The benefits and risks of using artificial intelligence in due diligence for M&A transactions.
The use of artificial intelligence tools in the “due diligence” stage of mergers and acquisitions conceivably signals an evolutionary milestone in transactions. On the other hand, use of AI in this context is arguably merely yet another incremental technology-based enhancement in an otherwise traditional task, much as the advent of photocopying, word processing, scanning, optical character recognition, personal computers, email, the internet, cloud services, and other developments during the past several decades have facilitated M&A due diligence. In addition, attorneys working on transactions are generally obligated under the rules of professional conduct to keep abreast of the benefits and risks associated with relevant technology. Thus, for practical, ethical, and other reasons, those engaged in due diligence should understand the benefits and risks of AI-aided due diligence.
Artificial intelligence can benefit M&A due diligence in at least four ways. First, AI tools expedite the due diligence process by analyzing voluminous information—including organizational documents, contracts, leases, loan documents, financial statements, invoices, licenses, policies, tax and environmental records, and other materials. Work that in the past required substantial time for tedious manual review can now be completed in hours or even minutes, allowing prompt evaluation and enhancing transaction agility.
Second, manual due diligence is susceptible to human mistakes, distraction, and inconsistency. While much has been made regarding AI mistakes (sometimes called “hallucinations”), a recent study showed that the error rates of humans and of good AI tools are now comparable. It is foreseeable that the error rate of AI tools will soon be materially less than the average human error rate. AI systems apply coherent parameters during the review, facilitating consistent analysis across a welter of documentation and reducing the risk of oversights or misinterpretations.
Third, AI tools are good at revealing oddities, such as financial discrepancies, inconsistencies in documents, or potential regulatory matters. AI’s predictive capabilities also allow for strategic examination of the assembled information, even including projecting possible outcomes or litigation risks, thereby enhancing analysis and negotiation.
Fourth, by automating repetitive review work, AI reduces deal costs, since teams are freed up to focus more quickly on more complex issues.
Of course, as with any tool, using AI in due diligence carries some risks. AI-enhanced due diligence currently usually involves uploading proprietary and confidential documents to third-party computer systems. It is therefore desirable to look into the AI vendors’ data security protocols.
As mentioned earlier, AI tools might make mistakes, or they might overlook nuances that humans easily spot. For that reason, individuals involved in due diligence should oversee the use of the AI tools and review the output with a critical eye.
In addition, AI tools derive their capabilities from being trained on massive amounts of data. So, if and to the extent the training data contained misinformation, unsubstantiated claims, or mere opinions, the AI tool might have “learned” that material, which can contribute to the AI tool’s error rate. Consequently, regularly reviewing AI tools for signs of such tendencies is desirable.
Those involved in due diligence should also expect to answer for the adequacy and accuracy of the results produced by AI tools, in the same manner as they would be responsible for the work product handed to them by humans. Too much reliance on AI tools or unquestioning acceptance of the results can adversely reflect on their own judgment and conduct.
Finally, after the closing of an M&A transaction, the parties potentially can argue over the ownership of AI-generated information created during the due diligence process. To forestall post-closing disputes regarding that data, including claims of misappropriation of proprietary information, the parties may wish to address that issue in the purchase agreement or other deal documentation.
In light of all that, best practices for the use of AI tools in M&A due diligence include:
- Ensuring human judgment is paired with AI use, with critical review of AI outputs, so that there is clarity regarding ultimate responsibility for due diligence results.
- Reviewing the offerings of AI providers, in order to ascertain their protocols and systems for data security, privacy compliance, and transparency in algorithms and methods.
- Keeping current on technological advances in AI, regulatory requirements regarding AI, and industry and professional guidelines regarding the use of AI, especially in the context of due diligence in M&A transactions.
- Documenting the use of AI in the due diligence process, including preserving the due diligence data room platform, noting the algorithms applied, and memorializing the nature and constraints of the AI-aided due diligence.
- Maintaining clear communication with the transaction parties as to the usage of AI tools during the due diligence process and the attendant benefits, limits, and risks.
Using AI tools in M&A due diligence can result in efficiency, accuracy, issue identification, and cost reduction. On the other hand, these advantages require risk management. By following best practices, including having good oversight and keeping on top of regulatory developments, individuals working on deal due diligence can gain the advantages of AI while advancing the parties’ mutual interests.
Click here to read Terry's article published by the Phoenix Business Journal.
ABOUT THE AUTHOR
Terry Thompson is a shareholder at Gallagher & Kennedy. His practice emphasizes corporate business mergers, acquisitions, financings, and public-private projects, including strategic joint ventures, water/wastewater infrastructure development, sports facility financing, and physician-hospital contracts. He participated in revising Arizona’s limited liability company statutes and chaired the multi-year State Bar committee project that oversaw the revision of Arizona’s corporate statutes.
Contact Terry or any member of the firm’s corporate law team for counsel on your next deal.