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:
- 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.
- 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.
- 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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