Y Combinator is an American startup accelerator. Young companies join the accelerator to be mentored, receive funding, and interact with investors. The setting is fast-paced, with teams building products and financiers evaluating potential markets. Operators and investors coordinate on the fly, often relying on verbal agreements with each other.
Reports of deals gone bad are a regular occurrence. Without a record, there’s no reliable way to establish accountability between parties. Remedying grievances in these cases would require a lot of resources, because context would have to be gathered from witnesses and those involved. Plus, with no formal arbitrator, these issues were getting resolved in a soft manner.
The Handshake Deal Protocol$^1$ was introduced to create an audit trail:
An offer must include a specific investment amount (not a range) and a valuation (e.g. $100k at a $5 million valuation). If the offer meets this criteria, and all 4 steps of the protocol are completed, the handshake is complete.
This protocol established a reliable audit trail for binding investment agreements. Y Combinator listed two main benefits. First, “...this protocol will tell us who’s at fault if we get a report of a handshake deal falling through”. The trail reduces the likelihood of wishful thinking and sabotage.
Second, “the protocol deliberately makes it impossible to say certain things”. Requiring specific numbers keeps deals firm by avoiding ambiguity. Conditions, ranges, and contingencies introduce too much wiggle room.
This case study illustrates two powerful qualities of protocols. They purposefully limit behavior and are path-dependent. The Handshake Deal limits investors and founders from making complex deals – this has downsides – in order to massively improve reliability. And its steps are path-dependent. They cannot be done in parallel, because the order in which they are completed is what provides an audit trail.
References:
$^1$https://www.ycombinator.com/handshake/#protocol