Make better strategic investment decisions: Reduce decision bias in M&A due diligence

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Jeana McNeil

Jeana McNeil
Vice President

Make better strategic investment decisions: Reduce decision bias in M&A due diligence

PE firms and corporate investors compete intensely for investments to expand their portfolio or augment their existing solutions.  In the due diligence process, decision makers face the dual pressures of accuracy in a high-stakes decision, and the need to work very quickly. Unfortunately, the time-pressure of makes these decisions vulnerable to the cognitive biases.

due diligence decision bias

The steady drumbeat of behavioral economics research in recent years highlights the prevalence of biased decisions, even among the professions we liken to Dr. Spock –the statisticians, economists, physicians, and computer programmers of the world.  M&A decision makers — Corporate Development and Private Equity investors – are also at risk. The pressure and tight timelines for M&A due diligence exacerbate the potential for biased decisions.

Investment teams use experience and sector knowledge to evaluate acquisition targets and expedite the decision process.  Experience and sector knowledge are generally assets; however, they also become liabilities.  Research shows that a high degree of experience may lead to:

  • Overconfidence bias: Experience causes the investment team to rely too much on what they think they already know, rather than carefully examining new data or the unique aspects of a particular deal.
  • Confirmation bias: Rich knowledge of a sector leads decision-makers to pay more attention to data that confirms their pre-existing view of the world, and overlook data that doesn’t support it.
  • Affect bias: Investors apply their experience to make an initial assessment of a prospective investment. If that initial assessment is positive – “I like this company”—new data is evaluated through that lens. When evaluating something we like, we minimize its risks/costs and exaggerate its benefits. When we dislike something, we do the opposite.

What can be done to mitigate against these and other decision biases in due diligence?

One answer is look to external partners: In addition to the requisite legal, technical, or analytical expertise, external partners provide an independent perspective. External partners are less vested in the decision and bring a different set of experiences than the core investment team.  While external partners aren’t immune to bias, their bias will likely be different and leads to a more robust analysis.

How do external providers improve decision quality?  Through Isurus’ work to support B2B software M&A due diligence, we’ve seen benefits from the following approaches in the context of primary market research:

1) Work from a pre-defined framework or analytical plan

The framework provides a checklist. It reduces the likelihood that important data are omitted from the analysis, and guards against too much weight placed on a particular element.  Without a pre-defined framework, stakeholders may struggle to agree on which data are needed, or brainstorm an excessive set of questions that stray from the main objective.  The framework can be modified for a particular market or scenario, when there is a strong rationale for doing so.

2) Listen to external partners’ point of view

Investment teams are skilled analysts. They dig into data, eager to form conclusions. In the case of primary market research results, the investment team should elicit more from their partner than just the data: Request their interpretation, conclusions and recommendations. External market research partners are less likely than the internal team to overlook data that contradicts a pre-existing opinion, or to weigh one piece of information too heavily in the analysis.

3) Encourage discussion of different interpretations of the data

When Isurus presents research findings, it is not uncommon that members within the investment team draw different conclusions from the same data point. Juxtaposing different interpretations often reveals useful nuances about market dynamics, growth potential, or considerations for the post-acquisition transition period. Research read-out sessions are particularly useful when the meeting is structured to encourage Q&A and discussion amongst the team.


For further reading on this topic, read “How Cognitive Bias Undermines Value Creation in Life Sciences M&A

Nobel laureate Daniel Kahneman writes in Thinking, Fast and Slow that “Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it. It is wise to take admissions of uncertainty seriously, but declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true.”  When confidence in a decision is abundant, it pays to confirm that data are at the root rather than emotion or bias.