Rand Fishkin of SEOMoz fame just wrote How to Choose The Right SEO Vendor. It’s solid, but I’m going to take advantage of my additional age experience and point out a few issues:

“Start with your Goals”

Absolutely. If you know what your goals are. If not, I suggest that this is a great opportunity to evaluate your potential SEO vendor. If they say something like ‘get a high ranking’ show them out.
If they say ‘increase sales’ or ‘improve visit quality’ or ‘increase non-branded search traffic’, say ‘hmmmm’, furrow your brow, and put them on your short list. They’re a keeper.

“Connect with your Social Network”

Yup. No arguments at all. Just remember your ‘social network’ includes some unique devices: The phone and face-to-face meetings.

“Get Advice from SEO-savvy People You Trust”

Again, no argument.
But make sure ‘SEO-savvy’ means ‘knows about SEO’ and not ‘Read an article in an airline magazine and now understands how important the keywords meta tag really is’.

“Ask for a List of Past Success Stories (not just clients)”

Bingo. This is the key. Listen not just to the success stories, but how the SEO discusses them.
Do they talk about advice and strategy? Good.
Do they talk about tricks and sneakery? Bad.

“Talk on the Phone or (if possible) Get Together”

A must. Do not hire an SEO until you’ve spoken to them.
SEO is like any other marketing. Chemistry matters.

“Present a Few Initial Issues Over Email”

I’m ambivalent about this one. You probably don’t know what the real issues are.
Instead, ask the potential SEO vendors what they’d fix.

“References?”

I agree with Rand. References are worthless. You think I’m going to refer you to people who hate me?

“Get an Informal Proposal from your top 2-3 Vendors”

Again, no arguments. Especially on the price. You get what you pay for. Don’t forget it. You want to make $500,000 on your web site? You’d damned well better be willing to spend more than $15,000.

“Have Smart, Sensible People to Review the Contract”

Hmmm. Put a contract in front of the smartest, most sensible people and they start acting like George Bush at a press conference.
Try it if you want, but remember: This is your decision. Look out for contracts that:

• Lock you in for a year with no termination clause.
• Let the vendor retain ownership of keywords and/or content.
• Make sure they include some basic deliverables and a timeline.
• Please, god, don’t get a lawyer to review it unless you really have to. I guarantee weeks of haggling. And the most airtight contract won’t prevent the vendor from flipping you the bird. It’s about finding people you can trust.

“Go With Your Gut”

Amen. Obey this above all else.