Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Earnout Insurance to Bridge Valuation Gaps
Transcript
- Lucas: Luna, you know how every M&A deal these days seems to have an earnout built into it — or at least the ones that don't price in a huge premium? I was looking at the numbers this week, and in the current market, where IPO activity is still pretty muted and acquirers are cautious about overpaying, earnouts are becoming the default tool to bridge a valuation gap. Luna: Right, and we've talked about earnouts from the founder's perspective — how to structure them, how to avoid the traps. But today I want to get into something that's been growing quietly behind the scenes: earnout insurance. Lucas: Exactly. Earnout insurance is a policy that a founder or an acquirer can buy to protect against the risk that the earnout milestones aren't met — not because the business didn't perform, but because of something the acquirer did or didn't do post-close. Think integration delays, product roadmap changes, or even a new owner slashing the sales team. Luna: So it's a way to transfer the risk of the earnout underperforming due to the acquirer's actions, rather than just trusting the contract language to protect you. Lucas: That's exactly it. And it's a cousin to something we've seen mature in the last decade: representation and warranty insurance — or RWI, as most in the M&A world call it. RWI protects buyers against breaches of the seller's reps and warranties. Earnout insurance is a much newer product, but it's growing fast. Luna: How does it actually work in practice? Walk me through a typical scenario. Lucas: So say a founder is selling a software company for a base price of eighty million, with an earnout that could add another twenty million if the company hits certain revenue targets over the next two years. The founder is confident they can hit those numbers, but they're worried the acquirer will slow down sales hiring or kill a product line that was key to the revenue forecast. Lucas: So the founder — or sometimes the acquirer — can buy an earnout insurance policy. The insurer underwrites the milestones. If the earnout isn't achieved, and the policy conditions are met, the insurer pays out the difference, up to the covered amount. The founder gets their twenty million regardless. Luna: That's a game-changer for founders who otherwise have to trust that the acquirer won't change course. But what does it cost? Lucas: Premium rates have actually come down. A few years ago, you'd see premiums around 3 percent of the coverage amount. Now, in August 2026, I'm seeing deals priced at 1.5 to 2 percent. So for that twenty million in coverage, you might pay three to four hundred thousand dollars in premium. That's a few basis points on the total deal value, but it buys a lot of peace of mind. Luna: And who typically buys it — the founder or the acquirer? Lucas: It can be either, but the more common structure I'm seeing is the acquirer buying the policy as part of a clean-exit negotiating tactic. They say, 'We'll give you the full earnout amount, but we're buying insurance so that if we have to pivot the business, you're still made whole.' That removes a huge sticking point in negotiations. Luna: So it's a way for the acquirer to say 'we believe in the earnout' while also protecting themselves from a founder who might sue them later over a missed milestone. Lucas: Right. And for founders, it's a way to avoid the classic post-close nightmare of being in arbitration with your former company over earnout performance. You get a lump-sum payout from the insurer if the milestone isn't hit, and you can walk away clean. Luna: But it's not without its own issues, right? I mean, the insurer is going to underwrite the earnout milestones pretty carefully. Lucas: Absolutely. The insurer is going to scrutinize the earnout milestones to make sure they're measurable and verifiable. They'll look at historical financials, the business plan, the integration plan, and they'll often require that the earnout be based on objective metrics like revenue or EBITDA — not subjective things like 'customer satisfaction' or 'strategic milestones'. Luna: So if you're a founder and you're thinking about proposing an earnout that's tied to something like 'successful product launch' — that's probably not going to be insurable. Lucas: Exactly. You need to structure the earnout in a way that an underwriter can model. That's one of the practical benefits of this trend — it forces both parties to be more disciplined about how they define earnout milestones. In the end, that can actually reduce the likelihood of disputes later. Luna: I also imagine that the claims process is a bit different from RWI. With RWI, you've got a breach of reps and warranties, and there's a negotiation between buyer and seller, often with the insurer stepping in. With earnout insurance, the trigger is simply that the milestone wasn't met — but the insurer will want to confirm that the cause wasn't the founder's own fault. Lucas: Right, and that's where the policy language matters. Most earnout insurance policies are written on a 'no-fault' basis, meaning the insurer pays when the milestone isn't achieved, regardless of fault — but they'll exclude situations where the founder's own actions or lack of cooperation caused the shortfall. So you have to be careful to remain involved and cooperative during the earnout period. Luna: That's a good point — so even with insurance, you can't just walk away and ignore your earnout obligations. Lucas: No, you can't. And that's actually healthy. It keeps the founder engaged and incentivized, which is the whole point of an earnout in the first place. But the insurance gives you a safety net if things go sideways through no fault of your own. Luna: So, with all this in mind, what should a founder do if they're in the middle of negotiating a deal with an earnout component? Should they bring up earnout insurance from the start? Lucas: I'd say it's worth raising early, but not necessarily from the first conversation. You want to get the acquirer comfortable with the earnout structure itself first. But once you're in the detailed negotiations of the earnout terms, that's the time to suggest, 'Hey, why don't we explore earnout insurance to de-risk this for both of us?' It can be a great way to break a deadlock. Lucas: And I've seen deals where the acquirer was hesitant to offer a large earnout because they were worried about the founder suing them later. When the founder proposed buying insurance, the acquirer relaxed and increased the earnout amount. So it can actually improve the deal economics for the founder. Luna: That's a really interesting dynamic — using insurance to increase the size of the pie, not just to protect against a loss. Lucas: Exactly. And it's not just for small startups. We're seeing earnout insurance used in deals ranging from five million to five hundred million. The market is still young, but it's growing because both sides are looking for certainty in an uncertain M&A environment. Luna: And this ties back to what we've been seeing in the broader market — with the IPO window not fully open and acquirers being more cautious, earnouts are a way to get deals done, and insurance is a way to make earnouts less scary. Lucas: Absolutely. Look at the tech sector — I was looking at Palantir's recent move, up over 6 percent in the last five days, and everyone's talking about AI valuations. But for the thousands of smaller startups that aren't household names, the exit path is more likely to be an acquisition with an earnout than a blockbuster IPO. Luna: So if you're a founder listening, what's the one takeaway you'd want them to remember? Lucas: That earnout insurance is a legitimate tool in your exit toolkit. It's not just a niche product for paranoia — it's a way to transfer risk that could otherwise sink your post-exit happiness. And with premiums having come down, it's more accessible than you might think. Luna: And it's worth talking to your M&A attorney or your banker about it, because they'll know which insurers are active in this space. Lucas: Yeah, and I'd also say — if you're a founder thinking about exiting, and you're listening to this podcast, you're probably already the kind of person who thinks about the details. This is one of those details that can make a huge difference in whether your earnout actually pays off. Luna: And before we wrap up, I just want to mention — because we're able to have these conversations in a deep, unsponsored way, and that's partly because of listeners like you who chip in a couple of dollars a month. It genuinely keeps the lights on. If you've gotten value from the show, buy me a coffee dot com slash fexingo — it's a small thing, but it makes a real difference. Lucas: Yeah, we don't have advertisers breathing down our necks, so we can go deep on things like earnout insurance without dancing around any sponsorship. Every little bit helps. Luna: So back to earnouts — one more thing that struck me is that earnout insurance isn't just for the earnout itself. There are also policies that cover other post-close contingencies, like working capital adjustments or indemnification baskets. Have you seen that? Lucas: Yes, that's part of the broader trend toward 'transactional risk insurance.' You can now insure all sorts of closing risks, not just earnouts. But the earnout insurance is the one that directly addresses the founder's biggest worry: 'Am I going to get my money after I've handed over the keys?' Luna: That's the crux of it. And for a founder, that peace of mind might be worth the premium even if you never have to make a claim. Lucas: Exactly. It's like any insurance — you hope you never use it, but you sleep better knowing it's there. And in the current M&A environment, where earnouts are everywhere, it's a smart move to at least explore it. Luna: So if you're a founder in a deal right now, ask your advisor: 'Is earnout insurance an option here?' It might be the difference between a good exit and a great one. Lucas: And that's the bottom line. Thanks for joining us, and we'll talk to you next time.