Keeping dealmaking personal

Attempts to look into the future can conjure up images of a disturbing, even dystopian world, but observers of the private equity market offer a rather more reassuring picture. Technology will be important, but so too will human input

When it comes to technology, many experts regard advances in artificial intelligence as the single biggest factor that will change dealmaking, because it will generate analyses of past and future corporate and industry performance based on pools of data so large that humans using conventional techniques could never cope with. Much of this will be ‘unstructured data’ – data that does not come in a predefined form, like numbers on a spreadsheet. Unstructured information includes social media feeds, digital pictures and videos; it has until recently been notoriously difficult to manipulate and techniques are still rapidly evolving.

This is partly about big-picture issues. Already, “larger private equity firms are increasingly using AI and data analytics to predict market themes and trends”, says Fenton Burgin, head of UK advisory corporate finance at Deloitte in London. “Today, for example, in the financial services and consumer sectors, we are already seeing the accelerating use of AI to predict generation Y and Z’s future spending habits. In five years’ time, it will be an absolute prerequisite to have access to these high-speed capabilities.”

AI does the heavy lifting

But AI can also do the grunt work of due diligence. Consider a target company in retailing with 150 leases, says Will Shields, co-chair of private equity at the law firm Ropes & Gray in Boston. The private equity firm’s lawyers must work out how many of the leases will require the consent of the real estate owner for any ‘change of control’, including the change of control involved in a private equity purchase. “You can use AI quickly to ferret out the answer by using keywords and analysing the language in the leases,” says Shields. “Perhaps more importantly, you can get an answer more cheaply: it would previously have taken 15 junior lawyers three or four nights of hard work to resolve.”

Blockchain will also transform due diligence, says Haresh Vazirani, investment manager in private equity at Aberdeen Standard Investments in Edinburgh. He notes it currently takes three to six months to do diligence. However, if blockchain becomes widely adopted for transactions, “all the data could be verified on the day itself”. Blockchain produces a ledger of transactions that cannot be changed, for example to flatter a company’s results, without this change being recorded in the ledger. Improvement in the reliability of information also “reduces the data asymmetry” between the company and the prospective private equity investor, says Vazirani.

Faster dealmaking

Use of technology is part of a broader impetus to accelerate the speed of dealmaking, which will be much more rapid in 10 years’ time, say observers. Shields says the use of technology by insurers to protect target companies against liability for painting an inaccurate picture of themselves is already becoming very common and will become more so.

This trend in insurance is rendering the process of making transactions quicker and easier, says Shields.

Shields believes this offloading of risk to a third-party could see another trend emerging over the next 10 years – “a narrowing of the acceptable starting and finishing points on deal negotiation”, since these negotiations at the moment largely cover who has liability for what.

Even in 10 years’ time other skills will still be needed at private equity firms beyond data science, say observers. “Private equity investment is 50 percent science and 50 percent art, 50 percent quantitative and 50 percent qualitative,” says Helen Steers, partner and head of European investment at Pantheon, the London-based fund of funds manager and private markets investor.

“You will need a twentysomething with the data background, and you will need the older people with the scars on their backs, who know that although data is a really important part of the story, there’s a whole bunch of other things that are important as well.”

“The data and numbers are one side of the equation, but the other side is interpersonal relationships,” says Steers. This includes building teams and impressing target companies. Steers gives an example of how the two halves complement each other. Ahead of that crucial meeting at which the firm is trying to persuade the target company to sell, the data scientists need to supply the negotiating team with a detailed picture of the company, since this will impress the management.

In the future, Burgin thinks European private equity firms will need to focus increasingly on how they differentiate themselves to persuade target companies to side with them – and human qualities will be key to this.

“In the current US markets, for example, where more than 50 sponsors may be reached out to on a deal, it is often the softer people skills that can really make the difference in the owner’s decision-making process,” he says. In other words, personalities will still win deals.

Private equity investors will be more specialised 10 years from now, predicts Ali Mazanderani, partner at Actis, the emerging markets specialist. Already, “the ability to distil information and distinguish good from bad investment opportunities requires a degree of specialisation that has increased dramatically”, says Mazanderani, an authority on fintech, and particularly on payment services.

“Consider a situation in which you go to an investment committee, and you’re having to not just tell the story, but to teach them the language. This is almost impossible when you’re talking to a group of generalist investors,” he adds. It is especially difficult in rapidly developing sectors where “the past is no longer the prologue – you’re having to predict the evolution”.

Because of this need for highly technical knowledge, Mazanderani predicts a growth in the number of niche firms where everyone understands a particular market. However, he also sees very large managers recruiting more specialists. A large manager has the chance to make the economics of hiring a professional with a narrow focus work, because it will have the war chest to make a large number of deals in that area. In short, Mazanderani sees a “bifurcation” in the market.

Another consequence of this specialisation is that firms will become less geographically restricted, as they seek opportunities to use their specialism throughout the world, says Mazanderani. However, he forecasts the continued existence of some regional managers, including emerging markets specialists such as Actis, because limited partners often want particular regional exposure.