Sweat equity, it sounds really unpleasant doesn’t it? But what is it, and how does it work? Our short video gives you the basics.
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Sweat Equity sounds really unpleasant doesn’t it?
So what is it? Shares in a limited company offered by the founder as non-cash payment for services. Sweat Equity is often issued by startup companies to pay for something that is central to the business plan. A good example is issuing Sweat Equity to a development team to write the code for a platform-based business.
So is it a good idea? It can work really well, particularly with Founders who are a close-knit team, but difficulties can arise with somebody from outside that team.
So what are the main risks? From the Founder’s point of view the main one is undervaluing the shares by offering too great a percentage. There are linked risks of feeling that a shareholder hasn’t really earned his or her shares and has underperformed and being stuck with that shareholder.
Given the risks , why pay with Sweat Equity paps? Payment installments can be agreed or even deferred payment but that misses the point really if you’re considering playing with Sweat Equity there’s probably no other option.
What then can the founders do to prepare for and guard against these risks? The first thing is to think about the projected future value of the business and therefore each share in it. It’s very difficult sometimes to row back from an ill-considered offer of 10 or 15% of the shares in your business. Agreed targets, milestones or a detailed role description against which performance can be measured consider whether the Sweat Equity should be issued upfront or in real time. In other words before the person has earned it or only as and when and if they earn it.
Discuss the pros and cons with your mentor, your tax advisor, your accountant and perhaps even with your lawyer but don’t fall at the last hurdle.
The Sweat Equity deal needs to be recorded usually this is done in a shareholders agreement or consultancy agreement that replaces initial conversations and initial exchanges of emails.
