How are Earnouts commonly funded in a SF?

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March 13, 2025

by a searcher from IE Business School in Mexico City, CDMX, Mexico

Which of the following options: Operating Cash Flow of Acquired Company, Bank Debt, Follow-on Investment from Cap Table, Escrow / Holdback when fundraising for the Acquisition

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Reply by a searcher
from Harvard University in MG9V+6H2, Guatemala City, Guatemala
You can fund with all of the above. However, which one you use can have different implications in mechanics as well as for the returns of the investment. In general, you’d prefer to use the following sources in this order: 1) debt, if the company is underlevered 2) operating cash flow or cash in balance sheet if availabe without crunching liquidity 3) primary equity from investors and 4) escrow/holdback. This prioritization is optimizing for capital efficiency. If you want to prioritize practicality, order switches to 1, 4, 3, 2, given that you’d want to limit interactions with 3rd parties as much as possible and start with what you have most control over to do it quick and easy
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Reply by a searcher
from Georgia State University in Atlanta, GA, USA
Earnouts are usually funded through operating cash flow, which makes sense since they’re tied to business performance. If structured well, they shouldn’t require additional financing. Escrows or holdbacks can be useful for protecting against downside risk, while debt or follow-on equity are less common and usually a last resort. The key is ensuring incentives align so the business can naturally support the payout.
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