Sweat Equity & Startups

- March 8, 2013 3 MIN READ

Paying employees with things other than money – sweat equity, products/discounts, love?

Yes, I know. You are a start-up. You have limited resources and a difficult cash flow forecast – but could really use some help. We spoke about interns a while back, now we are going to look a bit deeper into other ways you might think about to supplement the limited funds you have to hand to get the right person helping you out.

Generally speaking, employees work in return for wages. It is technically possible for you to pay for their work in other ways where you have their agreement and you satisfy your minimum obligations (at least pay the applicable minimum wage in actual money), and I have seen a number of creative mechanisms to entice the right person to come and assist you in the early stages of your developing business without paying top dollar – but you still have to pay something.

There is a real danger where founders try to get people to work in return for promises of future payment, sweat equity, free products or just the love of it. This is because you cannot “contract out” of the employee’s basic minimum entitlements – no matter how much that person might be willing to work for non-cash benefits. Down the track, that person can turn around and demand back-pay for all of the pay they should have received when working for you (no matter how many free widgets you gave them instead, or how many options they could have got if only business went a bit better).

Worked example – sweat equity

There will be cases where a few people can work together to build something – and that is different to the “employment” relationship.

For instance, if two people decide to start a widget business and both perform work for and on that business, and both share in the benefit of that work (that is, ownership in the business / entitlement to future profits that sort of thing), then “sweat equity” will be OK – if we can still use that term in this case. Perhaps it is better classed as “founders’ sweat equity”.

Difficultly arises when, a year into the business, the widget business needs a full time graphic designer, and promise to provide a third of the business to the incoming person in return for their labour. If that portion of the business is not handed over up-front then the graphic designer will not be working because they own a chunk of the business and expect to get the benefit of ownership like the founders, but will be working in return for the promise that they will eventually own a third of the business – and this “sweat equity” will not be OK.

Alternatives will be to pay the graphic designer the relevant minimum wage for all hours worked, and promise the equity (noting that this will give rise to a contractual obligation to actually follow through with the grant of equity); or to simply provide the full equity stake up-front (and a good shareholders agreement with options for dealing with any poor performance, relationship breakdowns or future buy-backs being a good place to start in protecting the equity base of the founders from the uncertainties of such a move).

Disclaimer – note that providing equity up-front is not necessarily sufficient and each case must be considered on its merits.

Some extra information – love work

Loved ones such as partners, parents, kids and siblings, are often the first people that you have helping out in your fledgling business. If they are willing to work for you for free, and you are willing to have them help you out, then there is a good chance that you will be able to get that boost you need with the free and friendly labour around you.

HOWEVER – there is a line that people should not cross when it comes to “love work” – and it is different to notions of how you will look over the family Christmas table. You should not exploit the people who work for you out of love (or, in many cases, a sense of obligation or fear that you won’t do something to them in return). In particular, you should not expect the free work to go on for anything other than a short period of time. Just because a person is your family member or partner, it doesn’t automatically follow that there is no entitlement to minimum wages. If you have a sibling working every Saturday for you for 3 years and you later have a falling out, that sibling may well turn around and try to recover unpaid wages – and has pretty good chances of being successful.

Moral of the story be careful to meet your statutory obligations (that is, pay the minimum wage for all employees), and don’t assume that you can get everything in return for non-cash benefits.

Oh, and beware of Fringe Benefits Tax too!