Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use SPAC Earnouts to Recoup Lost IPO Upside
Transcript
- Lucas: If these conversations are useful for what you are building or running, you probably noticed we do not run ads on these shows. That is deliberate. It keeps the conversation clean and focused on the story, not on some sponsor break. Luna: Yeah, it is a conscious choice. And people who appreciate that can support it directly if they want. The link is buy me a coffee dot com slash fexingo. No pressure, just an option. Lucas: Exactly. And today, we are talking about a tool that more and more SPAC founders are leaning on to protect their payout when the post-merger stock goes south. Earnouts. Luna: Earnouts in SPACs are fascinating because they are basically insurance for founders when the market turns against them. And right now, the market is definitely turning. The NASDAQ is down 7 percent in the last five days. Growth stocks are getting hammered. Lucas: Take a look at the numbers. Apple down 1.1 percent in five days, Microsoft down 5 percent, Google down 7 percent, Meta down 6 percent. Even NVIDIA is off 3 percent. That kind of broad sell-off hits the de spac universe even harder because those stocks tend to be more speculative. Luna: Right. So if you are a founder who merged with a SPAC in 2021 or 2022, your stock might be trading well below the ten-dollar trust price. Your sponsor promote is underwater. The earnout is one of the few levers left to recoup value. Lucas: Let us define the mechanism. In a traditional SPAC merger, the founder typically gets a promote — shares in the combined company — but those shares often come with restrictions. An earnout adds additional shares that vest only if certain milestones are hit post-merger. Those milestones can be stock price targets, revenue goals, or just time-based. Luna: Stock price targets are the most common. For example, if the stock trades above $12 for 20 out of 30 trading days, the founder gets another tranche of shares. That gives them a direct incentive to drive the stock price up. Lucas: But here is the twist. In the 2020-2021 SPAC boom, earnouts were often structured as one-time shots. If you hit the target, you got the shares. If you missed, you got nothing. Now, we are seeing more tiered earnouts—multiple milestones at different prices. Luna: So instead of one target at $12, you might have targets at $12, $15, and $18, each releasing a separate block of shares. That gives the founder multiple bites at the apple. Lucas: Exactly. And there is also a time dimension. Some earnouts have a sunset clause — if the target is not hit within, say, three years, the earnout shares expire. That puts pressure on the founder to deliver performance quickly. Luna: But what happens if the stock never recovers? Is the earnout just worthless paper? Lucas: In many cases, yes. But some recent deals have included cash settlement alternatives. If the stock stays below the target, the founder gets a cash payment equal to the difference. That is rare, but it is appearing in more contracts. Luna: I want to bring a real example. There was an EV SPAC that merged in early 2022. The stock peaked at $15, then cratered to $3. The founder had an earnout at $12. It never hit. So those shares never vested. Lucas: But in that case, the founder negotiated a revised earnout. They lowered the target to $8 and extended the timeline. The SPAC board agreed because they wanted to keep the founder incentivized. That is becoming more common too — earnout modifications. Luna: That is a key point. Earnouts are not set in stone. They can be renegotiated post-merger, especially if the founder has leverage. If the company needs the founder to stay, the board might adjust the targets. Lucas: Now, compare this to traditional M&A earnouts. In a private company acquisition, earnouts are typically based on revenue or EBITDA targets over one to three years. They are simpler. But in SPACs, the public market adds complexity because the stock price is influenced by so many factors beyond the founder's control. Luna: Right. Market sentiment, macro conditions, sector rotations. A founder can execute perfectly and still see their stock price tank because the Fed raises rates or because of a tech sell-off like we are seeing this week. Lucas: That is why some investors argue that stock price earnouts are unfair to founders. They are penalized for things outside their control. On the other hand, SPAC investors want downside protection. The earnout is a compromise. Luna: There is also a structural nuance. Earnout shares are usually classified as a liability on the balance sheet until they vest. That can affect reported earnings and dilute existing shareholders if they do vest. Lucas: Great point. Under accounting rules, earnout shares are marked to market each quarter. If the stock price goes up, the liability increases and hits the income statement. That can create volatility in earnings, which public company founders hate. Luna: So there is a tension. You want the earnout to be valuable, but if it becomes too valuable, it hurts your financial statements. Founders have to manage that carefully. Lucas: Let us talk about the data. According to a study from Stanford, roughly 80 percent of de-SPACed companies from 2020-2021 included earnout provisions. But only about 20 percent of those earnouts actually vested. That is a low hit rate. Luna: And that is because the targets were set too high. Most SPACs set earnout targets at 20 to 50 percent above the trust price. In a bear market, that is nearly impossible to hit. Lucas: So the learnings are filtering into newer deals. We are seeing earnout targets set closer to the trust price — maybe $11 or $12 instead of $15. And we are seeing more time-based earnouts that do not depend on stock price at all. Luna: Time-based earnouts are interesting. They are essentially retention bonuses. If the founder stays with the company for two years, they get the shares regardless of stock performance. That aligns incentives around long-term value creation. Lucas: Exactly. And that is actually closer to how traditional private company options work. It is less speculative. I think we will see more of that going forward, especially as the SPAC market matures. Luna: What about the relationship between earnouts and warrants? Because a lot of SPACs also issue warrants to founders and investors. Lucas: Right. Earnouts and warrants are both equity-linked instruments, but they serve different purposes. Warrants give the holder the right to buy shares at a fixed price. Earnouts give free shares if milestones are met. They can be used together, but they dilute differently. Luna: And warrants are often exercised early if the stock price rises, while earnouts vest automatically. So the dilution from earnouts is more predictable. Lucas: Predictable, yes, but it still catches some investors off guard. If a founder has a large earnout that vests, suddenly there are millions of new shares hitting the market. That can depress the stock price. Luna: So the market has to factor that in. When you look at a de-SPACed stock's valuation, you need to account for potential earnout dilution as if it were fully diluted shares. Lucas: Exactly. And that is something analysts are getting better at. In 2021, many ignored earnout shares. Now, they are standard in valuation models. Luna: Let me ask a broader question. Are earnouts actually good for founders? Or are they just a way for SPAC sponsors to justify lowballing the valuation? Lucas: I think they are a double-edged sword. On one hand, they give founders a path to earn more if the company performs. On the other hand, they lock up a portion of the founder's economic interest in a risky bet. If the stock never hits the target, the founder leaves a lot of value on the table. Luna: But compared to a traditional IPO, where founders can sell shares immediately on lockup expiration, earnouts are a constraint. In an IPO, there is no earnout. You just have a lockup period and then you can sell. Lucas: Right. So the trade-off is that SPACs offer a faster path to going public, but with more strings attached. Earnouts are one of those strings. Founders need to understand that before they sign the merger agreement. Luna: And they need to negotiate the earnout terms as carefully as the valuation. The milestone targets, the duration, the settlement method — all of that matters. Lucas: Absolutely. I think the key takeaway for today's episode is that earnouts are not just a boilerplate clause. They are a critical piece of founder compensation in a SPAC deal, and they deserve the same scrutiny as the promote. Luna: And given the current market environment — with growth stocks down sharply this week — earnouts are going to be front and center for any founder considering a SPAC merger in the second half of 2026. Lucas: Exactly. So if you are a founder or an investor, pay attention to the earnout structure. It could make or break your return from a SPAC exit.