Med diversified acquires tender loving care,” “Nellcor and MDE Establish Partnership,” “Drkoop Acquires Home Infusion Company.”

These recent headlines may be familiar to you because large companies are always merging or establishing a new type of partnership. But smaller companies do this as well. Would you know how to negotiate the sale of your business if a buyer approached you? Buyers often initiate the buy/sell transaction before a seller may have positioned the business for its optimal price. A few key components are important to consider before reacting to the buyer’s proposition.

After celebrating the fact that your company attracted another business, realize that you have likely been caught off-guard. The situation may appear strong because you are being courted, but it is possible that the proposition is weak because you are unprepared.

The biggest danger in being unprepared is that you may be unable to document the full value of your company to the buyer. For example, a couple of months ago, one of our clients asked me to help them buy another business. They gave me the names of their top three candidates. We agreed that it would be best if my client was anonymous until a letter of intent was presented to the seller.

I approached the candidates on my client’s behalf and caught them all off-guard. During the first meeting, they asked how their businesses might be valued. When I explained that I would consider, among other things, their recast earnings, the owner actually told me, “When I go to Wal-Mart to buy supplies for the business, I buy items for the family too, but the business pays for it. The amount is significant. If I show you those receipts, will you add them back to our profitability?” This candidate was trying to salvage the market value of his business and was clearly disadvantaged because he was not prepared to discuss the sale.

The first point to make is never give information pertinent to valuation. A good response if asked to sell is, “I might be interested in selling, but there are several things that I will have to consider. How much time can you reasonably allow me to consider some important personal questions?”

Second, during the first meetings, never ask questions about the potential buyer’s valuation methods or payment methods. Instead, try to find out why the potential buyer thinks your business is a good fit with his or her business. The buyer is probably interested because you offer a strategic advantage. For example, your company may cover a geographic area the buyer needs representation in, have contracts that the buyer needs to build on, offer services that the buyer needs to add, and/or have staff that the buyer needs to acquire. Or the buyer may simply need to produce sales and earnings growth for a publicly held company.

Understanding the strategic advantage your company holds for a buyer is key to getting the best value possible for your company. Consider that there are at least two valuations of a business. One is the appraised value, which in essence is the discounted value of future cash flows created by the business. The other is the strategic value, which is the discounted value of future cash flows of the business after assuming the effects of the synergy between the acquiring company and your company. To get a price that is better than the appraised value, you must understand the strategic value. Don’t expect to sell for the strategic value. You want to negotiate your price between the appraised and strategic values.

Third, quickly determine if you have an interest in selling. If you are interested, you probably have a few weeks to position the company before you meet with the buyer again. I recommend that you assemble a team to assist you, plan to work hard, and focus on the following five areas:

1. Recast earnings. Owners’ benefit is what you are trying to document. In general, it equals profit plus depreciation, owners’ salary, and other expenses from which the owners benefited. It is a critical factor in the valuation. Look back as far as you can. If you have a federal income tax return in process, stop the process, file an extension, and begin a review of every general ledger account that can impact the recast earnings. When you file the return, it should support your notion of selling the company.

Look at your accounting method. If you are using cash accounting, convert your presentation (not your tax return) to the accrual method. Look at your capitalization policy and adjust it so you expense less and capitalize more. If you report sales on allowable charges, change it to customary and show the allowance for contractual adjustments. If your inventory is not in a perpetual system, do a quick physical inventory. There is often hidden profit in understated inventory.

I recently met with the owners of a mobility and accessibility business that has been expensing its payroll related to van conversions rather than adding the appropriate payroll to inventory, work in process. They could affect their profitability by thousands of dollars and their market value by some multiple of that if they changed their accounting methods.

2. Forecast earnings. The buyer will consider both your recast earnings and what they will do to improve them. When you can identify the strategic advantage the buyer gains with your company, you can play to that strength and show how your earnings will improve if they acquire the company. The sellers’ objective in this effort is to increase the purchase price.

For example, a pharmacy has indicated an interest in one of my clients that specializes in HME and respiratory therapy. My client has a fabulous relationship with a managed care organization (MCO) that is willing to expand its relationship with my client. The strategic advantage to the pharmacy is the ability to add profits from updraft medications, infusion therapy, and wider geographic coverage for the MCO.

3. Preferred structure. Formulate your preferred methods of receiving payment for your company. Few deals are all cash. You may be lucky and receive cash without having to accept a steep discount in the purchase price, but never count on it. More often than not, the payment of the purchase price will be a combination of cash, buyer’s stock, notes, and employment or consulting agreements. Determine the right mix for you.

4. Taxation. Before the second meeting with the buyer, talk to your certified public accountant. Ask him or her to review what you have done with an eye to taxation of the proposed transaction. You may wish to modify your preferred structure or reconsider how you are treating elements of the recast earnings. The objective, of course, will be to avoid some structure that will ultimately be too burdened with taxes.

5. Legality. This, too, must occur before the second meeting with a buyer. They must enter into a nondisclosure agreement. You should try to negotiate a noncompete agreement, too. That way, in the event you do not consummate the sale/purchase, they will be unable to use your confidential information to compete against you.

With a dedicated team, lots of work, attention to detail, and good advice, you can talk to a suitor within a week after the courtship and be confident that you will sell your business for a good price.

Wallace Weeks is president of The Weeks Group Inc, Melbourne, Fla. Contact him at (321) 752-4514 or by email at wallace@weeksgroup.com.