Can artificial intelligence impact investment in the private equity sector?

14TH January 2023

Artificial intelligence (AI) is revolutionizing many industries, and the private equity sector is no exception. As you know, Private equity firms invest in and manage privately held companies. The process of finding, evaluating, and managing these investments can be time-consuming and resource intensive. This is where AI can intervene to streamline and improve many aspects of the private equity process, covering different activities such as due diligence, portfolio management and deal sourcing. 

However, AI can be very challenging from a private equity point of view, especially that private equities frequently rely on brilliant people using simple tools rather than being early adopters of new technology.

Of note, this article digs deeper into the inclusion of AI in the investment world, … and has been written partly with an AI bot!

AI-powered deal sourcing

AI can be used to identify and evaluate potential investment opportunities. Private equities are constantly on the lookout for new companies to invest in, and the process of finding and evaluating these opportunities can be time-consuming and resource-intensive.

AI can be used to identify potential investment opportunities that may not be easily identified through human analysts.

For instance, an AI system trained to analyze financial data and identify companies that are undervalued or have untapped potential for growth can help firms find and evaluate new investment opportunities with higher accuracy and lower time.

AI proves to be a very helpful tool in supporting the negotiation process. Furthermore, AI systems can analyze market trends and assist private equities in determining the optimal price to offer for a potential investment. 

To sum up, the use of AI in deal sourcing has the potential to increase the speed and accuracy of the investment process in the private equity industry. According to a report from 2020 by Cerulli Associates, hedge funds with AI capabilities had a significant competitive advantage over their rivals. 

Furthermore, to find and evaluate early-stage opportunities, companies like Pilot Growth, EQT, and Jolt Capital have developed their own AI-powered deal-sourcing tools. On the other hand, there are AI-powered platforms available on a subscription basis for private equities that would rather focus time and money on core business development strategies than software development. An appreciable substitute for developing an internal solution is provided by platforms like Udu for example.

AI-powered powered Due Diligence

As stated earlier, the process of finding and evaluating potential investments in privately held companies is complex and time-consuming. 

Private equity firms conduct a thorough due diligence process each time they want to assess the risks and potential returns of a potential investment. This process typically involves analyzing a wide range of data, including financial statements, market trends, and the performance of the target company. 

This is where AI unlocks opportunities in Private Equities by improving and accelerating the due diligence process. By using machine learning algorithms and natural language processing, AI systems can analyze large amounts of data and identify trends and patterns that are not easily identified and analyzed by human analysts.

By using just one tool, you would be able to gain insights into various types of information, including the price of the average basket in a merchandising store you’ve invested in, as well as information about the typical user of a SaaS product you’re considering. This tool would provide you with a comprehensive understanding of the data, without the need for you to sort or process it first. This would save you time and resources, and make it easier to identify patterns, trends and opportunities for growth and improvement.

This is the promise of a tool like Kira, a Canadian company that uses AI to transform raw data such as legal or financial documents into a comprehensive dashboard that provides a holistic view of a company. With Kira, you can automate tasks such as data extraction, review and analysis, allowing you to gain insights more efficiently.

Instead of proof-reading contracts personally to perform due diligence, Shearman & Sterling, an international law firm, uses artificial intelligence to search through contracts for insights and to arrange information in those contracts. This is a great example of how major firms can also use AI to make more informed investment decisions and potentially reduce the risk of making a non-profitable investment, particularly because the due diligence process becomes more efficient since more data will be analyzed in a shorter time.

AI-powered portfolio management

Apart from due diligence, AI can also be employed in portfolio management in the investment industry. Private equities manage and monitor several portfolios, and analyzing each portfolio’s performance is a crucial yet critical part of the job. AI can be used to track key performance indicators (KPIs) and identify trends and patterns that may indicate the need for action.

For example, an AI system could be trained to analyze financial data from a portfolio company and alert the private equity firm if there are any concerning trends, such as declining sales or increasing expenses. It can also help to forecast how a pandemic will affect an industry, under identical circumstances by examining the effects of a previous pandemic, such as COVID-19, on the sector. This can allow the firm to take immediate actions that address potential problems and improve the performance of the company.

The automation and self-learning capabilities of artificial intelligence in due diligence are another major advantage. With AI, you can automate tasks and the algorithms continue to learn with each deployment, increasing their accuracy over time. This means that they become more and more effective with each use, allowing you to get more accurate and reliable insights in less time.

The use of AI in portfolio management can also help private equity firms make better-informed decisions about how to allocate resources and optimize the performance of their portfolio companies. For example, an AI system could be used to analyze data from multiple portfolios and identify which companies are performing well and which are in dire need of additional support. This can help private equity firms make more effective use of their resources and maximize the return on their investments. Overall, the use of AI in portfolio management has the potential to improve risk management and decision-making in the private equity industry.

Challenges, considerations and applications 

It’s also important to note that while AI can be a powerful tool for due diligence, it is not a panacea and should not be relied upon too heavily. It is crucial to have human oversight to ensure that important information is not missed during the extraction process, and to avoid exposing clients to unnecessary risks. 

AI systems are trained to analyze data and identify patterns, but they rely on a given dataset and algorithms used to analyze that data. If the data is biased or the algorithms are flawed, the results produced by the AI system could be inaccurate or misleading.

To address this concern, it is important for private equity firms to ensure that they have a strong understanding of the limitations of AI and the importance of human oversight. This may involve hiring specialized staff with expertise in AI or partnering with companies that have expertise in this area. You could also use an expert network to be helped on this subject (we have written a success story about that).

Additionally, it’s important to consider the costs of incorporating AI into the due diligence process. The license fees for AI software can be high, and it’s important to weigh these costs against the benefits to determine if AI is the most cost-effective solution. A balance between AI and human oversight is crucial, a machine learning algorithm can assist by providing a more efficient process, but final decisions should be made by humans.

Finally, there are ethical considerations surrounding the use of AI in the investment industry, which makes it important for private equities to ensure that they are using AI in a responsible and transparent manner, and to consider the potential impact of their actions on employees, customers, and other stakeholders.

Overall, while the adoption of AI in the private equity industry has the potential to bring significant benefits, it is important for firms to carefully consider the challenges and considerations surrounding its use. 

Conclusion

In conclusion, artificial intelligence (AI) has the potential to significantly impact the private equity industry and revolutionize many aspects of the investment process. From streamlining due diligence and improving portfolio management to identifying and evaluating investment opportunities, AI has the potential to increase efficiency, accuracy, and speed in the industry. 

However, it is important for private equities to be aware of the potential challenges and considerations surrounding the adoption of AI. This includes the need for human oversight and expertise, the potential for bias in AI systems, and the importance of ethical and responsible deployment. Ensuring that AI is deployed in a transparent, accountable, and unbiased way is the key to realising the full potential of AI in the industry.