Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use SPAC Earnout Structures to Bridge Valuation Gaps
Transcript
- Lucas: So Meta is up 11 and a half percent over the past five days, NVIDIA up nearly 8 percent. Meanwhile Rivian down 13 percent, Coinbase down almost 6. The market is punishing any company with a fuzzy path to profitability, but it's rewarding the ones that have already proven they can print cash. Luna: It's a tale of two markets right now. And that's exactly the environment where founders looking to exit via SPAC have to get creative about valuation. Lucas: Right. Because if you're a founder trying to take your company public through a SPAC in today's market, the SPAC sponsor might want to cap the valuation at, say, 10 times forward revenue. But you think your growth trajectory deserves 15 times. That gap is where earnout structures come in. Luna: And we should say, this show is ad-free. If you find these deep dives useful for what you're building or running, supporting the show at buy me a coffee dot com slash fexingo helps keep it that way. Lucas: Yeah, we appreciate that. So let's get into earnouts. They're basically contingent consideration — additional shares or cash that get released to the founders if the stock hits certain price targets or operational milestones after the merger closes. Luna: It's a way to bridge the valuation gap without the SPAC having to write a bigger check upfront. If the company delivers, the founders get rewarded. If not, the SPAC investors don't get diluted. Lucas: Exactly. Let's make this concrete. Imagine a subscription analytics startup — we'll call it Sublytics — merging with a SPAC at a $1.2 billion enterprise value. The founders own 40 percent of the company. The SPAC trust has $400 million. The founders, the sponsor, and the PIPE investors all negotiate. Luna: And the sticking point is the valuation. The founders want $1.5 billion, but the SPAC's independent valuation caps it at $1.2. So they structure an earnout. Lucas: Here's a typical structure: the founders get their base shares based on the $1.2 billion valuation. But there's an earnout pool of 10 million shares — call it 8 percent of the post-merger company — that gets released to them only if the stock trades above $15 for at least 20 out of 30 consecutive trading days within 18 months of closing. Luna: That $15 price tag implies a market cap of about $1.9 billion at the earnout share count. So if the company hits that, the founders effectively achieve a valuation closer to what they originally wanted. Lucas: And the beauty is, if the stock never hits $15, those shares just disappear. The SPAC investors aren't diluted. The founders only get the upside if they actually grow the business to justify that higher valuation. Luna: But there's a catch. Those earnout shares typically come with restrictions. They can't be sold until the earnout is achieved, and even then, there might be a lockup period. Lucas: Right. In our Sublytics example, the earnout shares might have a 6-month lockup after they're released. So the founders can't just cash out the day the stock hits $15. They have to hold for another half year, which aligns their interests with long-term shareholders. Luna: I've seen earnouts tied to operational milestones, too. Like achieving a certain annual recurring revenue run rate, or hitting a specific gross margin target. Lucas: Yes — price-based earnouts are more common in SPACs because the stock price is a clean, observable metric. But I've seen hybrid models: 50 percent of the earnout tied to stock price, 50 percent tied to hitting, say, $200 million in ARR by the end of year two. Luna: The tricky part is negotiating the threshold. If it's too easy, the SPAC investors get diluted unnecessarily. If it's too hard, the founders might not buy into the deal at all. Lucas: And there's a data point from the 2021-2022 SPAC boom: according to a study by Stanford, about 60 percent of SPAC earnouts never vested. The thresholds were set too high, or the business just didn't perform. But the founders still got their base payout. Luna: That's the key — the earnout is upside, not downside. The founders walk away with something either way. The earnout just sweetens the pot if everything goes right. Lucas: Let's talk about the tax implications. In the US, if the earnout is structured as shares, it's generally taxable as ordinary income when it vests, at the fair market value of the shares at that time. Luna: So if Sublytics stock is at $20 when the earnout vests, the founders owe income tax on $20 times 10 million shares. That's a huge tax bill. Lucas: Some founders negotiate an 83 election, which lets them pay tax on the shares at the time of grant — usually a lower value — rather than at vesting. But you have to do that within 30 days of the grant, and if the shares never vest, you've paid tax on nothing. Luna: It's a gamble. But for founders who are confident in hitting the earnout, it can save millions. Lucas: Another nuance: earnouts can be structured as options or warrants rather than restricted stock. That changes the tax treatment — options are taxed at exercise, not vesting. Luna: Which is why you need a good tax advisor. This is not DIY territory. Lucas: Let's zoom out. In the current market — July 2026 — we're seeing a lot of SPACs that were done in 2021 with aggressive earnouts that are now underwater. The founders are sitting on shares that are worth a fraction of the earnout price. Luna: I was looking at a SPAC that merged with an EV battery company in early 2022. The earnout threshold was $20 a share. The stock is now at $4. Lucas: That's painful. But it highlights why earnouts are a double-edged sword. They can give founders a path to a higher valuation, but they can also create a huge overhang if the market turns. Luna: An overhang because if the earnout shares eventually vest, they flood the market with supply, potentially depressing the stock. Lucas: Exactly. And some sponsors try to mitigate that by staggering the earnout release — tranches that vest at different price levels over time. For example, 3 million shares at $12, another 3 million at $15, and the final 4 million at $18. Luna: That way, if the stock hits $12, only a portion of the earnout shares are released. The market doesn't get overwhelmed all at once. Lucas: Right. And it gives the founders multiple shots at the upside. If the stock can't make it to $18, they still get some value at the lower thresholds. Luna: What about the SPAC sponsor? They often get their own earnout, right? Lucas: Yes — the sponsor's promote shares, which are typically 20 percent of the SPAC, are often subject to a performance-based earnout too. If the stock doesn't trade above a certain price for a certain period, the sponsor's shares get clawed back or converted at a lower rate. Luna: So everyone has skin in the game. The founders, the sponsor, and the PIPE investors. Lucas: I think the key takeaway for founders listening is: if you're considering a SPAC, don't just focus on the headline valuation. Understand the earnout mechanics, negotiate the thresholds realistically, and get good tax advice. The earnout can be a powerful tool, but it can also be a trap if you're not careful. Luna: And if you're an investor, pay attention to the earnout structure in the merger proxy. It tells you a lot about how confident the founders are in the business. Lucas: That's a great point. A very high earnout threshold might signal that the founders are betting on a moonshot, or it might just be a negotiation tactic. Either way, it's worth digging into. Luna: So if you're a founder navigating a SPAC exit right now, what's the one thing you'd recommend they do differently? Lucas: Model the earnout under multiple scenarios. Not just the base case, but the bear case and the bull case. And make sure you understand the lockup and trading restrictions on the earnout shares. You don't want to achieve the earnout only to find you can't sell into a thin market. Luna: Good advice. And maybe hire a banker who's done this before. Lucas: Absolutely. This is not the time to go cheap on advisors.