Paul Graham: when a handshake deal is not a handshake deal

Silicon Valley runs on handshake deals, uber-angel investor and virtual inventor of the modern startup accelerator Paul Graham says. But sometimes a handshake is not a handshake.

So Graham’s doing something about it.

From now on, Y Combinator companies will use a four-step protocol before assuming they have a handshake deal with an investor:

1. The investor indicates a desire to be in on a funding round at a certain valuation.
2. The startup agrees and verbally commits.
3. The startup sends the investor an email or text message asking for confirmation.
4. The investor replies and confirms.

The problem, Graham says, is that too many “handshake deals” are not really deals at all. Either an investor isn’t communicating clearly, or a founder is over-eager and reading too much into a very polite no, or something worse is happening. Investors who are new to the game — or simply dishonest — can cause startups huge issues:

The problem is compounded by the fact that some investors deliberately mislead startups about how interested they are in investing. Startups’ prospects can change rapidly. If investors say no in a way that sounds like yes, they can essentially take a free option to invest. They haven’t actually committed, so it costs them nothing, but if the startup turns out to be a hot one, they can retroactively claim that their almost-yes was an actual yes, and that the startup is morally obliged to let them invest.

The process that Graham outlines seems long and excessive, but he argues that with mobile phones, it can and should all happen in person, right away. The difference is that now there is a digital track that confirms what the founder hoped he or she heard and what the investor actually committed to.

But Graham didn’t just make these comments off-the-cuff. He checked with Valley super-angels and VCs Ron Conway, Ben Horowitz, Chris Dixon, Marc Andreesen, among others, before publishing.

photo credit: Leonard John Matthews via photopin cc