A new business is often built on sweat equity and financing from investors. It is the term used to define the contributions of a member of a company, whether it is an employee or investor. In most cases, the term is used for the owners of new businesses who often work without compensation in the early years before the company is profitable. Sweat equity can also be applied to employees of a company who accept reduced wage or no pay at all in exchange for a level of ownership in the company.
When you’re starting a business, sweat equity is often a critical component of your negotiating leverage with investors, early stage employees and others who are salary sacrificing to help your business flourish. As the business owner, you should be the expert on valuing sweat equity. Before determining the sweat equity, you first need to evaluate the following aspects in your partners and employees:
- Commitment – Are they committed to being a founding partner for your business?
- Unique contribution – Do they bring specialized knowledge, skills, leadership ability or experiences that you don’t have or lack in?
- Hopes and dreams – Are their hopes and dreams for personal wealth, business success and self-determination the same as yours? If not, are the differences substantial enough that they’ll pull the company apart?
Sweat equity can be healthy for a startup business. It can help the company acquire payroll savings that can be used to cover the overhead costs, marketing materials, and other expenses essential for a new business. Sweat equity can also be a positive indicator for other investors that your business is promising. Having committed employees and partners willing to work for minimal or no pay can often be a strong sign to potential investors that these individuals believe in the company’s potential for long-term success. They would not forgo pay in exchange for an equity stake in the company unless they believe that equity will be valuable in the long run.
When you don’t have the enough capital to jumpstart your business, negotiate a package with shareholders where you can salary sacrifice for equity, buying shares at a discounted rate and growing your ownership based on performance. Without much personal startup capital you can ‘pay’ with your personal time. Often, this method can get a product or idea off the ground while still providing you with the control and future profits that you desire.
Sweat equity is great when you are able to put your heart into your business and share it with your employees and partners. A little sacrifice in the beginning can go a long way.