Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Earnout Structures Reshape Founder Exit Payouts
Transcript
- Lucas: So Rivian started deliveries of the R2 this week. That's the SUV they're betting the company on, and the stock dropped thirteen percent in five days. Luna: Classic sell the news. But that kind of volatility is exactly why earnouts exist in M&A deals. Lucas: Exactly. If Rivian were being acquired today, the acquirer would look at that stock drop and say, 'We're not paying full price for future promises.' So they'd put part of the consideration into an earnout — tying a chunk of the purchase price to hitting specific milestones post-close. Luna: And earnouts are everywhere right now. With the broader market down — Apple off six percent this week, Microsoft down five — valuation gaps between what founders want and what acquirers will pay have widened. Lucas: Right. So an earnout becomes the bridge. The founder gets a guaranteed base, say seventy percent of the target valuation at signing, and the rest is contingent on hitting revenue or product milestones over the next two to three years. Luna: I want to get into the mechanics. But first — what's the actual percentage of deals that include earnouts now? Lucas: According to SRS Acquiom data from last year, roughly thirty-five percent of private-target M&A deals included an earnout. In tech, it's closer to fifty percent. And that number has been climbing since 2022. Luna: Because when multiples compress, sellers don't want to accept a lower price, and buyers don't want to overpay for future growth that might not materialize. Lucas: Exactly. So the earnout aligns incentives — in theory. The founder stays on, hits the milestones, and earns the full payout. But the devil is in the details, and I think a lot of founders underestimate how hard it is to actually collect. Luna: Yeah, I've seen statistics that roughly forty percent of earnout targets are missed. And even when they're hit, disputes over how to calculate revenue or user growth can lead to litigation. Lucas: Let's walk through a specific case. I talked to a founder a few months ago who sold a B2B SaaS company for a base of fifty million with a potential earnout of up to twenty million more. The earnout was tied to net revenue retention staying above one hundred and ten percent for two consecutive years. Luna: That's a high bar. Net revenue retention above one-ten is great for a mature SaaS company, but if you're trying to maintain that while integrating with a larger acquirer's sales team? Very tough. Lucas: Exactly what happened. The acquirer reorganized the sales comp structure six months in, and the founder's team lost some key account managers. Net revenue retention dipped to one-oh-five. The founder argued it was the acquirer's fault. The acquirer said the contract didn't excuse 'changes in business operations.' Luna: That's the classic earnout trap — the acquirer controls the levers, and the founder has limited ability to influence outcomes after closing. Lucas: Right. So the founder ended up settling for an extra five million, not the full twenty. And he spent almost eighteen months in post-merger integration instead of starting his next company. Luna: So are earnouts ever really good for founders? Or are they just a way for acquirers to offload risk? Lucas: They can be good, but only if the founder negotiates the right terms upfront. First, define the metrics narrowly. Don't use vague terms like 'revenue growth' — specify whether it's GAAP revenue, bookings, or collections. Second, tie the earnout to things the founder can actually control, like product development milestones, not sales targets if you're not running sales post-close. Luna: And third — have a dispute resolution mechanism. Some deals include a neutral arbitrator who steps in if the acquirer and founder disagree on whether a milestone was met. Lucas: Exactly. Another thing: founders should push for a 'most favored nation' clause — meaning if the acquirer changes any policy that affects the earnout metric, they have to adjust the earnout target proportionally. Luna: That's smart. It's essentially a hedge against the acquirer sabotaging your earnout. Lucas: Yeah. And then there's the question of how the earnout is paid. Cash is best. Stock in the acquirer can be risky, especially if the acquirer's shares are volatile. I've seen deals where the earnout was paid in acquirer stock that then lost value. Founder hits the milestone, but the payout is worth less than expected. Luna: So a founder might be better off taking a lower base in cash and a higher earnout in cash, rather than a higher base in stock and a lower earnout. Lucas: It depends on the acquirer. If it's a public company with a stable stock, like Microsoft or Apple, stock can be fine. But if it's a volatile growth stock, cash is king. Luna: Let me ask you this — what about the current interest rate environment? Does that change earnout math? Lucas: Yes. Higher rates mean the time value of money matters more. A dollar paid two years from now is worth less than a dollar today. So founders should push for a higher earnout multiple to compensate for the delay. Some sophisticated buyers already discount earnout targets by a cost of capital factor. Luna: Right, so if the earnout is twenty million over two years, the present value might be more like eighteen million. Founders should negotiate for the nominal twenty, but understand that the real value is lower. Lucas: Exactly. And on the flip side, acquirers like earnouts because they can keep the purchase price off their balance sheet as a liability until milestones are met. It's a way to finance part of the deal with future earnings. Luna: Speaking of financing, this show is ad-free and listener-supported. If you get value from these deep dives and want to help keep it that way, you can support us at buy me a coffee dot com slash fexingo. Lucas: Yeah, we don't have sponsors, so listener contributions are what keep the episodes coming. Every bit helps us spend time researching these topics. Luna: And we really appreciate it. Okay, back to earnouts — one thing I want to touch on is the 'earnout cliff'. Lucas: Oh, good point. Some earnouts have a cliff — meaning if the milestone isn't met in the first year, the earnout resets or disappears entirely. Founders should avoid that. Better to have a trailing earnout that pays out partially each quarter based on cumulative progress. Luna: So partial credit for partial achievement. That seems fair. Lucas: It is. And it reduces the all-or-nothing dynamic that leads to disputes. Another creative structure is the 'earnout collar' — a floor and a cap. The founder gets a minimum payout if they hit eighty percent of the target, and a maximum if they hit one hundred twenty percent. That way both sides have certainty. Luna: I also want to bring up the Rivian example again. If Rivian were to be acquired — and that's a big if — the earnout might be tied to R2 production numbers. Given the stock drop, the acquirer would want a low base price and a big earnout tied to hitting fifty thousand units. Lucas: Right. And Rivian's management would push back, saying the earnout should also account for the R3 and the commercial van line, not just the R2. That's where the negotiation gets complex. Luna: So the broader lesson for founders is: treat the earnout as a separate negotiation, not an afterthought. Bring in a lawyer who specializes in M&A earnouts. Lucas: Absolutely. And don't let the earnout period run too long. Two years is standard. Three is long. Anything beyond three years and you're basically an employee with a lottery ticket. Luna: And if you're an employee with a lottery ticket, you probably want to rethink your exit strategy. Lucas: Exactly. So in summary: earnouts can bridge valuation gaps, but they carry real risk. Founders should negotiate narrow, controllable metrics, cash payments, and dispute resolution upfront. And understand that the earnout is a bet on alignment post-close — and alignment is hard to maintain. Luna: Well said. Next episode, we'll look at how founders are using structured installment sales to defer taxes on their exits. Lucas: That's a good one. See you next time. Luna: Take care.