Overview of #221: Earnouts, Ratchets and Consent Rights: The Exit Terms Founders Miss - Jesse Welch
In this episode of the Practical Founders Podcast, Greg Head talks with Jesse Welch, partner at MidCap Global, about the deal terms that can dramatically change what founders actually take home in an M&A or private equity exit. The conversation focuses on the “hidden” mechanics behind a headline sale price—especially earnouts, rollover equity, consent rights, preferred equity, liquidation preferences, ratchets, and working capital adjustments. Welch argues that founders often fixate on the headline number while overlooking the contract terms that determine who gets paid, when, and how much.
Key Themes Discussed
The headline number is not the real deal value
- Welch calls the announced sale price a “vanity metric” because it rarely reflects the cash founders actually receive.
- The real value of a transaction is determined by the terms, not just the top-line price.
- He emphasizes that sophisticated buyers use structure to protect themselves and improve returns.
Earnouts are one of the most dangerous tools for sellers
- Earnouts are common in lower middle-market deals and often used to bridge a gap between buyer and seller valuation expectations.
- Welch warns that earnouts are especially risky for founders because the buyer now controls the business after closing.
- Buyers can influence whether earnout targets are met by:
- reducing marketing spend,
- adding overhead or monitoring fees,
- changing operating priorities.
- His core warning: you may be betting on the same horse, but with a different jockey.
Rollover equity is usually better than an earnout
- Welch says rollover equity is generally healthier than an earnout because the founder still owns part of the business and benefits if the company grows.
- That said, rollover equity still needs careful scrutiny:
- vesting schedules,
- what happens in a future sale,
- whether the company is sold as an asset sale,
- what protections exist if the business is folded into another entity.
- He notes that rollover equity can work well when the buyer genuinely grows the business and the founder stays aligned with the new ownership.
Consent rights can quietly create control issues
- Consent rights give investors veto power over major company decisions.
- These can range from ordinary protections, like approving debt, to more intrusive controls, like:
- changing vendors,
- setting executive pay,
- approving bonuses,
- blocking a sale at a certain price.
- Welch warns that consent rights are often reasonable on paper but can become weaponized depending on how the rest of the agreement is structured.
Preferred equity and liquidation preferences can skew the upside
- Institutional investors usually buy preferred equity, not common stock.
- Common features include:
- 1x liquidation preference,
- participating vs. non-participating preferred,
- payment-in-kind (PIK) coupons.
- Welch explains how these terms protect downside for investors and can significantly reduce what founders and common holders receive on exit.
- He notes that a 1x preference is normal; 2x or 3x becomes much more aggressive.
Ratchets can be especially dangerous
- Ratchets protect investors from dilution, especially in down rounds.
- Welch describes how a ratchet can force founders to give up more equity if performance falls short.
- He shared an example where a founder was effectively trapped by a performance ratchet tied to an obscure metric, eventually losing control of the company.
- His point: certain clause combinations can create a “hamster wheel of death” where the founder is forced to optimize for investor-defined metrics rather than business growth.
Working capital and cash flow details matter in software deals
- In software and AI-enabled businesses, buyers increasingly scrutinize:
- annual contracts paid in advance,
- deferred service obligations,
- working capital needs at closing.
- If a customer paid upfront before the sale, the buyer may argue that some of that cash must stay in the business to service the customer post-close.
- Welch advises founders to expect this negotiation and be prepared with numbers, not assumptions.
Major Takeaways for Founders
1. Know what you’re actually selling
You are not just selling a business for a headline number—you are selling under a structure that may include preferences, holdbacks, earnouts, ratchets, and control rights.
2. Assume every clause can matter
Welch’s advice is blunt: assume every clause could be used against you. Even normal-seeming terms can become unfavorable if the broader deal structure shifts power away from the founder.
3. Buyer and seller incentives are not the same
Private equity and strategic buyers are playing a math game. Their obligation is to maximize returns for their investors, not to maximize the founder’s outcome.
4. Good advisors are essential
Welch stresses the need for a three-person team:
- a CPA/CFO-type financial expert,
- a lawyer,
- an M&A advisor or investment banker.
He argues that lawyers alone are not enough because they ensure legality, but not necessarily deal strategy or leverage.
5. Patience and flexibility increase leverage
Founders who can wait for the right buyer and remain flexible on structure often get better outcomes. More time usually means more leverage.
Terms and Concepts Explained
Earnout
A portion of the purchase price that is only paid if the business hits certain post-close targets, usually profit or EBITDA targets.
Rollover equity
Part of the founder’s ownership is rolled into the new entity, allowing participation in future upside.
Consent rights
Investor approval rights over significant company decisions.
Liquidation preference
A term giving preferred investors the right to get their money back before common shareholders receive proceeds.
Participating preferred
Preferred investors can take their preference and also participate in the remaining proceeds with common holders.
Non-participating preferred
Investors choose either their preference or conversion to common, but not both.
PIK / Payment in Kind
A coupon or return that can be paid in additional equity rather than cash, compounding investor ownership over time.
Ratchet
A protective adjustment for investors, often triggered by dilution or a down round, that can increase their equity position or economic rights.
Working capital peg
The agreed amount of operational cash that must remain in the business at closing to support day-to-day operations.
Practical Advice for Founders
Before signing an LOI:
- Don’t focus only on the purchase price.
- Ask what terms are attached.
- Model earnouts, preferences, and rollover implications.
Before closing:
- Run a quality of earnings or quality of revenue review.
- Understand cash, deferred revenue, and working capital impacts.
- Review any control provisions carefully.
If you’re considering PE or growth capital:
- Know whether the investor is offering help that creates real value or just capital.
- Ask how they make money and how their structure affects your upside.
- Be especially careful with provisions that can shift control over time.
If you’re a founder thinking about exit:
- Treat the transaction like a once-in-a-lifetime event.
- Build a team of advisors early.
- Use your business strength and optionality to negotiate better structure, not just a better number.
About Jesse Welch
Jesse Welch is a partner at MidCap Global, a boutique investment bank focused on middle-market M&A and capital raises across industries. He also produces Capital Love Letters, a media channel where he breaks down common deal traps and misconceptions for founders, especially around private equity and exit structures.
Bottom Line
This episode is a cautionary guide for founders who assume the exit price is the whole story. Welch’s message is clear: the structure of the deal matters as much as the headline number—and often much more. Founders who understand earnouts, preferences, ratchets, consent rights, and rollover terms can negotiate from a position of strength and avoid costly surprises at exit.