Latest / The Startup Exit Podcast with Fexingo: IPOs, Acquisitions, and Founder Liquidity Events / How Founders Use Contingent Value Rights to Bridge Acquisition Gaps
Transcript
- Lucas: If you're building a company and thinking about an exit, there's one negotiation tool that doesn't get enough attention: contingent value rights, or CVRs. Luna: We've talked a lot about earnouts on this show. How is a CVR different? Lucas: Good question. Actually, while we're on the topic of tools that don't get enough visibility, I want to mention something about this show itself. We keep the podcast completely ad-free because we believe these conversations should stand on their own value. If that approach resonates with you, supporting us is easy — just visit buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small way to signal that this kind of content matters. And it helps us stay independent. Lucas: Exactly. Now back to CVRs. An earnout pays you based on future performance — usually revenue or earnings — over a couple of years. A CVR is a separate security, often tradeable, that pays out if a specific event happens, like an FDA approval or hitting a billion dollars in sales. That structure shifts risk in a different way. Luna: So with an earnout, the buyer holds back cash. With a CVR, the founder gets a piece of paper that might be worth something later. Lucas: Right. And because CVRs are securities, they can be listed on an exchange or traded over the counter. In biopharma, for example, it's common to see CVRs tied to drug trial results. A buyer might pay 80 cents on the dollar today and issue a CVR worth another 20 cents if the drug passes a Phase 3 trial. That can happen two years later. Luna: Let's ground this in current market conditions. NVIDIA is trading around $207 today, Coinbase around $158. The IPO market is still selective. How does that affect the appeal of CVRs? Lucas: When public market valuations are uncertain, buyers are less willing to pay a premium upfront. CVRs let them share the risk. If the milestone isn't met, the buyer doesn't pay. If it is, both sides win. That's especially relevant now, with headlines like Monday.com blaming AI for layoffs — companies are being disciplined about cost. A CVR structure lets an acquirer say, 'we'll pay more if the product works, but we're not betting the farm today.' Luna: There's also the Boring Company reportedly raising at a $20 billion valuation. That's a private round, not an exit. But it shows that private market valuations can get frothy. Could CVRs help bridge the gap in cases where the buyer thinks a startup is overvalued? Lucas: Absolutely. If a founder believes their company is worth $500 million but the buyer sees $400 million, a $400 million upfront deal plus a $100 million CVR tied to hitting a growth target can close the gap. The founder gets a higher headline number; the buyer retains downside protection. Luna: What are the pitfalls? I've heard CVRs can be illiquid and hard to value. Lucas: That's the biggest risk. If the CVR is not exchange-traded, the founder might hold a piece of paper with no clear market price. Even if it is listed, like some biotech CVRs on the NASDAQ, the trading volume can be thin. Founders need to negotiate a cashout mechanism or a guaranteed floor. Luna: Also, the milestone definitions can be contentious. FDA approval is binary, but revenue targets can be manipulated by the acquirer's behavior. Lucas: Exactly. If the milestone is 'hit $100 million in sales within two years,' the acquirer might underinvest in that product line to avoid paying out. Founders should insist on a 'most favorable nation' clause or even a stand-alone obligation to market the product. Those details are worth thousands of dollars in legal fees and potentially millions in outcome. Luna: Let's talk about a concrete example. Who's used CVRs well? Lucas: One of the most famous is Celgene's acquisition of Juno Therapeutics in 2018. Celgene paid $9 per share upfront plus a tradable CVR worth $9 if Juno's car t therapy, which is a cancer treatment, met certain milestones. That CVR actually traded on the NASDAQ, giving founders and early investors liquidity before the event. In the end, the CVR paid out in full. Luna: So the CVR was a nice bonus. But what about cases where it didn't pay out? Lucas: Consider the deal between Dendreon and Valeant in 2015. Dendreon's CVR was tied to sales of its prostate cancer drug. Sales disappointed, and the CVR expired worthless. That's the binary risk. Founders have to decide how much of their payout they want to put at risk. Luna: So it's a tool for founders who have high conviction in their pipeline and want to maximize total consideration, even if it means delaying part of the payout. Lucas: Exactly. And it's becoming more common outside biotech. In tech, we're seeing CVRs tied to user growth or churn reduction. For instance, when a company like Monday.com gets acquired — not that it is, but hypothetically — a buyer might use a CVR to protect against the risk that ai powered churn accelerates. They'd structure it so the payout depends on retaining customers over 18 months. Luna: That ties directly to the layoff headlines. If a startup is cutting costs to become profitable, it might be a target, but the acquirer is wary of integration risk. CVRs could bridge that hesitation. Lucas: Precisely. And with the Boring Company raising at $20 billion, think about if they ever exit to a larger construction or infrastructure player. The buyer might have doubts about the tunneling technology's regulatory path. You could structure a CVR around receiving permits for major projects. That would let Elon Musk claim a $20 billion exit headline while giving the acquirer a discount if the regulatory timeline slips. Luna: That's a creative use. But I imagine most founders have never heard of CVRs. Lucas: That's the point of this episode. If you're approaching an exit, ask your banker: 'Could a CVR increase the headline while protecting the buyer?'. If they don't know, find a banker who does. It's a niche but powerful tool. Luna: Last question: how does the tax treatment differ? Lucas: CVRs are generally taxed as capital gains at the time they are paid out, similar to earnouts. But the structure matters. If the CVR is considered part of the purchase price, the payout is treated as additional consideration — taxed as capital gains. If it's effectively a separate security, there might be nuances. Always consult a tax advisor. But the key takeaway: CVRs can be a win-win in uncertain markets. Know them, negotiate them, and don't leave money on the table. Luna: So for our listeners who are founders or board members, next time you're in a term sheet negotiation, consider suggesting a CVR. It might be the bridge to a deal that otherwise wouldn't close. Lucas: Absolutely. And if you want to support more conversations like this, you know where to find us — buy me a coffee dot com slash fexingo. We'll be back next week with another mechanism that can reshape your exit.