Placing a fund’s future in the hands of portfolio company executives requires a significant level of trust. Ensuring those companies are worthy of your trust—and your capital— requires pre-investment due diligence that goes beyond company financials and takes a thorough look at the individuals you are relying on to make the right decisions day after day.
Today, it’s more challenging than ever to conduct that due diligence on business leaders which is why more and more investment firms are turning to advanced technology solutions that leverage artificial intelligence. This process grows even more complex when simultaneously evaluating people across the globe who are with companies that are less known to the investment team. Furthermore, if questions do arise during an initial review, the time required for investigation can significantly delay an investment committee decision to allocate capital.
The need for more in-depth screening that goes beyond simplistic methods like Internet searches and personal references goes back for over a decade, but in the past few years the market dynamics have created a perfect storm where traditional methods for background checks are no longer sufficient. This situation is only compounded by the global pandemic where investors are unable to meet in person with executives to establish a rapport and “look them in the eye.”
In the recent past, background checks were conducted as a formality and were limited in scope. Today, however, they are complex multi-level assessments including a full review of court records, property deeds and mortgage documents, liens, news media, regulatory filings, and more.
Given that some of this data can easily be manipulated, findings from hundreds of thousands of sources across multiple jurisdictions needs to be reviewed. It takes more than a keen eye to do this; it takes artificial intelligence to deliver the 1) Comprehension, 2) Accuracy and 3) Speed required for fund manager due diligence.
Faced with more data to review, due diligence teams do their best to sift through the information and come to suitable conclusions. However, their reports are often only based on a fraction of the potential data available. Even when working with a reputable vendor, the report may have been completed by a less experienced junior associate who misses many key points and connections. In contrast, some AI-enabled solutions can scan more than 400,000 different data sources to provide digestible insights.
Sometimes a seemingly innocent adverse piece of data can give real insight to the nature of the fund manager being reviewed. For example, while an executive may have a stellar short-term business track record, a background check that turns up involvement in a number of prior court cases may indicate character flaws to investors, giving them insight not to trust him with their investment. Similarly, personal debts and liens against assets can reveal financial pressures that may cause some to act unethically.
The proliferation of data brings an excessive amount of noise to background checks. Background checks that simply present a regurgitation of data are confusing and offer marginal insight into the risks associated with the investment. Background checks conducted on individuals with family names, such as “John Adam Thompson III,” pose
a huge accuracy threat because human analysts are hard-pressed to distinguish the records of the person in question from their similarly named relatives and complete strangers.
Due to human limitations, companies struggle with maximizing the due diligence work that can be accomplished within a certain time frame. For due diligence managers, time is of the essence as other teams are awaiting their input regarding investment decisions. Screening for potential risks requires the utmost attention to detail, alongside the ability to review copious amounts of data quickly and identify what is relevant. This challenge is suited perfectly for the use of artificial intelligence. Some automated systems produce background checks up to seven times faster than industry standards.
One real-world example is Hamilton Lane, a leading private markets investment management firm with $757 billion in assets under management. Supporting more than 450 employees in 18 offices, the team needed a user-friendly solution that could enable their multinational team to effortlessly access, track and share information. By using an AI-powered software solution, what used to be a tedious process now delivers insights into an individual within hours of requesting the report. And because links to source material are provided in the platform, team members around the globe can easily review issues in depth and quickly determine whether further action is required.
Choosing the Right Solution
The first steps to enhancing your firm’s pre-investment due diligence are to integrate thorough executive background checks into your standard processes, to recognize that the old approach is not sufficient, and to choose an AI-powered solution. But how do you know which solution is the right one? Ask yourself the following questions:
1. What does the solution look at?
Ask how many sources the solution uses, what geographies and countries they are in, and whether both public and private (i.e., paid) sources are included. You will quickly find there to be a significant discrepancy between claims and reality.
2. Will I get the right information?
The most comprehensive solution in the world is not good if it puts the burden of sorting through the results onto your team. The right solution will not only distinguish between relevant and irrelevant data, but it will also highlight what is most important, will allow you to customize the findings for your needs and will “learn” with each search to get more accurate over time.
3. How quickly will it get the job done?
Private investment gets more competitive every day and the ability to make decisions quickly is critical to success. A great solution that needs two weeks to deliver findings is no solution at all. Make sure that the software you choose will fit into your investment timeline.
4. Does it fit with how my team works?
If you have one person managing all pre-investment due diligence, this is an easy question to answer. However, it’s likely that you have people across many time zones who will want to look at the findings to make their own judgments. Furthermore, the
last thing an investment team needs is to keep track of multiple background check documents. A platform that enables sharing across the company is a requirement for an effective solution.
Integration of AI-powered diligence on portfolio executives not only gives private capital firms full confidence in the holdings of their portfolios, but it provides an added layer of security for Limited Partners and streamlines the investment process ensuring informed and timely capital allocation decisions.