With the rise in the number of people starting businesses recently, one of the common questions you may have as a founder surrounds what kinds of investments you need to make in your business. A common type of non-monetary contribution towards a business is commonly referred to as Sweat Equity. It's all that hard work you are putting in to get your business off the ground, but most new business owners don't think about it as a contribution to the business. Instead, you feel like you are just doing what you need to do to get the business off the ground.
What is Sweat Equity?
Sweat Equity is a commonly used notion for the founders of startups who don't have a lot of money to invest into the business. Since you aren't investing money into the company, it is considered a "non-monetary" contribution that you are using to fund your business. If you are starting your business alone, you may not need to consider your Sweat Equity contributions until you get to a point where you are taking on an investor.
But if it's a partnership, the initial partners in the company who are putting in all kinds of non-monetary contributions will usually get Sweat Equity to reward their hard work when the business is getting started. The partners will each want to make sure they are being recognized for their contributions. Another manner of recognition can be stock options that would allow them to share in the success of the business as it grows.
How Do You Calculate Sweat Equity
Since there isn't a financial investment when it comes to Sweat Equity, you normally will look at the time being spent by each person (although this is the way it works, I would actually argue that your time is usually worth more than money). Once you've analyzed the time that everyone is spending, you can either assign a monetary value to the time or you can measure it in terms of a portion of the stock of the business. For example, if you've issued 100 shares in the company, you can assign proportional shares to each person who is investing Sweat Equity into the venture.
Because many business owners don't have a lot of cash on hand when they start their company, Sweat Equity is a smart way to make up for the lack of cash. Sweat Equity is as valuable as equity that is purchased with money when an investor wants to invest in the company in the future. A valuation is placed upon the business when the investor buys in, and at that point, the Sweat Equity is "monetized" and the initial hard work of the employees is rewarded.
If you are starting your business and aren't flush with cash, you should consider whether it's a good idea to contribute Sweat Equity to make sure your hard work is compensated when your company grows and takes on investors.
Next Steps
If you're just starting your business and want to make sure you've got a strong legal foundation, let's set up a Legal Strategy Session to help discuss the next steps for you and your business.
