Key notes: 5 insights on investing

There's an art to making sense of dollars and cents. And that's where Scott Shane comes in.

Shane, managing director of the Comeback Capital Fund and a professor of economics at Case Western Reserve University's Weatherhead School of Management, brings to the table more than 30 years of academic insights into entrepreneurship and innovation, as well as 19 years of investment expertise.

During the second of our Rubber News M&A Live events, Shane unpacked some of the advantages and challenges of capital investing and highlighted ways companies—both big and small—can find success in the arena.

Here's a look at five key notes from the 25-minute discussion, which is available on demand for Rubber News subscribers.

Capital venture investing is a high-stakes game. And major multinational corporations are playing, particularly in the tire industry where the work you do is defined more and more by the mobility trends and technologies you harness.

Each of the top four tire companies—Michelin, Bridgestone, Goodyear (through Goodyear Ventures) and Continental—are placing plenty of bets in start-ups and emerging technologies in mobility, recycling and alternative bio-based sustainable materials.

"We see this the most in big companies because these bets are very risky, and you need to do a lot of the bets to hit upon the winners that might transform an industry," Shane said.

"The rule of thumb is that if you make one or two bets on a novel technology, you are pretty much going to lose whatever you invest in, because that is not enough to be diversified."

But capital venture isn't just about making money. And it's not really about making an acquisition, either. Capital venture is about the big picture—piecing together a broader understanding of a given industry's future and gaining ground in your understanding of the latest technologies.

"Going out about the past 20 years or so, we have data that shows about a quarter of companies engage in purely financial investing when they invest in start-ups, a quarter are purely strategic and about half are a combination of a strategic goal and a financial goal," Shane said. "And that number hasn't really changed by more than one of two percentage points over that whole period. … So one would say that in 75 percent of the companies, the knowledge or insight, or information or a look into future technologies are really a focus of why they are making those early-stage investments."

Great ideas—sometimes even the best ideas—don't make business sense. For one reason or another, the technology or start-up doesn't pan out. Sometimes it has to do with costs or ability to scale up to commercial rollout. But even successful, commercially scalable technologies could fall through if the customer base isn't there.

That's what makes investing risky.

It's also why framing your gains through the lens of acquired knowledge or industry insight is critical. That makes establishing a clear road map for what should be gained from any investment—be it talent, knowledge or financial payoffs—makes all the difference.

"The biggest challenge is that, at best, 1-in-5 of these (investments) will be successful—and it's probably more like 1-in-10," Shane said. "And so, the first challenge is, how do I manage this in a way that isn't just like picking a number on a roulette wheel and hoping that one comes up?"

Shane contends that the capital venture investments can and should be an important part of the overarching strategy for any business, regardless of size. And there are plenty of opportunities, he said, for small and mid-sized companies to join the game, build partnerships with start-ups and collaborate on projects, especially at the university level.

The caveat is knowing the level of risk in each move and having a clear definition of what successful investing generates.

If small- and mid-size businesses do that, and they are comfortable with whatever outcome may occur, they actually may have an advantage with their agility.

"The problem with a giant Fortune 100 company is the levels of hierarchy you have to go through to get a deal approved," Shane said. "At a small enterprise, the start-up pitches the boss to say, 'Hey I would like to try a pilot with you.' The boss of the small- to medium-sized enterprise goes 'Yeah. That could possibly help us. Sure. Do the pilot. Talk to these two people, and we'll do the pilot with you.' Those are the (valuable) mechanisms that I see at the small- and medium-sized enterprises."

One way to look at it, Shane said, is through the idea that you are investing in your talent. Especially in instances where your research and development engineers can collaborate with start-ups or universities. In doing so, they gain insights and understanding they otherwise would not have had.

And in the case of university partnerships, the collaboration could go a very long way in shaping the next generation of young talent in your ranks.

"At the worst. Even if the projects that you work on … (don't) pan out, there is someone to hire," Shane said. "There are students who worked on that project and, when they graduate, you can get talent."

Potential doesn't always look the way it should. Especially when it comes to new ideas.

Because new ideas—new products—by nature need room to grow into something more beautiful, more streamlined. So the key to finding success in the capital venture space may be fine-tuning your firm's ability to see the true potential of a new idea.

"Almost always, what the new companies are doing, is very crude," Shane said. "They are not very efficient. It is really hard to see the potential of things that are crude.

"The stereotypical idea is that somebody has put something together—it's a prototype with duct tape and chewing gum holding it together with scrap material. And it's very hard to envision the industry-robust version of that. And so I think the second big challenge is seeing the potential of something and not rejecting it before you had a chance."

Don't think of capital investments as stepping stones to acquisitions. After all, Shane said, the failure rate of the new idea, company or product is between 80 and 90 percent, so acquisitions are very unlikely.

That said, expect to see major players make acquisitions. Because any hint of success will open doors of opportunity.

"When there is a positive outcome—that is the start-up hits on something, it's working—acquisitions are a dominant solution for two reasons," Shane said. "The first is because that would benefit a given company a lot by having the advantage of that new technology or market they are going after.

"The second is defensive, which is that they don't want their competitors to have that technology or that market. And the way to do this is to acquire it, even if (the technology or product) isn't that great, just to keep your competitor from having something that is just a little bit better than what you have."