Glossary - Sweat Equity
Sweat equity refers to the non-monetary investment that founders, partners, or employees contribute to a business, often in the form of labor, effort, or intellectual property rather than cash. This type of equity is particularly common in startups and early-stage companies, where cash may be scarce and significant personal time and effort are invested to grow the business. Sweat equity is recognized as a way to earn ownership in the company or a share of the profits.
Also known as
- Equity Compensation
- Founder's Equity
Use cases examples
- Shareholders' Agreement: The founders are entitled to 25% of the company's equity as sweat equity in recognition of their efforts to establish the company prior to receiving any external funding.
- Partnership Agreement: In lieu of initial capital investment, each partner's contribution of expertise and time to the development of the partnership's technology is valued at $100,000 in sweat equity.
Considerations for investors
- Evaluating the realistic contribution and value of sweat equity is vital in assessing the company's worth.
- Understanding the terms under which sweat equity may be converted into actual shares or cashed out is important for future liquidity events.
- Sweat equity should be aligned with the company’s performance, ensuring that founders or employees remain motivated to contribute to growth.
Considerations for founders
- Valuation of sweat equity can be subjective; it’s crucial to reach an agreement on its value early on to prevent disputes.
- Documentation of contributions and agreements regarding sweat equity is essential for clarity and future reference.
- Considering the dilution of sweat equity after fundraising rounds is important for understanding long-term ownership stakes.
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