To provide value (and generate income as an individual or a business), you need to solve a problem for someone.  

It’s actually why we get out of bed every day and go to work. If a company you’re looking to invest in doesn’t do the same, it’s likely that company will fail. 

In this series of articles on First Principles, we show you how to easily define the basic elements of a businesses 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?  

We’ve discussed the Market Opportunity and The Challenges. Let’s break down The Solution.  

Assuming the market opportunity and challenge(s) to realizing that opportunity have been identified, the business needs to provide a viable solution to that challenge.  Ideally, it is relatively simple (usually the simpler, the better). That being said, it may be, by its very nature, highly complex.  A prospective Investor should ask the following questions:     

• What does the company need to deliver the solution? Answers can vary and can include capital expenditure (capex). Will that solve the problem alone, or are there additional solutions required such as technology development, or regulatory approval, staff training, or even third-party resources?
• It’s good to know that there’s a solution, but how did the company arrive at its solution? Has it been tested to determine its viability, e.g., has one team undergone training and management can point to its positive results? Is there a way to determine whether the solution will have a lasting effect, or is the problem likely to reoccur? 
• Did the company come up with a proprietary resolution?
• Has the company’s solution created “barriers to entry” that deter competition and, possibly, enable higher-margin and longer-term profitability? 

Over the years, we’ve listened to many a struggling entrepreneur complain that their customers “don’t get it,” and, so, the business isn’t making its sales projections.  That’s a red flag.  The business needs to deliver a solution that is readily desired.  The best solutions are ones customers can’t live without (sometimes literally).  

A First Principles-approach to investment analysis provides Investors with a simple framework – a process for understanding the why’s of a business – from which to base all other discoveries about the securities Issuer.  In another Carofin white paper, “Seven Key Questions for Evaluating a Private Company,” we present a guideline for quickly and comprehensively understanding the fundamental “what’s” of a company and the securities it is offering to Investors.  Another helpful resource may be our due diligence guidelines: “Due Diligence” and Investments: What do I Really Need to Know.”  

Editors Note: Carofin would like to recognize Farnam Street’s First Principles: The Building Block of True knowledge, for its influence on this article.