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07 Nov Disintermediation: Digitizing the DealMaker

If Elon Musk is correct, robots, artificial intelligence (AI) and automation will replace most jobs within our lifetime. The social and economic impact of this eventual, widespread displacement of human capital will be vast. No sector will be devoid of its own “Uber moment”–investment banking will be no exception. But when it comes to fintech market attention, retail and consumer banking receive the lion’s share. The reason: the impact is more readily palpable. The replacement of bank tellers and the removal of physical bank branches are perhaps the most noticeable. On the other hand, rapid changes in investment banking–particularly middle-market investment banking–are much less conspicuous to the general market, but the digitization is occurring rapidly. Understanding the who, what, when, where, why and how these digitization and automation changes are occurring should prove helpful to investors, deal makers and company issuers alike.

Automation, Outsourcing & Crowdsourcing

As disintermediation in investment banking marches forward, there is a spectrum of what constitutes complete automated replacement and simple process disruption. For instance, automation is eclipsing Deal Origination, Know Your Customer (KYC), Anti-Money Laundering (AML), Bad Actor Checks, Deal Marketing, Due Diligence and even Legal processes and agreements. In an effort to save time and monetary costs for doing deals, many investment banking managing directors in-source and outsource many of the core functions required of their clients. Pitchbook/CIM preparation, deal origination, deal marketing and other laborious processes in a deal have been pushed to both internal associates and external outsourcing firms with specific prowess and specialization in these areas.

One area nigh to impossible to fully automate or outsource is Due Diligence (DD), but that is rapidly changing as well. Crowdsourcing due diligence processes (e.g. financial, accounting, legal, operational, etc.) have been touted as a potential game-changers for both ibankers and investors. While the licensed and regulated investment banker remains “the one throat to choke” when it comes to DD, his/her tasks relative to DD can be greatly augmented by the assistance of the crowd, similar to a fintech version of Amazon’s mechanical turk. There are many challenges to the potential success of managing DD through the crowd–confidentiality and disclosure being potentially the most risky.

In contrast, crowdsourcing as a means for deal/investment-vetting is likely to prove highly-beneficial. The success of such a strategy is based on the premise that the wisdom of all of us is greater than the wisdom of a few. Two special considerations are vital here.

First, vetting deals based on the crowd is more fitting for less-tested pre-revenue companies. This is the market void equity crowdfunding is currently attempting to fill. Unfortunately, except for some real estate platforms for direct investing, equity crowdfunding is still experiencing some growing pains. Moreover, most middle-market investment banks steer clear of startup and early stage deals, particularly when it comes to raising startup capital from retail investors. It’s risky for everyone involved and the time and monetary cost for DD can be significant, especially in the absence of upfront engagement fees which most startups are unable to afford.

Second, crowd-voting on the viability of a particular investment assumes some scale to the polled market. The best data would need to be sourced from a particularly large sample size. The stark differences between Title II, Title III and Title IV of the JOBS Act precludes true crowd-like scale for many-a-deal, particularly for Title II, Regulation D 506(c) offerings where the average number of investors in a given deal is <20.

Will Investment Bankers Even Provide Value?

Understanding that the legacy investment banker is being disrupted, one might rightly ask:

Will investment bankers truly provide value in the future?

If so, how is it quantified, particularly with the understanding that deals are nothing more than an advanced process run with human intervention.

Complex? Yes, but processes nonetheless. Given current and future advances in automation and AI, eventual disintermediation between issuers and investors is a foregone conclusion, regardless of the level of complexity involved. We are already seeing the impact of automation on bulge-bracket investment banks. Further disruption “down market” is where we are headed, but instead of eliminating investment bankers altogether, the more noticeable alterations are likely to occur in the following ways:

  1. Reduction in Deal Makers. The number of investment bankers and other members of extended deal teams required on any individual deal is likely to decrease as tools become more advanced to match the complexity of the projects.
  2. Greater Scale. Deal team size reduction will also mean the most efficient teams will be able to scale the number of deals when provided with the appropriate transaction tools.
  3. Reduction in Fees. The savings gleaned from efficiency-creating process automation for investment banking deals is likely to be passed-on to the client.



True AI is also likely to further enhance the aforementioned items, providing a positive feedback loop. Much of the inherent complexity in the process will become less of an issue as well.

Emotion & Soft Metrics

Fortunately for investment bankers, no deal is done in a vacuum. This is particularly true with lower middle-market deals where company sellers and issuers are, quite literally, selling their baby. It is relatively commonly understood that there are many qualitative aspects of doing deals that often require the watchful eye of an experienced ibanker playing the role of psychologist. Without delving too deeply into the potential for schizophrenia in a deal, it is sufficient to say that psychology and therapy are likely two industries with relative job security in the coming decades of digital disruption. And, because even the most smooth transactions often involve some dose of schizophrenia.

Lucky for investment bankers and the other deal advisors, soft metrics like hustle, psychology, negotiations and bedside manner play a much bigger role in the deal process than we have generally assumed in this discussion. While investment banking is being disrupted, most of the disruption is occurring on the side of software and efficiency tools that make the lives of investment bankers easier. The platforms themselves–with some exception–are not living up to the initial, promised hype. The “post and pray” platform psychology will likely never replace the hands-on blocking and tackling of an experienced and accomplished, professional deal maker.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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  • William Hansen

    Good read. Very interesting perspective on AI and the digitization of the deal maker. I agree more so with your closing comments that emotions and “soft metrics” will still play a huge factor in this industry. However, hard to see how a platform would ever replace the A-Z of deal making. Few platforms truly provide value in the process – lots of shiny bells and whistles but nothing yet that is a game changer. I don’t think it possible that AI and/or a technology platform would every replace a team that has the experience and logged the hours. In many cases I have found its the last second “gut check” or in the moment “street smarts” that makes or breaks a successful event.

    • Nate Nead

      Hi William,

      I couldn’t agree more. Technology should never (and likely will never) be the tail that wags the dog when it comes to doing deals. In some rare exceptions, full disintermediation will be possible. However, the regulatory burden, combined with the overall complexity of deal processes will continue to require someone at the helm of the deal, shepherding it through to completion.

      My main point should have been:
      1) Tools and technologies will move from “nice to have” to absolutely necessary.
      2) Said tools will become less disparate across varied and somewhat un-related platforms
      3) The tools will keep getting more advanced in their ability to assist in complex processes like M&A and capital formation.

  • Raymond Rubin

    Hi Nate,

    Interesting and well argued piece, looking forward to seeing how this gets applied to transactions and to discussing with our PE/M & A clients; at Algovalue.com , we would like to add SaaS delivered GAAP/EXCEL compliant valuation and cap-table modelling/scenario building.

    Let me know how this could work for you.

    Best

    Raymond

  • Ronald Newcomb

    Congress’ goal of reducing the start-up costs is being thwarted on every hand by those who have made untold millions selling their services, and who wish to continue to do so. The limited universe of Investment Bankers and BrokerDealers I have dealt with in the past year seem to be driven more than ever to take as much as they can from the entrepreneur and founders. One broker wanted 30% of the equity and that was before he introduced his partner who wanted the same. Sixty percent is what you expect and early investor who fund all the needs, not someone merely servicing your needs. That was another non-starter. Even 506(c) “crowd” offerings have dozens of service providers swarming around to take bites out of deals. One wants you to run through a gauntlet of their friends “services” before you list and the entire process will cost $12k or more before you pay the listing fees. Only a few will allow you to list for little or not up front cost. In other words, the others take no risk, all the risk is yours. But frankly, this is how most brokers and bankers work, you pay heavy up front fees then pay a huge percentage of the money or equity for the privilege of them taking no risk. The entire business remains upside down, again, not what Congress envisioned. Look for a Banker who will only take a percentage of what they are successful in raising.

    • Nate Nead

      The picture you paint is the age-old give-take push between investment bankers and issuers. We have written about it numerous times before. That is one of the reasons, it is very difficult to find investment bankers that will work with pure startups or take on deals that represent a high level of risk. It’s also the stark reality of where regulation puts the banker. The banker can be jointly liable on the deal if things go south.

      Complete disintermediation is likely a long way off. Hopefully some hybrid of the two will help to alleviate many of the issues you present here.

      • Ronald Newcomb

        That would be most welcome, and ultimately the goal of the JOBS act. The models used will eventually adjust to the new regulations to the benefit of the entrepreneurs. The successful intermediaries of the future will be those who work with the new model, not against it.

  • Jeff Mason

    Well written, thanks for sharing.

  • Pavel Iliev

    There is one important aspect that artificial intelligence and disintermediation won’t and cannot replace – people relationships, which is of predominant value in investment banking. Fully agree on outsourcing of mechanical processes. Trust formation will remain a people to people process.

  • Matthew Robinson

    Interesting article. One of the principles of business I learned working in financial services is that its all about building relationships – which I suppose falls under emotion and soft metrics. Technology continues to advance at a rapid pace, and I’m sure very welcome if it can help finance start-ups. I believe there will always be a balance between technology and human relationships.

    • Nate Nead

      I agree Matthew. The more complex and emotion-driven the process, the more human intervention is needed. Complete dislocation is not going to occur, but if they can automate the burger-flipper ( see http://www.businessinsider.com/momentum-machines-burger-robot-2014-8 ), there is certainly room for some upending in investment banking as well.

  • Great article. As Matthew Robinson below has noted – as have others – business is all about relationships. Start-ups are unique in that the emotion involved for the founder far outweighs any perceived benefit from a purely mechanical process – meaning each start-up being funded will be a give and take between the investors and the founders. Where mere “money” is concerned and how/where to invest it, the Millennial generation seems to be favoring apps like WealthFront which invest your money at varying degrees of automation – which makes me think. Why can’t there be an app, say, for private equity funds, endowments, hedge funds, et al, that seeks out specific companies or a group of companies according to business sectors, analyze the risk factors with the investor inputting their goals/ROI and the app returns a list of those companies that match the given profile? Just thinking….

    • Nate Nead

      Thank you for connecting here Perry and thank you for your thoughts. The coming wave of roboadvising and roboinvesting (one area where WealthFront — and many others–are pushing) is the perfect example of disintermediation. It’s truly cutting out the traditional licensed Financial Planner from the picture in many instances.

      The struggle I see on the VC, hedge fund, private equity group, etc. side of investing is the information asymmetry that exists between the issuer and the investor. Anytime you attempt to move to anything below a typical bulge-bracket deal in the middle-market, there is always going to be a gap in information. Once you get above $100M in revenue, the number of shareholders and outright “scale” of the co. justifies the internal cost of paying for audits, syncing accounting with GAAP and otherwise providing legitimate reporting. In the absence of standardized metrics within, it’s not only anyone’s guess, but the cost falls upon the investor and not the issuing company to do more of their own due diligence. It’s more than just “trust, but verify,” it’s more like, “verify, verify, verify and then maybe we’ll trust you.” If there were a way to create some type of crowdsourced market for bridging the information gap on private deals, bringing the information to a larger group, then it might work, but then you run into other issues such as confidentiality.

      Moreover, it is this very real information disconnect that creates opportunity in the first place. Until a true market is created for a stock, savvy buyers and sellers will use the private markets as their fertile hunting ground for investment yield. Luckily accredited investors have more access these days, but a large amount of work still remains to truly bring smart private investing to the masses. We are not there yet, but we are making leaps and bounds.

  • Clearly a very interesting articles, by the responses, and close to the vest of many still in the 30-40s age bracket I suspect with worries about the future of their own careers and retirement years. This comment, however, does an excellent job of summarizing along with placing AI in perspective: “Without delving too deeply into the potential for schizophrenia in a deal, it is sufficient to say that psychology and therapy are likely two industries with relative job security in the coming decades of digital disruption.”. Within accounting, XBRL I think is heading clearly in the direction of automation and in many ways is eliminating manual financial analysis by electronically ‘joining-the-dots’ and bring potential areas of concern and risk exposure upfront before damage control implementation is after the ‘horses have bolted’. Not necessarily either schizophrenia nor psychology, but in years gone by your friendly banker was generally able to assist customers they knew personally from financial ruin by lending or creating financial relief giving someone/businesses a chance to recover. Today everything has become automated, credit scores by applying dehumanizing criteria, and for most recovery is out of reach. Intelligent automation is value-added, robotic-minded automation is destructive.