Sweat equity allows individuals to obtain ownership in a business by trading labor for equity. It involves establishing terms for contributing labor or services in exchange for equity. The main advantage of sweat equity is raising capital without giving up much ownership. One disadvantage is the difficulty in valuing the labor.
In startups, it is commonly used to compensate for non-monetary contributions. The founder benefits from significant sweat equity after the product development costs have been accounted for. In real estate, homeowners may use sweat equity to perform repairs instead of paying others.
The Value of Sweat Equity
While it can be valuable, sweat equity also has the potential to create unequal roles within a company since the contribution values vary and may avoid fair pay.
Precisely calculating sweat equity is crucial to appropriately value businesses and to avoid underselling them to investors. For cash-strapped startups, it can be a means of survival, with the potential for returns when founders later sell the business.
Sweat Equity in Real Estate
The term ‘sweat equity’ is also used in real estate to describe the physical labor and time someone puts into improving a property, such as renovating a kitchen or landscaping a yard.
Why Founders Favor Sweat Equity
Startup founders often favor sweat equity because they are passionate about their companies and are willing to put in the extra work to ensure their success.