That kind of commitment can be a necessary prelude to a more formal agreement. Graham writes: “Things can happen fast in the startup world … so both investors and founders need a way to reserve space in a transaction.” However, he notes that these deals also fall through:
Handshake deals are not unique to Silicon Valley of course. They tend to arise wherever trust is sufficiently high and speed is sufficiently important. Diamond dealers apparently use them a lot.
Unfortunately, things don’t work as smoothly in Silicon Valley as among diamond dealers. This is not a closed community of pros who deal with one another day after day. Many participants in the funding market are noobs, and some are dishonest.
To try to avoid confusion, or at least to clarify who is at fault when a deal falls through, Graham is proposing “the handshake deal protocol.” It starts with a concrete offer, with an amount to be invested, a valuation or valuation cap, and an optional discount, followed by these steps:
Didn’t follow the steps? Then you don’t have a handshake deal. Graham said that the Y Combinator team is starting to implement this, and that he’s hoping it spreads throughout the Valley.
To me, it seems very Silicon Valley to try to standardize an informal process. It sounds like some investors benefit from that ambiguity, so individual entrepreneurs might not have the power to resist. YC, on the other hand, could make a difference. By creating a clear process and a (digital) paper trail, the incubator can now track whether investors are breaking their verbal agreements, and if they are, those investors might find that they’re no longer as welcome at Demo Day.
And some investors may just be glad that the protocol doesn’t involve any real handshakes.
Y Combinator is a venture fund which focuses on seed investments to startup companies. It offers financing as well as business consulting along with other opportunities to 2-4 person companies looking to take an idea to a product. Y Combinator looks for companies with “good” ideas over companies with experience and a business model. The company made its first investments in Summer 2005. Y Combinator selects companies to finance and consult with twice a year. They are located in...
Paul Graham is a partner at Y Combinator. He is also the author of On Lisp (1993), ANSI Common Lisp (1995), and Hackers & Painters (2004). In 1995, he and Robert Morris started Viaweb, the first ASP, which in 1998 became Yahoo! Store. In 2002 he discovered a simple spam filtering algorithm that inspired the current generation of filters. Graham has a B.A. from Cornell. He earned an M.S. and a Ph.D. in Applied Sciences (specializing in computer...