Hand Shake Deals in Silicon Valley
In Silicon Valley and in tech industry in general, handshakes deals are common due to the fast-paced, informal and collaborative nature of startup ecosystem. Companies have been created, financed and exited based on handshake deals. However, companies and partnerships have also been destroyed as a result of this types of deals. Notwithstanding this, handshakes deals are likely to continue due to their convenient nature. In fact, it is expected at almost all startups have closed handshake deals in a bid to save funds, usually during the early stages of a company when there’s little-to-no investment to pay an attorney to prepare a written contract.
Typical Handshake deals in Silicon Valley
From a contract law perspective handshake deals are enforceable contracts but are hard to prove from an enforcement perspective. We typically see handshake deals in three scenarios. Scenario one is between founders when starting out, for example Facebook and Snapchat and both ended in feuds. The second scenario is, between founders and investors, usually at Demo Days after startup companies participating in an accelerator program present their pitch to investors, and investors informally or orally agree to invest in the company. Sometimes, this oral agreement is couched in a manner such that the investors have plausible deniability and can pull out from the deal on a whim. The third scenario, where handshake deals are also common is when an advisor and a startup agree about advisory services. We tend to see a lack of follow up in this area from both sides of the equation, i.e., both the founder and sometimes the advisor, and understand that this generally leads to lost opportunities.
Y Combinator Protocol
In 2013, Y Combinator’s founder Paul Graham proposed the Handshake Deal Protocol, has seen wide acceptance in the startup ecosystem, as an attempt to bring a specific kind of order to a whole lot of chaos that he observed with the handshake deals. This Handshake Deal Protocol was created mostly for use when agreeing to an investment deal as it defines an offer as an amount to be invested, plus a valuation or valuation cap (or no cap), plus an optional discount. Some offer examples include but is not limited to — $50k at $1 million pre-money, $50k at a $1 million cap. $50k uncapped or $50k uncapped with a 20% discount.
A deal under the Handshake Deal Protocol is closed as follows:
1. The investor says “I’m in for [offer].”
2. The startup says “Ok, you’re in for [offer].”
3. The startup sends the investor an email or text message saying “This is to confirm you’re in for [offer]. This offer is valid for 48 hours, please confirm acceptance. You agree to fund your investment no later than 10 business days from the date of your acceptance of this offer.”
4. The investor replies yes.
This has the basic elements of a contracts — an offer, acceptance, consideration and intention. The irony of this is that the handshake protocol is effectively a written contract, i.e., via the email or text and is no longer merely an oral handshake deal!
In 2015, Y Combinator went a step further by creating a new “Handshake” button for investors in the audience of its Demo Day. With this, the investor can “like” or “handshake” a startup they are interested in. “Liking” expresses interest from the investor and an intention to get in touch with a specific startup while with the “handshake” button, after discussing with the founder(s) an investor can specify if they have already settled on the terms with the startup and it auto-generates an e-mail with the terms agreed. The startup then gets the notification and may accept the virtual handshake.
While the Handshake Deal Protocol was created specifically for founders and investors negotiating investments deals, it can be applied in other areas. For example, when inviting on board an investor as an advisor, an offer in a Handshake Deal Protocol becomes: an offer to provide advice to the company in a specific area for a specific time for a specific consideration. An example of an offer is — provision of marketing, sales and strategic advice for 2-year for stock options (0.2% of fully diluted cap table) with 2years, one cliff vesting. The deal can then be closed following the steps of the Handshake Deal Protocol detailed above.
Helpful Tips
As with any deal, when negotiating, it is important to understand the details. Learn the lingo, particularly if you’re raising funds. At the very least, know the meaning of terms “fully diluted cap”, “valuation cap”, “discount rate”, “interest rate”, “maturity date”. Next, research, check out, and understand the fundraising process. Also, due to the nature of handshake deal, you will need to be as precise as possible, so agree to the major points in a clear and concise manner and all other points can be hammered out while negotiating the term sheet. Most important, never skip the email or text confirming a handshake deal. In fact, try to send it out on the spot, while still with the other party. It would help to have a template on your electronic device before starting the negotiation and adapting to what was agreed.
Lastly, understand that a handshake deal, when done right is a valid and binding contract and you want to understand what you’re agreeing to.
