Where to Invest
Private enterprises that have served sectors and industries for extended periods of time build a deep understanding of the opportunities that surround those businesses. The people who focus on those areas often have knowledge of where solutions can be developed that don’t exist today, so it can be fertile ground to start. Initial questions include evaluating the gaps in the market – where are they? Are there extensions to existing products of the operating business that have attractive growth and value profiles? The costs of building new capabilities can sometimes be limited and incremental if the new products and services rely on an infrastructure similar to that of the existing business, so they can be quite advantageous to pursue.
For others, however, there is a different reality, with unfavorable characteristics surrounding one or more existing businesses – margin erosion caused by commoditization and/or increased competition, product obsolescence risk, or declining market demand. In those cases, it may make sense to pursue investments in other, uncorrelated areas. While existing market knowledge may not be helpful in this instance, there may be effective business approaches or time-tested values that can create a competitive advantage in a new market. The benefits of ownership and capital also remain.
In the latter instance, there comes a need to ask the honest question: Are we the best people to build this new and unfamiliar capability, or should someone else do it? There is a gradient of approaches to consider. One is to acquire new capabilities through merger. The intention with that strategy is to integrate those newly acquired capabilities into the legacy business to leverage the talent and know-how in the combined enterprise. For this to work, however, the legacy and target businesses need to have cultures that will pragmatically fit together post-merger.
Another approach is to acquire an emerging business and leave it as a standalone operating entity. Here, the owners must rely on the strength of the management team to execute on their vision. Owners must also accept risk of the unknown – whether that industry or business will create or sustain the value that is anticipated.
Emerging industries and businesses are tricky when the industry/business has little track record, or where an investor has little domain expertise. It can be unsettling for business owners who are not accustomed to this kind of uncertainty. In fact, it’s challenging for people who do it professionally. “Picking unicorns isn’t easy,” says Scott Kupor, managing partner at Andreesen Horowitz, one of the largest venture capital firms in the United States. An investor may have a thesis about an industry and its impact, but it isn’t always clear which businesses will come out a winner. “One of the biggest mistakes that can be made here is getting the category right but picking the wrong company,” Kupor says. Taking a broad investment approach to an emerging industry during early stages increases your chances of finding your way to value creation.