would’ve otherwise done by humans.
8. Remove human bias from valuation
Research has shown that when it comes to valuation, humans are affected by:
- Anchoring bias
- Engagement bias
Using AI-powered diligence tools can eliminate human bias and evaluate the company based on its as-is documents and other factors.
9. Leave no stones unturned
Digital solutions function within a rule-based framework. So when conducting due diligence, the technology would follow a series of steps in a checklist, with efficiency. So if there’s a missing document, or if there is a need for supplementary data, the machine learning algorithms would automatically flag it. This helps the company in minimizing blind spots to ensure that the future of the investment is profitable.
For more on process automation
If you are interested in learning about other use cases of process automation, read:
- Top 13 Automation Use Cases in Private Equity
- RPA in Treasury Management: 5 Ways It Helps Liquidity
- AI Resume Screening: 10 Ways It Helps Hirings Managers
And if you want to invest in a process automation solution, we have a data-driven list of BPA solutions.
We can help you in the selection process:
Cem has been the principal analyst at AIMultiple since 2017. AIMultiple informs hundreds of thousands of businesses (as per similarWeb) including 60% of Fortune 500 every month.
Cem's work has been cited by leading global publications including Business Insider, Forbes, Washington Post, global firms like Deloitte, HPE, NGOs like World Economic Forum and supranational organizations like European Commission. You can see more reputable companies and media that referenced AIMultiple.
Throughout his career, Cem served as a tech consultant, tech buyer and tech entrepreneur. He advised businesses on their enterprise software, automation, cloud, AI / ML and other technology related decisions at McKinsey & Company and Altman Solon for more than a decade. He also published a McKinsey report on digitalization.
He led technology strategy and procurement of a telco while reporting to the CEO. He has also led commercial growth of deep tech company Hypatos that reached a 7 digit annual recurring revenue and a 9 digit valuation from 0 within 2 years. Cem's work in Hypatos was covered by leading technology publications like TechCrunch and Business Insider.
Cem regularly speaks at international technology conferences. He graduated from Bogazici University as a computer engineer and holds an MBA from Columbia Business School.
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