I have recently been arguing with an entrepreneur about how to approach the subject of company valuation when talking with a potential investor.

My suggestion is always to let the investor put forward a valuation and you can then begin your negotiations. 

The best way to learn how to negotiate effectively is to try to sell a diamond in the Diamond District.  As all good diamond merchants know, the person who quotes a price first, loses. 

The way you start the negotiations is the most important part of the whole experience! If you want to make a big mistake you go into a store, plunk down your diamond, and say you want $15,000. The merchant will either say yes or no, but you really don't know what axe he has in the deal, and because of this, you don't know if $15,000 is too expensive or too cheap a price. You have spent your time and energy, revealed your deal, and made either a good or bad impression on someone you might be able to do future business with - and you have received nothing. Or, you have sold your diamond at possibly a very cheap price, and you will never know.

The smartest way to start this negotiation is to go into the store and nose around asking questions. Remember the TV show Colombo? He was a detective who solved the unsolvable crimes by wandering around asking questions and appearing naive. That is what you want to do because your most valuable tool is always knowledge. So you keep looking at diamonds and asking questions that will draw out information. Your goal is to [1] know whether the merchant is looking to buy any diamonds today and what kind [2] what price diamonds similar to yours are selling for, [3] what the market for diamonds is doing in general, [4] what problems the merchant has that you might be able to solve (in other words, will he give you a better price on your diamond if you buy some saphires), and [5] what style of business the merchant does and whether you like or trust him.

Armed with the above knowledge, you can either repeat the exercise at another gem shop or two, or you can pull out your diamond and say "What do you think this is worth?" and if he wants your diamond, he will tell you. Then you ask what he would pay for it.

The diamond merchant will do anything to avoid giving you a price because he wants to be able to buy your diamond for a low price. By this stage of the negotiations you have a little information that may or may not be correct, but at least you have some knowledge. So you can formulate a price that you believe to be too high, and when the merchant says "No!" and walks away, you know the price is too high. So you act naive and offer a lower price. If the merchant grabs your offer immediately you are probably selling at a low price. However, if you need to sell the diamond even a low price, as long as it meets your need, is okay. This goes back to the old win-win negotiation theories.

Applying this method to negotiating with an investor, you begin by asking for advice about your company. Most Angel Groups will put you through a 'boot camp' which serves to prepare your knowledge base in much the same way questioning the diamond merchant gave you knowledge of price and the merchant's interest in buying.

Even though the very most important part of the negotiation, in YOUR mind, is the amount of money you will get, the most important part to the investor is whether s/he will receive any return on this investment and whether it will end up being nothing but a big headache!

Put yourself in the shoes of your investor: If you are going to give someone $1-million+ you want to have some feeling that person is going to talk with you if they hit a brick wall. You want that person to be wise enough to be looking for the value-add investor. You don't want to give all that money to someone who is so stubborn and defensive that s/he will be difficult to work with and might spend the money incorrectly.

As an entrepreneur, your goals are much the same unless you are too inexperienced to appreciate an investor who adds value to your company beyond the investment amount. Money is not the only thing your company will need, after all.

So, when negotiating with your potential investor, proceed on a win-win basis and do not make any demands or set any firm price until you have acquired as much knowledge about the investor's interest as possible.