We all have challenges to overcome.

But, when it comes to private investments, understanding the challenges a business must overcome in order to capture a market opportunity, are fundamental when considering an investment in that company.

In our series of articles on First Principles, we show you how to easily define the basic elements of a business’s inherent value proposition.

  • What is the market opportunity?
  • What are the challenges that a business must overcome in order to capture the value of that market opportunity?
  • What solution(s) does the business have to overcome those challenges, to ultimately capture the value of that market opportunity?

If a business doesn’t address these inherent challenges, it will not succeed.

Stop for a moment and consider what challenges the last few companies in which you invested faced.  For example, if the business is growing crops, there’s a whole host of issues, beginning with the weather. Too hot? Too dry? Too overcast…? But there are many others to consider, e.g., pestilence, equipment breakdown, collection and distribution hurdles, seasonality and irregular cash flows, etc.

Alternatively, a company providing cybersecurity solutions faces radically different challenges than might a manufacturer, a consumer marketing company or a service company.

Take technology, for instance. Has the company assembled a team that can provide technology solutions to the market ahead of its competition?  Can they resolve issues quickly, thoroughly and economically?

Or, think about highly specialized industries – the medical field, for instance. Their challenges may relate more to training and keeping a skilled workforce that keeps current in a rapidly evolving environment. Is there a large enough pool of potential employees trained in the skills necessary to produce and market the company’s product? Or will the company have to expend time and resources to train employees, further delaying the day that the company becomes profitable?

Then there are industries, such as manufacturers, distributors, aerospace or aviation companies and many others, that are heavily dependent upon capital. Does the company have easy access to inexpensive capital to stay on target? Additionally, is the management experienced in the particular industry? Has it built a company from scratch, has it hired skill sets that the founder lacks, and is the founder open to others’ opinions?

When grappling with a company’s impediments, we’ve found that some are broadly understood. One of our issuers, for example, was in the frozen food manufacturing and distributing business. It’s pretty easy to grasp that, if the production line breaks down, product distribution and consequent revenues will be delayed, potentially creating a cash flow problem. If a relatively common industry problem, another manufacturer may have a more dependable solution that can be substituted.

On the other hand, some are pretty obscure — both harder to discover and protect against, e.g. software glitches, unforeseen weather events causing a disruption in the supply chain or a rapid rise in cost of materials.

If an issue has a long history, it should be discoverable, explanations available, steps to overcome clearly identified and solutions in the works. On the other hand, an obstacle may have recently occurred that leaves the investor with questions unanswered. We witnessed U.S. Navy budgets (that would purchase our issuer’s service) pushed off until next year’s government appropriations, leaving the company, and its investors, in a difficult spot.

With some digging, solutions may exist for these challenges. Other businesses may have a suitable work-around that can be utilized. A friendly competitor may be willing to purchase the company’s product at a reasonable discount until the company is back on its feet. It’s important to find out how other businesses are addressing these challenges.

We hope this aspect of “First Principles” rings true. Please be on the lookout for the final installment, The Solution.