Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Earnouts to Bridge Exit Value Gaps
Transcript
- Lucas: So Salesforce just announced its acquisition of Cohere for one point three billion dollars — headline number, big AI talent grab. But here's the thing I keep coming back to: the founders probably aren't walking away with one point three billion in cash on day one. Luna: Right, because there's almost certainly an earnout baked into that deal. And earnouts are one of those structures that sound great in theory but can get really messy in practice. Lucas: Exactly. An earnout is basically a deferred payment tied to the startup hitting certain milestones after the acquisition closes — revenue targets, product launches, customer retention numbers. If the startup hits them, the sellers get extra money. If not, the acquirer keeps that portion. Luna: And it's not just a niche thing anymore. What's the stat — I've seen something like forty percent of M&A deals now include some form of earnout? Lucas: Yeah, roughly four in ten, especially in tech. And the numbers are climbing. When you look at the current market environment — just this past week, Palantir dropped fifteen percent, Coinbase down sixteen, Shopify off eleven — acquirers are getting more cautious. They don't want to overpay upfront for a company whose growth might slow in a downturn. So earnouts become a way to share that risk. Luna: It's a hedge. The acquirer says, 'We'll pay you a premium if you deliver the growth we're betting on, but if you don't, we're not on the hook for that full amount.' Lucas: Right. And for the founder, an earnout can be a way to bridge a valuation gap. Say the acquirer is offering eight times revenue, but you think you're worth twelve times. You negotiate a base payment at eight times, with an earnout that could take you to twelve if you hit certain targets over the next three years. Luna: Which sounds reasonable, but here's the catch: the earnout period is usually two to four years, and during that time, the founder is still running the business — but now with an acquirer's constraints. Budget approvals, integration teams, new reporting lines. It's a very different game. Lucas: Hundred percent. I talked to a founder last year who sold his B2B SaaS company for about eighty million, with a fifteen million earnout tied to revenue growth. He told me that within six months, the acquirer had reassigned his top salespeople to another division. He couldn't hit the target because the resources he needed were pulled. He ended up getting maybe five of that fifteen million. Luna: That's the classic earnout trap. The acquirer controls the levers, but the founder is still accountable for the result. And there's often a 'good guy' clause or a 'best efforts' clause, but those are hard to enforce. Lucas: So what do you do if you're a founder negotiating one of these? First, you want to tie earnout milestones to things you actually control — or at least things that are clearly measurable and hard to manipulate. Revenue is usually better than profit, because profit can be buried with allocated overhead. Luna: And you want a shorter earnout period if possible. Two years is better than four. The longer the period, the more likely the acquirer's priorities shift — new CEO, new strategy, budget cuts. Lucas: Exactly. Also, negotiate for a 'most favored nation' clause on resources. Something like, 'The founder's team will not be disproportionately affected by any resource reallocation across the combined company.' It's not bulletproof, but it gives you something to point to if things go sideways. Luna: Another angle: some founders are now asking for earnout payments to be tied to the acquirer's stock performance instead of internal milestones. If the acquirer's stock tanks, the earnout is still worth something, because it's based on the combined entity's value. Lucas: That's interesting. I haven't seen that much, but it makes sense — especially in a volatile market. Look at Microsoft, down nine and a half percent this week alone. If an earnout was tied to Microsoft's stock, a founder who closed a deal two months ago is already underwater on that earnout. Luna: Right. So there's a timing element too. If you're closing a deal in a market where big tech stocks are dropping, you might want to push for a fixed cash earnout rather than stock-based. Lucas: Let's go back to Cohere for a second. We don't know the exact earnout terms — they're rarely public — but if I were advising the Cohere founders, I'd be asking about the earnout structure right now. What are the milestones? Who controls the budget for the team that needs to hit them? What's the governance around changes to the earnout plan? Luna: And I'd be especially careful because Salesforce has a reputation for aggressive integration. They've done over seventy acquisitions, and they're known for absorbing teams quickly. The earnout could feel like a golden handcuff that turns into a trap. Lucas: That's the thing about earnouts — when they work, they're a beautiful alignment tool. The founder stays motivated, the acquirer gets the growth they paid for, and everyone shares in the upside. But when they fail, it's usually because of culture clash or resource shifts that the founder couldn't predict. Luna: So what's the alternative? If you're a founder who doesn't want an earnout, what are your options? Lucas: You can try to get a higher upfront price, obviously. But in this market, buyers are risk-averse. You could also structure the deal as a stock for stock exchange instead of cash, so you participate in the combined company's upside without a specific performance target. Or, if you have enough leverage, you could push for a 'double trigger' earnout — where the earnout accelerates to full payment if the acquirer undergoes a change of control or a material restructuring. Luna: Double trigger is smart. It protects you if the acquirer gets acquired or if the division you're in gets restructured. It's like a change of control provision for your earnout. Lucas: Right. And honestly, if you're a founder who's been offered an earnout, the most important thing is to get a lawyer who specializes in M&A earnouts — not just any corporate lawyer. The nuances are brutal. There's case law about 'efforts clauses' that can make or break your payout. Luna: Yeah, I've heard stories where a founder missed an earnout because the acquirer didn't 'commercially reasonable efforts' to hit the target — but the definition of 'commercially reasonable' was vague enough that the court sided with the acquirer. Lucas: Exactly. So if you're listening and you're a founder thinking about an exit, or even just curious about how these deals work, the earnout is one of those things that can make or break your financial outcome. Luna: It's like a second negotiation that happens after the deal closes. And you want to win that negotiation before you sign. Lucas: Honestly, if this conversation was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's what keeps the show ad-free and independent. Luna: Yeah, it's a small way to support the work we do digging into these topics. And we really appreciate it. Lucas: So let's zoom out for a second. Earnouts are becoming more common because the market is uncertain. But they're also becoming more sophisticated. Some acquirers are now offering 'earnout accelerators' — if you hit the target early, you get a bonus. Luna: That's interesting. So instead of waiting the full three years, if you hit the revenue target in year two, you get the full earnout plus a premium? Lucas: Exactly. It's a way to incentivize speed. And it's becoming more popular in AI deals, where the technology is moving fast and the acquirer wants to capture market share quickly. Luna: So the earnout is evolving. It's not just a static set of milestones anymore — it's a dynamic tool that can be tailored to the specific situation. Lucas: And that's why founders need to educate themselves before they get to the negotiation table. Because once you're in the room with a seasoned corporate development team, you don't want to be learning about earnout mechanics on the fly. Luna: Agreed. Know the levers, know the risks, and know what you're willing to accept. Because at the end of the day, an earnout is a bet on your own future performance — but with someone else holding the dice. Lucas: That's a good way to put it. And on that note, that's the conversation for today. Next episode, we're looking at how some founders are using SPACs again — but in a completely different way than the 2021 frenzy. You won't want to miss it.