Transcription
Hey everyone, David Barnett here. Today we're going to be talking about the changing value of information in businesses that you might be looking at and some things that we should be thinking about when analyzing a business that claims a great deal of its value is driven by intellectual property or data or information that they're using on a regular basis.
I'm David C. Barnett and you're tuned in to Small Business and Dealm, the podcast, YouTube channel, and blog, where I talk about buying, selling, financing, and managing small and medium-sized businesses while controlling risk. So, if you're looking to take control of your future through buying a business one day, or if you already own a business and you're looking to grow or exit, you've come to the right place. I talk about interesting things, I talk to interesting people, and I answer your questions every week right here. So, be sure to hit like and be sure to hit subscribe, and let's get to it.
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All right, everyone. Uh, there was once a time when information was actually hard to come by. If you can believe this, and if you're one of the younger people in the audience, you you may be blown away by this fact. Behind me on that bookshelf, in fact, there are several books that don't exist anywhere except on print. And when I mean in print, I mean like 200-page books photocopied at a copy shop with a coil binding inserted, sold through the mail, and you had to go figure out where to mail a check to in order to get that book delivered to you. Right?
So this is back in the days when uh when the internet was first around, people would use the internet to order things through the internet like CDs and books and things like that. But even before that, people would have to go and find sources of this kind of information through little ads in the back of newsletters and magazines and and and places like that. Like it was hard to get your hands on information. Some of the information back there that inspired the knowledge that I used when I wrote the book Invest Local, for example, about calculating rates of return on second uh on secondary market note transactions and stuff like this. Like it just the content wasn't anywhere and you couldn't even find a book about that in the library because it was a very small community of people that were doing those kinds of things and they were talking at conferences and things and just a couple people decided to to write a book and but it wasn't available through any major publisher.
So, so that's what I mean when information when I say information was once scarce and because information was scarce sometimes information proprietary intellectual property actually held tremendous value because uh it was not easy to replicate. Um, but the world as we all know is changing now. The internet changed at first. Suddenly information was much easier to find. You could search for instructions, examples, templates, videos, forums, explanations, etc. uh things that might once have taken weeks or months to figure out. Sometimes you could find them in minutes.
And now with AI, this is happening even faster. You can ask an AI tool to create a lesson plan, for example, if you want to teach something to somebody else and it'll just whip one up and then you can obviously tweak it or or maybe add context to the request by putting other information into it. Um, but things are moving faster and it's becoming easier and easier to assemble information and and that doesn't mean that all information is worthless. But it does mean that if you're buying a business that has any degree of intellectual property value that you have to ask much better questions about this value than maybe people have been asking in the past.
So the question is really, what exactly am I buying? Am I buying something that is truly difficult to recreate? Or am I buying information that used to be hard to assemble but can now be recreated quickly and cheaply with all these modern tools that we have.
So let me give you an example. So imagine a business that teaches children how to code. For example, a kids coding camp like a day camp in the summertime. 20 years ago if someone had developed a really good curriculum for teaching kids how to code, they that would have represented a lot of value. They had to figure out what the children could understand. They had to determine the right sequence of lessons. They had to create projects that were fun. They had to learn what kept the children engaged and had to build materials, worksheets, examples, the instructor guides, all that kind of stuff. That took a huge amount of work. And because it took a lot of work, a buyer might look at that curriculum and say, "This is an asset. This is a really important part of what I'm getting in this business."
But today you've got to be more skeptical about this kind of thing because a basic coding curriculum for children can be created very quickly. Uh, you know, lesson plans can be drafted, worksheets can be produced, project ideas can be generated very quickly through AI and then if you simply hire a consultant or or get someone who has experience in this kind of field, they can review it with you, suggest some tweaks and like bing bang boom, like the thing is put together, right? Um, so if you if you're looking at a business like that and the seller says the value that we have is is in this this IP, this intellectual property, then you have to slow down and think really carefully because the curriculum in this case of the coding camp may not actually be the valuable part anymore.
The what a buyer has to actually ask is, what part of this business is actually the difficult part to recreate? And this is where we have to separate information from execution because execution is the hard part. You know, people are always coming up with ideas for a business, right? I've met hundreds of people over the course of my life who say, "I have a million-dollar business idea." And I'm like, "Great. What is it?" And they're like, "Oh, I don't want to tell you, right?" Because they think that the idea itself is valuable. But anyone who's ever started a business or whatever will tell you that ideas for businesses are a dime a dozen. What counts is pulling it off and executing the idea. Right?
So execution is the ability to uh, you know, craft the business concept and then do it well over and over again profitably without everything depending on one person ideally, right? A curriculum like in the coding camp example, that's just information. But a functioning camp business might include the ability to hire and train instructors. It might be the ability to manage the children safely. Uh, the ability to deal with the parents professionally. Uh, the it might include building a good reputation in the community, relationships with schools, community centers, churches, municipal facilities, and the people that work and manage those places. It might include a registration system that works, a marketing system that fills the seats, right? A way to handle refunds, complaints, lunchtime allergies, cancellations, behavioral issues, staff no-shows, and the little problems that pop up when you're dealing with real customers in the real world. And and that part is not just information. That's operational capability. And operational capability is very different from just a pile of content, right?
So, so this is the question that the buyers need to ask when you're looking at a business that is that's got this kind of character, these kinds of characteristics. Is the value in the content or is the value in the machine that delivers the content? Right? Because there's a big distinction here between the two things. Um, you know, if they say they if the seller says we have a proprietary method, proprietary curriculum, unique system, etc. Special chain, special training or knowledge base, that that could be true, but you've got to test it, right? So the question is, could a competent person recreate 80% of this material using AI? And and if that's the case, then the value of that intellectual property has to be brought into question.
And and here's where this is a real danger because if you're looking at, for example, a kids coding camp that has an SDE of $200,000 a year and the seller is asking for an asking price that relates to that cash flow, right? Then the the way we approach it is we're approaching it like it's a going concern business. We're saying, "Okay, well, the the cash flow is here. All the different employees are doing what they need to do. I'm obviously buying a going concern business." Where this really comes into play is when businesses are not necessarily performing with a a good amount of cash flow. We see this across the spectrum of businesses. Um, I I in one time years ago, I used the example when I was talking about internet companies and pre-pre-revenue companies and what they would be worth. And I said that if you bought a backhoe and a dump truck, that you would own a pre-revenue foundation company, right? Meaning that you had no sales, you had no earnings, you had no revenue, but you had a backhoe and a dump truck. So, you were ready to go dig holes for foundations. You just hadn't done it yet, right? And that somebody could argue that the value of that business was the value of the dump truck and the backhoe, right? They're like, "Oh, you have these assets. They're worth something."
That's exactly the kind of framing that I'm seeing this particular problem appear as. It's when a business maybe isn't performing too well or hasn't been profitable or maybe it's even been closed because the owner of the business got sick and now they're trying to sell the business. And similar to looking at the backhoe and the dump truck, they're trying to say, these are the big assets within my business and this is why my business holds value. It's not in the cash flow. It's in this, you know, intellectual property, knowledge, sort of uh uh foundation for this business. And and this is where people can be tempted to overlook the lack of cash flow and buy into the idea that the information itself could be the thing that holds the value. But it it just isn't the case.
What we have to do is we have to think, what part of this would be very difficult for anyone to put together. So, um, you know, here are here are the, you know, reasons to buy a business that might have this kind of like IP nugget at its at its center. Um, does the business have existing customers that would be difficult to replace? Right? So we know that goodwill is associated with profitability and that profitability is usually tied to the fact that there are customers. So existing customers, cash flow is another one we just mentioned that, brand recognition. If the kids coding camp, for example, has been operating in a given community for 20 years and everybody knows the brand and they have a database of parents' email addresses that they've been using to market to every year, then that is the actually the part that holds the value. It's not the IP or the the curriculum. It's the fact that they've got the email lists, right? That they can start sending emails in before school ends to try to book those spots into the children's camp.
Now, if that business doesn't operate one summer, for example, if the owner is ill, then you're like, okay, well, now our email list is two years out of date. A lot of the kids who might be represented by that list now are too old for any kind of camp. We always have a certain number of them that that depart every year, but now we've got two years' worth of of sort of exiting children, and we didn't have the pipeline open last year to get new people in. See where I'm see where I'm going here?
So, there are things like contracts, locations, licenses, vendor relationships, search rankings on Google, for example, uh, reviews on on Google, all that kind of stuff, which would represent like the local reputation. Those things can actually be valuable and the buyer needs to identify them specifically. Here are the things that I think are really hold value in this business and this is why it would be worth acquiring as long as I can negotiate a deal that makes sense. Right?
In in this book that I put out in 2014, Buying Versus Starting a Small Business, I I talk about how when you're looking at doing a business acquisition, doing a copycat startup is always something you should consider. And sometimes you should. When you look at it, you realize, oh my goodness, like there's so many different things that would have to come into play here and be just perfect in order for me to produce the cash flow that the current owner has. It it becomes obvious that yes, I should try to buy the business. But when the business is way overpriced and you realize that doing a copycat startup may not be that onerous a task, then you realize, hm, I should not be investing this huge amount of money in this acquisition if I can truly replicate it for much, much less money. And you know, even if I have losses for a year or two, the overall investment is going to be far less than what the seller is trying to get in their deal. Then it can push the needle towards doing a startup as being a better opportunity or simply just, you know, drawing a solid line in the sand saying like, I will not pay more than this because it's just not worth it when the alternative is relatively budget-friendly, uh, small startup, right? With with much more limited risk, no leverage, no taking on debt, all that kind of stuff.
So the the value in any business acquisition is on what advantage it gives the buyer today. And if the advantage can be recreated quickly and cheaply, it's not worth very much, obviously, right? So, we're looking for loyal customer bases, trained teams, recurring revenues, strong reputation, documented systems that people actually use, uh, hard-to-get licenses or locations, for example. So, you know, the the church hall across the street from the elementary school for your after-school coding camp, like if if there are limited places that could host that kind of uh activity at a reasonable price with such proximity to the school without the need for like a bus, right? Like, wow, getting that location holds some kind of operational value to a business owner. That is going to be something that's worth something. Uh, proven sales channels, operational know-how, again, execution, um, the history of profitable execution. These are the things that justify an acquisition.
Um, a a business is more likely to be recreated instead of acquired when its main value is generic information that that we know we can copy, right? Without any kind of special team. What the trap is here is looking at these businesses with yesterday's mindset framing, right? Because 20 years ago, this stuff held a lot of value. There was scarcity attached to it. Today, not not the case.
Um, this can even apply to some franchises, right? If if the franchise is just about giving you a manual, a logo, or some basic training and that playbook can be recreated, then really, what is the value? Um, I've I've had many conversations over the years, for example, with people that have looked at franchise restaurant concepts, like this is the next wave in plant-based vegetarian dining. And I'll ask them questions like, well, if 50% of all people suddenly became vegetarian, do you think this business would have an advantage? And they'll they'll eagerly say yes. They'll be like, "Oh yeah, if half the people are vegetarians, then you know, this place is going to boom because it's a vegetarian restaurant." And then my follow-up question is, what prevents every other restaurant that's already open from simply adopting a vegetarian menu or vegetarian items on their menu? And of course, there's no barrier to that, right? In fact, I have been at many restaurants where you start to look at the menu and you see like a little leaf logo beside some of the items and if you look down at the bottom, you're like, "Oh, it's a vegetarian option." Right? So, these mainstream restaurants that do serve uh meat, different, you know, meat things, they're they're they're adding vegetarian items to their menu to accommodate the people in the population who are looking for that, right?
So, so having a plant-based franchise doesn't really hold any water. In fact, it's a big strike against someone because if a group of people, you know, three vegetarians and one meat-eater were going to go out for lunch, then there's actually a reason not to go to the vegetarian restaurant because the group of people knows that one part person in their party is going to be disappointed with the menu, right? So again, what exactly are you buying?
In fact, some of the food supply companies um, you know, that that wholesale to restaurants actually have generic business plans and operating manuals that they give out for free, right? Like where you could say, "Hey, I want to open an Irish-style pub." And they're like, "Oh, hey, here's the Irish pub operating guide we have for you and here's all the food we can sell you, you know, for your uh shepherd's pie or whatever." Right? So, so again, information, processes, systems becoming increasingly available. Um, and the barriers to entry for all of this stuff is coming down.
Um, so are you buying brand, are you buying customers, are you buying a team, are you buying processes, are you buying a machine that produces results? Or are you just buying something that can be easily recreated? And that is the distinction because the value of information is changing, right? That that's the whole point of this video. Um, so when you look at a business, especially one that is involved in the communication of information and the example of the kids coding camp is one that comes to mind, then you really have to start looking carefully at what it is that you're getting.
You know, my own business is a consulting business that has some information products. Um, the information products, yes, it costs money. Can people find information for free about business acquisition, for example? Yes, they can. But the LLM models cannot give you the same kind of information that I produce. And there's a step up in value because people ultimately, if they're going to do a deal, will often want to get my help to actually analyze their deal. And it is easier and more cost-effective to interact with me on a consulting basis if somebody has already done Business Buyer Advantage, for example. Right? So this is why when I do live events like my boardroom events that I do in person, I will always say in the content, if you have already completed Business Buyer Advantage, you will get far more out of this session than someone who has not because you'll already be up to speed on the concepts, the jargon, the know-how, etc. Like I will sometimes have to spend hours and hours and hours explaining basic things to people who have not done Business Buyer Advantage and it costs them way more in in consulting with me than when the people who do do Business Buyer Advantage then they find a deal, look at it, book me for like a 40-minute consulting call and we chew through the file literally in 40 minutes because I don't have to explain things to them. I I will spot things and point things out to them and then and like remember this, this, this and they'll be like, "Oh yeah, I remember that from the course," and and we just keep it's like having the fast-forward button on through a a long uh detailed investigation into something.
So, so, but here's the thing is that the IP or the information in my business, you you might think, hey, if I'm going to buy David's business one day, then I get to be the owner of that Business Buyer Advantage course. Really, the true IP in my business is in here. And and the problem is is that it's not very transferable, right? If if if I was going to sell my business to someone, I'd have to spend probably years working with them side by side in order for them to, you know, absorb through osmosis and through their own experience and dealing with people the the degree of information and knowledge that they would need to be able to execute on the same level that I do with clients directly. So, so that's just another example from I guess the other end of the spectrum when it comes to uh information, knowledge, experience uh and execution.
So, how about you? Have Have you looked at a business recently that had some large amount of IP uh or content value that was proposed to you? I'd be curious to learn what you thought of that and how you valued it and what ultimately that particular asset played in your decision whether to make an offer or to back away from the deal. Please head down to the comments down below. Let me let me know what you think or tell me a little bit about the story. Um, and uh, we will see you next time. Cheers.
So, how can you learn more about buying, selling, financing, and managing small and medium-sized businesses? Easy. Go over to my blog site, davidcbarett.com, where you can learn more about me and how I work with my clients. You can learn more about my books and courses that I prepared for you. You can find out how to subscribe to my email list, the YouTube playlists, and more. There's literally hundreds of hours of content there, all for free. And I'd love for you to be my guest.