This might be by design. I think all investors probably realize the legal ramifications. The net effect of this could be to sniff out the ones who don't make good on their handshakes, since the ones who do probably won't mind putting terms in an email.

Having a light shined on activity that pollutes an environment based on trust IME is a better disincentive than fear of legal threat, esp. considering the power disparity between the parties.

Thanks you. A lot of people commenting on this thread don't seem to realize that oral contracts are just as legally valid as written contracts (as long as all the elements of a contact are present), email records notwithstanding.

Not necessarily. In New York state for example, it's required that any contract worth $500 or more be written. Oral contracts over $500 aren't enforceable.

You could make a similar reservation about written contracts, as the scale of formality goes even higher. Some kinds of contracts require a notary and the worst ones might even require a priest or a rabbi :)

Doesn't an email count as written? I'm pretty sure there's case law on that. (Not sure about a text message, though.)

Still, you've got proof with this that someone is at least less than honorable, even if you can't legally force anything to happen.

Right. And under CA law...

Though this does follow the qualities of a contract, it's important to note that oral agreements only get you so far in many jurisdictions and particularly have an upper limit on the value, around the order of $500. So while its great this is an explicit and clear conversation, I don't think you can say that it is assuring unenforceable agreements aren't made.

There is a written component to the protocol: The follow up email/text. "This is to confirm you're in for X." "Yes."

I do wonder what happens without step 4 occurring.

I wondered this too. How long could an investor wait before sending the "Yes" and have it still considered valid? Could the investor not reply for a few weeks or months and only send the "Yes" once the startup is growing and worth more than the initial deal's valuation?

I think there needs to be an explicit timer between step 3 and 4. Something on the scale of a few hours or at most a few days.

> Where no time is specified in the offer, the offeree has a reasonable period of time to accept the offer. After a reasonable period of time expires, the offeree's power to make a contract by accepting the offer "lapses". ... When a seller purports to accept an offer after it has lapsed by the expiration of time, the seller's acceptance is merely a counteroffer and does not create a contract unless that counteroffer is accepted by the buyer.

-- Anderson's Business Law, Formation of Contracts: Offer and Acceptance: Lapse of Time

Legally, that's murky. There's still the oral agreement. Others have suggested that the oral agreement would be unenforceable due to the statute of frauds. But I don't think it actually applies here. So I think the oral agreement might, in principle, be enforceable. Being practically enforceable is another matter.

That being said, it appears the intention of the protocol is not to recommend a set of best practices for forming legal agreements, but rather to establish some community norms. I think the assumption is that anyone who violates the community norms will suffer a loss of reputation.

In that light, the analysis becomes easier. If step 3 happens and the investor subsequently goes quiet--failing to deliver a "yes" or "no"--then the investor has violated the community norms. (Even a "no" might be considered poor form following the oral deal, but it's certainly better than ambiguous silence.) Presumably, some community self-policing happens at this point, and if the investor remains obstinate, then word spreads and the investor is shut out of future deals.

that's what steps 3 and 4 are for, aren't they? Wouldn't that make it a written contract instead of just an oral one?

As someone who hasn't been past first year of law school, I can't say whether an SMS creates a valid written contract.

Emails definitely do (though IANAL).

Some background on what makes a contract from Nolo (http://www.nolo.com/dictionary/contract-term.html):

"A legally binding agreement involving two or more people or businesses (called parties) that sets forth what the parties will or will not do. Most contracts that can be carried out within one year can be either oral or written. Major exceptions include contracts involving the ownership of real estate and commercial contracts for goods worth $500 or more, which must be in writing to be enforceable. (See: statute of frauds) A contract is formed when competent parties -- usually adults of sound mind or business entities -- mutually agree to provide each other some benefit (called consideration), such as a promise to pay money in exchange for a promise to deliver specified goods or services or the actual delivery of those goods and services. A contract normally requires one party to make a reasonably detailed offer to do something -- including, typically, the price, time for performance, and other essential terms and conditions -- and the other to accept without significant change. For example, if I offer to sell you ten roses for $10 to be delivered next Thursday and you say "It's a deal," we've made a valid contract. On the other hand, if one party fails to offer something of benefit to the other, there is no contract. For example, if Maria promises to fix Josh's car, there is no contract unless Josh promises something in return for Maria's services."

There is much to be decided about any investment deal beyond what is contemplated in the protocol. For some examples:

http://mashable.com/2011/05/27/term-sheet-startup-investing/

Just as a thought experiment, let's imagine what would happen if you tried to enforce this handshake deal (complete with email confirmation per steps 3 and 4). How would the courts decide all the issues that would normally have been negotiated and agreed to in a terms sheet?

Courts have some leeway in what remedies to use, precisely for some of those pragmatic reasons. One remedy for a contract breach is for a court to issue an injunction ordering performance of the contract. As you note there are some practical problems with a court ordering VCs to invest on the basis of this kind of agreement. But another remedy is for the court to just award monetary damages (how to calculate damages for nonperformance of a contract is a whole other can of worms, but it's something courts do).

Taken literally - yea. But you can fix it pretty easily just by adding the standard "this is nonbinding" language that all term sheets have. That's a little inelegant though. Probably what would be best is just to have a page defining the protocol (and clarifying that it is nonbinding) and have people link to it in their handshake email.

What's the point in making a non-binding agreement? Isn't it easier to just not make one?

The same as with this handshake deal - it formalizes a level of commitment that the community recognizes as one that you should not back out of under normal circumstances (e.g. if the other side is being perfectly reasonable). You don't want the handshake deal to force people to invest no matter how unreasonable the company ends up being in the paperwork they send over.

Same reason you might get engaged prior to getting married?

While I agree this is a legal contract, more importantly, I think this is pg setting expectations for both founders and investors.

I speculate that the underlying motivation is that YC partners are spending too much time on handshakes that have gone wrong, rather than helping building businesses.

"This protocol causes a valid and enforceable contract to be formed."

Don't agree but if that were the case it would be a good reason not to use it. Details matter and this protocol doesn't have enough details (nor can it) that I would ever use it to form an legally binding agreement.

I already to a version of this with other types of investing (email back and forth essentially or sometimes a text) and the underlying assumption is that it is always subject to a formal contract which needs to be signed.

The general rule is that intent of the parties to bind themselves forms a contract, even if the parties intend to draft a formal agreement later.

It's likely that other casual agreements that you don't think of as contracts are also contracts.

I'm not a lawyer, I'm a guy who took a business law class during undergrad, but my prof drilled it into my head that a contract consists of offer, acceptance, consideration, capacity, and legality. It can be on a napkin, it can be verbal, it can be in a text message, so long as those elements are present.

The difference between an offer and preliminary negotiations is the intent to contract, and language can be used to provide evidence on either side of this one. "Would you take $100k with a $5MM cap" is negotiating language, while "I'll give you $100k with a $5MM cap" is an offer.

Again, not a lawyer, but this "handshake protocol" appears to create valid contracts.

"It's likely that other casual agreements that you don't think of as contracts are also contracts."

Well I'm not a lawyer but I've been in business a long time so long that I'd rather not say and reveal my age.

I've done plenty of deals over the years and have dealt with plenty of lawyers and situations. While what your prof has drilled into you is true in the real world it may or may not be applicable depending on the situation and the specifics.

The fact that it's a "contract" is meaningless to me. The only thing that matters is the issue and the cost of enforcement combined with whether there is a leg to stand on and how motivated the other party is and who they are.

You could have a deal with a very wealthy person (or company) with an iron clad contract and they might not pursue enforcement simply because they don't want to spend their time over the issue. Or, they may be vindictive and decide to spend time and money to make a point. Or everything in between.

I've been involved in situations that have no legal merit whatsoever but someone was able to tie up a deal for 2 years over something written on a napkin agreeing to sell something that was only signed by one party of the business entity. It wasn't even valid for that reason alone but the aggrieved party was able to still file a lawsuit and hold up a deal and extract a settlement. Prior to the lawsuit being filed other lawyers scoffed and laughed at the idea that anything could happen. But it did.

Your professor probably also mentioned that there must be intent to make a binding agreement. If these agreements are regularly made in this situation merely as an offer to negotiate an actual contract at a later time, then the parties do not intend to be bound and they are not contracts. I believe that to be the case.

From Anderson's Business Law:

> Because a contract is based on the consent of the parties and is a legally binding agreement, it follows that the parties must have an intent to enter into an agreement that is binding. Sometimes the parties are in agreement, but their agreement does not produce a contract. Sometimes there is merely a preliminary agreement, but the parties never actually make a contract, or there is merely an agreement as to future plans or intentions without any contractual obligation to carry out those plans or intentions.

> In some cases, the fact that important terms are missing indicates that the parties are merely negotiating and that a contract has not been made. When a letter leaves many significant details to be worked out later, the letter or printed matter is merely an invitation to negotiate. It is not an offer that may be accepted and a contract thereby formed.

Yes, I remember that intent to contract was one of the requirements of an offer, and I remember that intent to contract is indicated by language. To quote my notes:

The second element of a valid offer requires the party who offers the proposal to intend to contract. Phrases such as “Are you interested” or “Would you give me” are words of preliminary negotiations.

Terms such as “I bid,” “I will give you,” or “My lowest price is,” show a present intention to contract and constitute valid offers.

That said, I'll take this opportunity to reiterate that I'm not a lawyer, I'm not accepted by the bar in any state, and for all I know the standards on this matter may vary by jurisdiction.

I'd simply err on the side of asking my lawyer before I started using this protocol with entrepreneurs or investors that I didn't know very well.

The difference, according to the lawyers who served as my professors, is that one is considered by the courts to show intent to contract, and that the other is considered by the courts to be negotiation.

That said, I'm just repeating what a lawyer taught me about how courts determine intent to contract. I'm not a judge or a lawyer. I'm an entrepreneur who took some business classes.

edit: I just sent an old professor an email with the question, and a prompt to try to help him remember who I am. If he responds, I'll share the response no matter what it says.

At the very least it makes people accountable and open to shaming if they don't follow through. And in a small community word would spread about who breaks their deals.

Also I think PG should make this into a small mobile app. Every VC is going to add some wiggle text to his boiler plate.

"makes people accountable and open to shaming if they don't follow through"

And what exactly might be the method of shaming? A blog post? A central repository of shame? It's not like there is going to be some ebay type feedback system on investors that will take into account investors failing to live up to their promises. New entrepreneurs are hatched everyday. The "reputation" that an investor earns will have to be etched pretty clearly for them to find that info and believe it's ubiquity.

Reputation among what group is the question. I'm guessing if someone backs out on such a deal Y Combinator will remember, pass it on, fail to invite to Demo Day. This protocol works to YC's benefit even if the information never spreads beyond employees, participants and alumni. Any spillover is a bonus.