When Due Diligence Becomes Reverse Engineering: Legal Risks in AI M&A

In a widely circulated article, Bain & Company described a diligence exercise in which a team evaluating an AI-native healthcare startup reportedly built a prototype rivaling the target’s product in roughly two weeks. The exercise ultimately led the potential acquirer to walk away from the transaction.

While Bain framed the example as effective diligence, the scenario raises uncomfortable questions for founders, licensors, and anyone sharing sensitive information during M&A or investment discussions, particularly in the AI context.

A Thin Line Between Diligence and Replication

According to Bain’s own description, the diligence team had access to proprietary materials during the acquisition process and used that access to validate whether the target’s technology could be recreated internally. The stated goal was to assess competitive risk rather than proceed with the acquisition.

From a legal perspective, this framing matters, but it does not eliminate risk.

In traditional M&A, diligence is meant to evaluate whether to buy, not to determine how easily the buyer could recreate the product instead. As AI development cycles shorten, that distinction is becoming harder to maintain.

Key Legal Questions Raised by This Scenario

This type of conduct puts several core legal concepts into tension.

1. Scope of NDA “Permitted Purpose” Language

Most diligence NDAs restrict use of confidential information to a defined “business purpose,” typically tied to evaluating a potential transaction.

A critical question is whether using disclosed materials to recreate a competing prototype falls within that purpose, or whether it exceeds the scope of permitted use.

2. Internal Validation vs. Reverse Engineering

Some parties argue that internal testing or validation is necessary to assess technical feasibility.

But when validation crosses into functional replication, the analysis changes. Courts often look at substance over labels: what was actually done with the information, not how it was described.

3. Remedies After the Transaction Dies

Even where misuse occurs, practical remedies can be limited once a deal is abandoned:

• Injunctive relief may be difficult to obtain after the fact

• Proving damages can be challenging

• Evidence of internal use may be hard to uncover

This asymmetry is precisely what makes diligence misuse so concerning for startups.

Why This Risk Is Increasing in AI Transactions

AI changes the diligence dynamic in three important ways:

1. Prototypes can be built quickly

2. Synthetic data can substitute for real datasets

3. Functional parity can be demonstrated without full-scale deployment

As a result, the informational leverage created by diligence access is far greater than it was even a few years ago.

Notable Revisions to the Bain Article

Interestingly, the Bain article itself was later revised. The revisions appeared after the following statement from the original article was widely circulated on LinkedIn: ""When a financial sponsor performed diligence on an AI native healthcare company it hoped to acquire, the diligence team built a prototype rivaling the functionality of the firm's technology and tested it with clinicians. The prototype, which took only two weeks to develop, outperformed the target's product and convinced the acquirer to pass on the opportunity."

Subsequent edits reframed the effort as an “outside-in” assessment designed to evaluate competitive vulnerability rather than direct replication.

The revisions underscore the sensitivity of how these activities are characterized and how easily diligence narratives can shift.

Practical Takeaways for Founders and Sellers

For companies entering diligence discussions, especially in AI or data-driven sectors, this example highlights the need to reassess standard practices.

Key considerations include:

• Narrowly defining permitted use in NDAs

• Limiting technical depth shared early in diligence

• Avoiding recorded meetings or uncontrolled artifacts

• Structuring staged disclosures tied to deal progression

• Treating diligence access as a form of IP exposure, not a formality

What once felt like market-standard diligence may no longer be safe by default.

The Bigger Picture: Weaponized Diligence

Whether labeled “reverse engineering” or “validation,” this scenario reflects a broader shift. Diligence is no longer purely evaluative. In some contexts, it can function as a strategic capability test: one that disproportionately benefits the party with greater resources.

As AI accelerates development timelines, founders and licensors should assume that anything shared in diligence could be used to test how replaceable they are. That reality demands more careful legal and operational guardrails than most legacy diligence frameworks provide.

The information provided is for educational purposes only and does not constitute legal advice. Reading this article does not establish an attorney-client relationship.