We are looking to acquire a smaller competitor that claims to have built a proprietary AI matching engine, but we suspect it is just a basic wrapper around a public API. How do we run a valuation framework during our due diligence to avoid paying a software multiple for a manual operation?

Question

Tyler Smith · Accepted Answer

Do not buy a marketing story. Many founders are dressing up basic manual processes or simple API calls as proprietary AI to command a SaaS-like relative valuation multiple.

To protect your capital, you must use both absolute and relative valuation frameworks during your due diligence. First, demand to audit their actual operational efficiency. If their AI engine is truly proprietary and integrated, their revenue-per-employee metric and EBITDA margins should be significantly higher than the industry standard.

Next, run a Thinking Time session focused on their technical infrastructure. Ask: How easily could our own team replicate their workflow using off-the-shelf tools within ninety days?

If the answer is that you can build it yourself for a fraction of the cost, you are not buying proprietary software; you are buying a standard customer list.

Value the acquisition accordingly. Do not pay a software multiple for a business that relies on human labor disguised as automation. Instead, price the deal based on their historical cash flow using an absolute valuation framework, and discount the price based on the operational risk of their undocumented workflows. This unsentimental approach ensures you only pay for true intellectual property.