A significant amount of your time is spent selling when starting a company. Assuming you are good at selling your company/product/vision, you will often get to the point where you need to close the deal. In between the selling and signing the contract is a chasm that many inexperienced entrepreneurs struggle to cross: negotiation.
Negotiation is simply the act of agreeing on terms for a deal. If you have never done it before you may envision it like a TV show with adversarial parties sitting across a table trying to crush the other party. That is rarely the case. Most negotiations are between two parties who really want to reach a mutually beneficial deal and just need to establish the terms of the deal. That does not mean people will not try to take advantage of you, but let us assume a basic negotiation where both parties have good intentions.
The actual act of negotiation is simple. One party makes an offer and the other party either accepts the offer, makes a counter offer or ends the negotiation. This continues until the parties reach an agreement or part ways.
But how do you know what offers to make, and whether the offer you get from the other party is a good offer? To answer that you need to understand some basics of negotiation and a simple process will help.
Step 1: You Win or Lose Before You Start
It’s a general misconception that whether you get good terms for a deal is based on whether you are a good negotiator. That is almost never true. Good negotiators know that the person who gets better terms is the person who has a better BATNA.
BATNA stands for Best Alternative To Negotiated Agreement and represents the worst case scenario for both parties if no agreement is reached. Whoever has the best outcome if there is no agreement has the advantage in the negotiation because they have less incentive to close the deal and can more easily walk away.
For example, let us say you are selling an apartment and someone moving to this city would like to buy it. If there are only a few apartments for sale and the buyer needs to move in the near future you have the advantage as the seller. You could choose not to sell the apartment and wait for another buyer (your BATNA) while the buyer would have to desperately find another of the few apartments for sale quickly (their BATNA). On the other hand, if there are many apartments for sale and the buyer is buying the property to rent it out then the buyer has the advantage. You might not be able to sell your apartment since there are so many for sale and the buyer can simply wait for a better deal elsewhere. In both cases, the BATNA determines which party has the power in the negotiation based on their incentive to close the deal.
The lesson here is to make sure you optimize your BATNA before even starting a negotiation. Consider some common deals you might close and how to position your BATNA for success:
- If you are raising money, make sure you have plenty of runway (9-12 months at least) so that you are not under pressure to close quickly. Also be sure to line up as many potential investors as possible so you have your choice (and fallback).
- If you are selling your product, always have a healthy pipeline of customers and never bet everything on selling to one particular customer. Try to avoid having one customer make up more than 50% of your revenue.
- If you are hiring employees, start the hiring process long before you will need the person since it will take time to find the right candidate. Always interview multiple people for the position even if you think you have found the right fit, just in case you can’t close the deal.
Step 2: Get Into The Zone
While both parties have a BATNA (worst case), they also have a preference for the terms of the deal if it closes (best case). For example, if you are buying a house there is a price you would prefer to pay (practically speaking) and the seller has a price they would like you to pay. The combination of your BATNA and your preferences forms what is called the Zone Of Possible Agreement or ZOPA.
You can visualize the ZOPA as follows:
As you can see, both the buyer and the seller have a range of acceptable prices between their BATNA and their preference. The ZOPA is the overlap in these ranges, the difference between their BATNAs. Note that while this diagram uses Cost as the dimension of negotiation, it could easily be anything including the length of contract, legal terms or location.
If a deal gets closed, it will be in the ZOPA. Ideally, assuming both parties are interested in a mutually beneficial agreement, you would pick the midpoint of the ZOPA and that would be the terms of the deal.
How then do you know where the ZOPA lies? Very few partners will tell you their BATNA, even if they have the best intentions. They have no incentive to reveal their true BATNA and if they can convince you their BATNA is higher/lower than it really is then they can convince you the ZOPA is smaller and get favorable terms.
And in that tension is where negotiation exists.
Step 3. Choose Your Strategy
When you are negotiating you know your BATNA and your preference but not for the other party. Hence, you know one end of the ZOPA but not the other end. There are a number of strategies you can employ to determine the scope of the ZOPA and/or reach a deal on favorable terms.
Here are some examples:
- High Initial Offer. To try and determine the BATNA of the other party, you can start with an arbitrarily high (or low) offer. Anchoring the negotiation will force the other party to start higher (or lower) than they might have otherwise and hopefully expose their BATNA quickly. This is why cars are priced so highly on the lot of a dealership, even though no one pays those prices. Dealerships want to determine your capacity to pay and motivation to buy.
- This or That. The initial offer does not need to be a single offer and instead could be two different offers with different kinds of terms. For example, you might make two offers of a loan where one has a high interest rate while the other has a pre-payment penalty. The other party, in indicating their preference for one of the options, will help you understand the ZOPA and guide the negotiations in a positive direction.
- Iteration. Since neither party knows enough about the other, you can make offers back and forth in an iterative fashion and slowly converge on a result in the middle. Each offer moves toward the other party’s previous offer by some small amount. This slow process of back and forth allows you both to understand the other party’s range and ensure you end up somewhere in the middle of the ZOPA. Most international diplomacy involves this kind of strategy since the parties disclose so little of their internal plans.
- Take it or Leave it. In this method, you make an offer to the other party that they can either accept or not but that will be the end (no counter offers). Since you don’t know the other party’s BATNA, you make a guess and give them an offer based on that guess. This is most common when one party knows it has the superior BATNA and can force the deal to be more favorable to them.
Whatever strategy you choose, it is important to consider the impact of the initial offer especially if you are making the initial offer. Whatever the initial offer you make, you will rarely get better terms and in almost all cases you will get worst terms. Hence, you need to make sure that your initial offer is not your BATNA or you will not be able to iterate with your partner.
For example, when negotiating your salary for a new job you should realize that when you are asked for your current salary they are asking you to make an initial offer. You should not ask for a million dollars, but you should tell them what you think you are worth and not the least amount you are willing to accept.
The best negotiators are the ones who can convince you that their BATNA is much different than it really is and in doing so get favorable terms on a friendly basis.
Step 4. Plan For The Long Term
Unlike selling your house, deals that you close when building your business will likely impact your business for the long term. You want to build a positive relationship with your customers, employees and investors that will span many deals and many years. Hence, you need to optimize for long term relationships and not just short term deal terms. This means choosing a strategy that will maximize both the terms of the deal and future deal potential.
With this in mind, it is often not a good idea to pursue aggressive strategies and hard nose negotiation where you win a given deal but decrease the likelihood of future deals. At the same time, friendly but prolonged negotiations can give partners the impression that you are hard to deal with and have a similar negative effect on future deals. Being practical and productive in negotiations will establish your reputation and open doors in the future.
For example, when hiring people for a start up company it can be a good idea to pursue the This or That strategy where you give the employee a choice between a low salary and high equity or high salary and low equity. This gives the employee a chance to show their preference and reduces the amount of negotiation necessary to reach a favorable term.
Conclusion: Negotiations Are Not Basic
While the discussion here involves a single dimension of negotiation where each party has a single BATNA, preference and ZOPA, that rarely occurs. In most negotiations there will be many different dimensions such as cost and time, each with their own ZOPA. You will need to give in on some terms to get better outcomes on other terms. Always keep track of the terms that are most important to you and never drop below your BATNA or else you may find yourself in deals that are not worth doing.