Sweat equity can be defined as the time and effort the founders of a company invest in order to get it off the ground when it initially started. Sweat equity is not determined by the money owners invest into the business. But, sweat equity does holds a value. Sweat equity is the representation of the knowledge, time and the effort an individual puts in it. It can be considered a very critical component that plays an important role in negotiations of shares of the founders and early employees. It can be very challenging as it is difficult determining how much your partner is worth.
Factors to determine partner
- Evaluate if your founder/partner is trustworthy enough to stick around for a long time. This is very important or else you might end up giving shares to someone who might leave as soon as the first sign of trouble appears.
- Ask important questions regarding the kind of value they bring to the company and if such resources are difficult to replace or to be found. And, how important are they to the company’ success.
- See how aligned are they towards the company’s goals and vision. Find out if they harbour different goals from the company.
Determining sweat equity
To determine the value of sweat equity, you will have to put value on your time. One important thing to remember is that market value is not always equal to the sweat equity invested by those in the business.
Proving your sweat equity’s value when raising funds from an investor is very important as this will help you get funds from them at a higher valuation. This also means you will keep a larger portion of the company. Make sure that you are are careful if your business is a one-person game. If it is, then you should not exaggerate with paying yourself huge amounts of money from the revenue. The more money that you are able to keep in the company the faster your company will grow.
Business Plan
Make sure that your sweat equity is recorded onto the business balance sheet as capital investment, with monetary value, in your, your partners’ and your employees’ name. There are certain complications involved so it is always better to go about it with the help of good professional advice. If you don’t get this into your business’ books with monetary value, this will come to haunt you when negotiating with investors or future owners of the business. Your accounting should reflect reality at all times and should also give justifications for the efforts you have put and the decisions you took.
Prowse Barrette (Previously Prowse Chowne) is equipped with lawyers in services related to Shareholder and Sweat Equity Agreements. If you are considering a Shareholder or Sweat Equity Agreement, feel free to contact the Lawyers at Prowse Barrette (Previously Prowse Chowne). Our team consists of experienced Lawyers and Paralegals who will work with you and will help you find the best possible solution for your company.
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