Sweat equity is the non-monetary contribution made to an enterprise or project. For cash-strapped entrepreneurs, sweat equity is used to grow the business when throwing money at it isn’t an option. The labors put into the business increase its value, creating equity.
When it comes time to assess the value of your business, how can you determine the worth of sweat equity?
In theory, it should be easy to calculate. The basic formula would be overall value minus compensation taken equals sweat equity. However, sweat equity is more nuanced, taking into consideration more than just physical labor. That condensed calculation method doesn’t take into account distinctive contributions or personal risk.
What is brought to the table?
Think about the types of sweat equity used to grow your business. Did your joint venture partner bring special skills or experience into the partnership? Did you bring a robust network group that was used to drive business growth? Both of these would benefit the business, but in ways that are difficult to assign a dollar amount to.
Sweat equity agreements
In general, the focus should be on creating a strong product or business, not on who gets the biggest piece of the pie. Having a sweat equity agreement, preferably from the earliest stages, can help ensure everyone is satisfied with the fruits of their labor.
Some things to consider:
- Vesting period: How long do you need to work on the project before you earn vested ownership?
- Type of equity: Are you working for shares in the company? If so, how many shares will you receive?
- Separation clause: How long is the length of the agreement? If you or your joint venture partner chose to part ways, how will the equity be paid out?
There are many additional pertinent considerations and individual agreements would be tailored to a specific situation. Consulting with an attorney before committing to a sweat equity agreement can save your finances and reputation.