Private equity due diligence in the age of AI + a case study

Due diligence in private equity is notoriously complex. To get the full picture of a potential investment, research analysts need information scattered across structured and unstructured sources — from databases and corporate records to news articles and market reports. Sorting through this amount of data isn’t just time-consuming but carries the risk of oversight.

Analysts are also under pressure to conduct due diligence quickly, often racing against tight deadlines imposed by deal teams. This increases the chance of missing crucial details, a mistake that can undermine investor trust.

In this blog, we’ll explain how AI automates and augments due diligence for private equity firms, so analysts within compliance teams can quickly assess a deal and return to the front line sooner.

Private equity firms are facing headwinds

In 2023, private equity firms felt the impact of inflation and rising interest rates, leading them to be more careful about how they deploy funds. The market saw a substantial 29% decrease in deals as a result. 

Firms are now taking more time for due diligence when exploring investment opportunities. Meanwhile, investors are closely scrutinising general partners (69% will prioritise this in 2024) to make sure they choose the right firm. From both sides, due diligence is crucial for uncovering financial, reputational, and regulatory risks. Neglecting it could lead to:

Risk of investment failure

Not identifying potential problems like financial liabilities or unresolved legal matters can lead to investment losses.

Loss of investor trust

Investors expect PE firms to carefully assess risks before investing. Failures caused by insufficient due diligence can make investors hesitant to provide future funding.

Reputational damage

A firm’s reputation can suffer if it makes poor investment decisions. This may make it difficult to attract future investment opportunities or partnerships.

Analysts are torn between speed and depth

Compliance teams within a PE firm are reliant on the information accessible to them. Initially, these were government records, but as regulatory risks evolved, compliance databases were created to check against Politically Exposed Persons, sanctioned entities and watchlists to prevent working with anybody involved in financial crime. 

In today’s digital landscape, static databases aren’t dynamic enough to keep up with these risks. Analysts need to search billions of internet pages to understand a subject thoroughly. But the amount of data available is practically impossible for a human to go through, with many analysts unable to afford deep due diligence across the entire internet. 

Manual research is slow and time-intensive, which can strain the compliance team’s relationship with the first line. Analysts often rely on quick internet searches and stop when they’ve reached a certain parameter to strike a balance between speed and sufficient information. However, this approach exposes a firm to significant risks if something gets missed, which can’t be undone once a deal is closed.

AI-powered due diligence for private equity firms 

Technologies such as artificial intelligence (AI) are eliminating the need for manual human research. AI can search through structured and unstructured data in a fraction of the time it would take a human analyst.

Example: Private equity firm A approves a potential investment as low-risk through manual due diligence. Private equity firm B uses an AI tool like Xapien from the start to check for red flags. Within five minutes it finds that one of the directors has ties to a sanctioned individual in the media. The compliance team in firm B has an upfront view of the investment’s risk profile and can present the Xapien report to the investment team, leading to early discussions on how to proceed. 

Here are some more ways AI is turning in-depth due diligence work from days into hours:

Accelerated data analysis

AI can draw the dots between information at an unmatched speed. For instance, Xapien generates a summarised report in under 10 minutes, covering both compliance data and open-source information. This would have taken a human analyst days, if not weeks, to do with the same level of detail and nuance. AI is also highly scalable, so analysts can evaluate more opportunities and enhance deal velocity.

Enhanced insights

AI helps you work smarter. It equips compliance teams with deeper insights into their target companies and the broader ecosystem in which they operate. Traditional due diligence methods might miss subtle connections between a company and potentially sanctioned individuals or entities. AI, on the other hand, can analyse extensive media coverage and other open sources to uncover these hidden associations. 

Strategic decision-making

By automating the more mundane and labour-intensive aspects of information gathering and analysis, AI frees up human analysts to concentrate on what they do best: strategic decision-making. With AI handling the groundwork, analysts can dedicate more time to interpreting data, understanding nuanced market dynamics, and developing strategic insights. This not only improves the quality of investments but also boosts job satisfaction for analysts, allowing them to engage in more impactful work.

Ethical and sustainable investing

ESG principles are now critical in investment decisions, mirroring a societal move towards sustainability. Europe’s push for net zero and the US Inflation Reduction Act’s substantial subsidies for green energy investments provide significant opportunities for private equity firms. AI plays a crucial role in analyzing ESG data and sentiments, identifying sustainable investment opportunities, ensuring compliance, and amplifying the impact of investments.

Read more: ESG in private equity: how investors can minimise risk with AI

Preemptive risk management

Ultimately, the integration of AI into the due diligence process enables PE firms to make more informed investment decisions. You’ll gain a greater depth of understanding and the ability to foresee and address risks before they become problematic. While traditional methods may overlook connections to sanctioned individuals or hard-to-spot supply chain risks, AI can uncover hidden associations—a critical advantage in mitigating risk. When the right information can make or break an investment, AI provides a competitive edge that safeguards the interests of both the PE firms and their investors. 

Screening portfolio companies in minutes with Xapien

With Xapien’s simple-to-use online platform, one leading private equity firm is now streamlining their due diligence process to swiftly identify risks, enhance decision-making, and allocate resources judiciously. The compliance team can now navigate the intricate web of potential risks with confidence, safeguarding the firm’s interests and reputation.

With Xapien, it’s easy for the compliance team to uncover any red flags lurking beneath the surface. By swiftly screening potential deals, they can preemptively identify risks, preventing unnecessary resource allocation on ventures that may not progress further. This proactive approach not only saves time but also ensures a more focused allocation of resources towards viable opportunities.

Xapien is empowering the compliance team to conduct due diligence with unparalleled depth and precision, rather than relying on rudimentary, time-consuming web searches. Xapien delves deep into structured and unstructured data, unravelling complex corporate structures and shedding light on potential risks and red flags. 

In just 10 minutes the team has a comprehensive written report, allowing the team to swiftly assess the suitability of companies for a deal. These reports are not only comprehensive but also securely stored and time-stamped. The compliance team can revisit reports if any concerns come up later, ensuring accountability and transparency throughout the due diligence process. Read the full case study here.