Earn-out Agreements Become a Roadblock for Tech Innovation, Investment Should Return to Common Sense of Shared Risk

Changing the recognition of the principle validity of gambling agreements in judicial practice, returning to the market economy common sense that “sharing profits must share risks,” and allowing venture capital to truly bear risks.

The Politburo of the CPC Central Committee proposed on April 30, 2024, to “actively develop venture capital and strengthen patient capital.” During the 14th Five-Year Plan, technological innovation and industrial innovation have become the core of cultivating new productive forces. Venture capital should rely on its tolerance for failure and risk-bearing capacity to become the “escort” for tech entrepreneurs, helping China’s economy shift towards innovation-driven development.

However, because judicial practice generally holds the view that gambling agreements are valid, they have become a common risk control measure in the equity investment industry, leading to a serious trend of short-term and risk-averse investments, and even affecting the survival of some early-stage tech startups. The China Securities Investment Fund Industry Association issued a “Reminder on Investment Terms of Private Equity and Venture Capital Funds” in December 2025, attempting to reverse this chaos, but the reminder alone cannot form binding constraints. To fundamentally change the situation, the only way is to alter the judicial recognition of the validity of gambling agreements, return to the market economy common sense that “sharing profits must share risks,” and let venture capital truly bear risks.

Judicial opinions act as a guiding force influencing society. The Supreme People’s Court issued the “Minutes of the National Court Civil and Commercial Trial Work Conference” (hereinafter referred to as the “Nine-Minute Minutes”) in November 2019, which clearly affirmed the validity of gambling agreements. This judicial orientation has made gambling agreements the “standard” in the equity investment industry, deviating from the essence of “sharing risks and sharing profits.”

In the “Nine-Minute Minutes,” a gambling agreement refers to an agreement designed by the investor and the financing party when reaching an equity financing agreement, to address uncertainties about the future development of the target company, information asymmetry, and agency costs. It includes provisions such as equity repurchase and monetary compensation to adjust the valuation of the target company in the future. Simply put, when the invested target company encounters difficulties and cannot meet investment goals, the investor has the right to require the target company or major shareholders to buy back the invested equity or shares at a set price, often the principal plus a certain annualized return. Gambling agreements allow investors to avoid paper losses. These three purposes of designing such agreements completely contradict the logic of investment.

Investment always involves uncertainty (risk). Believing that gambling agreements are to solve future uncertainties for “both parties” is not objective. Gambling agreements cannot solve investment risks; they merely transfer the risks to the target company or major shareholders, only addressing the investor’s own uncertainty.

The principle of investment is to earn within one’s knowledge scope. Using gambling agreements to resolve information asymmetry violates the fundamental rule of “not investing without understanding,” providing an excuse for unknowledgeable investors to participate.

Attempting to impose shackles on entrepreneurs with gambling agreements, replacing pre-investment due diligence and post-investment management, and saving agency costs, also weakens some investors’ professional empowerment capabilities, causing risk investment to lose its inherent value.

The core of venture capital is to share risks and benefits with entrepreneurs. This is an unshakable fundamental order of market economy and the essence of investment. However, risk investments with gambling agreements are essentially investors’ “guaranteed returns,” completely overturning this order and violating the public order and good morals stipulated in the Civil Code. On one hand, investors in the lower tiers of the financial pyramid are required to bear investment risks, and any guarantee clauses on returns are invalid due to financial security and market order concerns. The “Private Investment Fund Supervision and Administration Regulations” also explicitly prohibit promising investors that their principal will not be lost or that they will receive minimum returns. On the other hand, the most professional private equity investors at the top of the pyramid are exceptions, sharing profits when the target company is profitable and claiming to recover principal and fixed returns through buyback clauses when losing. This double standard in judicial rulings, where lower-tier investors are required to bear risks while top-tier private equity investors rely on gambling guarantees, also violates the principle of equality.

The widespread use of gambling agreements has already caused a series of negative effects, which have been fully exposed in industry practice.

First, it lowers the investment threshold, leading to industry淘汰. Investment is inherently a high-threshold activity requiring comprehensive abilities such as macro judgment, industry analysis, and post-investment empowerment. But the guarantee effect of gambling agreements causes some investors to lose motivation and ability for in-depth research and market judgment, turning them into “investors relying on gambling agreements in air-conditioned rooms,” rather than professionals who identify quality projects and help enterprises grow. This trend not only erodes the competitive advantage of truly professional investors but also leads the equity investment industry into a distorted development of “heavy risk control and light empowerment.”

Second, it makes long-term investment a hollow phrase. Equity financing is direct and inherently long-term, a form of patient capital. But the existence of gambling agreements causes capital to lose patience: once the target company encounters difficulties triggering buyback conditions, if one investor exercises the buyback right, others tend to follow, even if state-owned capital wants to practice long-term investment principles. Under gambling agreements, investors are more like spectators ready to escape at any moment rather than partners enduring hardships with the enterprise.

Third, it distorts project valuation and disrupts the primary market order. The value of capital lies in reasonable valuation and precise empowerment of startups, but the guarantee effect of gambling agreements causes some investors to lose rational valuation motivation. They blindly raise valuations to compete for projects, disregarding market logic, and this scale-driven approach is amplified by management fees based on investment size, ultimately distorting primary market prices and burdening startups with excessively high valuations, creating hidden risks for future development.

Fourth, it stifles technological innovation and causes huge social resource waste. Innovation is difficult, especially in tech, where failure is common. Silicon Valley’s success stems from its risk-friendly entrepreneurial culture that views failure as a learning experience. But in China, tech entrepreneurs under gambling agreements are mostly self-made; if they fail, they face not only the setback of failure but also buyback responsibilities and potential blacklist status, losing the chance to restart. The valuable experience, expertise, and exploratory spirit of tech entrepreneurs are social resources, but gambling agreements wipe these out, forcing tech innovation—already requiring tolerance—into a “one-failure lifetime” dilemma.

Fifth, it deviates from the original intention of cultivating entrepreneurial spirit. The new “Company Law” explicitly emphasizes promoting entrepreneurial spirit, and central documents repeatedly stress stimulating and protecting innovation and entrepreneurship. The law aims to protect those tech entrepreneurs exploring from 0 to 1, those brave enough to try despite uncertain prospects. But gambling agreements hang like a sword over entrepreneurs’ heads, making them anxious during the process and turning the promotion of entrepreneurial spirit into an empty phrase.

Capital’s pursuit of profit is innate, but the “profit” of venture capital should be based on shared risks. Reversing the distorted development of venture capital depends on correcting the judicial “guiding rod”—changing the recognition of the validity of gambling agreements, and clarifying that they are invalid due to violating public order and disrupting market order.

Only by doing so can investors return to professionalism, conduct thorough research, evaluate markets reasonably, and give enterprises fair valuations; enable risk capital to regain patience and work alongside tech entrepreneurs; allow technological innovation to break free from gambling constraints, encouraging entrepreneurs to innovate and take risks; and restore the essence of “sharing risks to share profits” in venture capital, making it a key force for technological and industrial innovation. Letting venture capital bear risks and returning to market economy common sense is not only a self-redemption for the industry but also a crucial step in clearing obstacles for technological innovation. This is both the duty of the judiciary and an inevitable path for industry development.