The Handshake Deal Protocol

Silicon Valley runs on handshake deals—verbal commitments to transactions that formalize later when documents are signed and money changes hands. In the fast-moving startup world, both investors and founders need a way to reserve space in a transaction before paperwork slows things down.

However, handshake deals in Silicon Valley don't work as smoothly as they do in tighter communities like diamond dealers. The funding market includes newcomers and dishonest actors. Investors sometimes deliberately mislead startups about their level of interest, essentially taking a free option to invest without actual commitment. If a startup becomes hot, they can retroactively claim their almost-yes was a real yes.

How the Protocol Works

A standard protocol for handshake deals can fix most of these problems. An offer consists of an amount to be invested, plus a valuation or valuation cap (or no cap), plus an optional discount. Examples: $100k at a $5M cap. $100k uncapped. $100k uncapped with a 10% discount.

According to the protocol, you have a handshake deal if and only if:

The investor says "I'm in."
The startup sends the investor an email or text message saying "Can you confirm you're in for [offer]?"—spelling out the exact offer including the specific amount and terms.
The investor replies yes.

Unless and until this process is completed, there is no handshake deal. This puts the burden on investors to complete the final step, since until they do, the startup is under no obligation to take their money.

Creating an Audit Trail

Both parties should ordinarily complete this process in person as the final step of the agreement, using mobile devices to send the messages. Each party should regard it as suspicious if the other is unwilling to do so.

This protocol creates a definite trail that will tell us who's at fault if a handshake deal falls through. More importantly, it will prevent founders from misleading themselves and discourage investors from misleading them.

The protocol doesn't require the offer to specify which documents will be used. In practice this is rarely an issue—people either use standard documents for small investments or negotiate in good faith for large ones. Market terms are well understood enough that it should be easy to see who's at fault if one party makes difficulties about the terms.

What the Protocol Prevents

The protocol deliberately makes it impossible to say certain things:

Unspecified valuations. An investor can't just say they'll invest $x without specifying a valuation or cap. Investors who do that can escape their commitment later by claiming the price turned out to be too high. An offer must specify a valuation or cap, or explicitly state no cap.
Range offers. It isn't possible to make a handshake deal on an offer to invest a range of money, like $50k to $150k. If a startup agrees to that, they're obliged to save $150k of space but the investor is only obliged to invest $50k. Instead, startups should do a handshake deal for the bottom end of the range and respond politely to the investor's interest in possibly investing more, without feeling obligated to take more money until the investor commits to it.
Conditional offers. There is no way to add conditions to a handshake deal. For example, an investor can't use this protocol to offer to invest if other people will, or as part of a larger round if you can find a lead. That sort of commitment is too worthless in practice to rely on.

Deadlines

While investors can't add conditions to a handshake deal, both parties can change the deadlines in which the offer must be accepted and the funding must be completed. These deadlines prevent situations where either party delays or where there's no time frame for the investor to send money.

Ten days is a reasonable period for both parties to complete the funding process, but they can agree to different timing provided there is unequivocal written agreement about a different deadline.

Startups and investors can make any arrangement they want, but they don't have a handshake deal according to this protocol unless the terms are precise and unconditional.