What can you do as a partner if you don’t have money but are looking to get equity in a business?
One way to contribute to a business is with “sweat equity.”
Sweat equity is a contribution to a business, project, or enterprise that is given in effort and work — thus the name “sweat equity.”
A Sweat Equity Agreements itself does not have any monetary value, but it offers work and value-enhancing actions performed by owners and investors.
You must have the correct sweat equity documents.
If you’re looking to get your Sweat Equity Agreement drafted or reviewed, email me at firstname.lastname@example.org
Want to know everything about the sweat equity partnership agreement?
In this post, I’ll guide you through the basic concept and implementation of this business agreement.
Let’s get started…
Why is Sweat Equity Necessary?
Sweat equity is as valuable equity when the partner does not have money to contribute.
Sweat equity works to build up the value of the business to be more valuable than the original value, and this is an important part of business ownership.
Many Sweat Equity Agreements will rely on one party investing funds to a business, whilst the other invests time and effort of the same value so that the business can progress and become more successful.
Investors and entrepreneurs alike always want to see their venture translate into financial success, and investors are always wary of the risk.
The concept of Sweat Equity is a term that is broadly defined as the increase in value that is created through the direct result of hard work. To be specific, it’s a preferred mode for entrepreneurs who don’t have the initial funds for their ventures. It’s the sweat off your brow, quantified into a price tag.
Understanding Sweat Equity: What is Sweat Equity?
To make it easier to understand, I’ll begin with a sweat equity partnership agreement example. Let’s take Jane. She’s an entrepreneur who invested $25,000 into her start-up.
After a year, her business takes off. She sells 30% of the stake to an investor for $60,000. This clearly defines the value of the company at $200,000 and of which Jane’s share is $140,000. Subtracting her initial investment of $25,000, her sweat equity is $45,000.
So in a way, sweat equity quantifies hard work. It quantified Jane’s effort of putting in her time, without having access to a larger source of investment.
In large part, sweat equity can be also seen as a party’s contribution to a project in the form of an effort, as opposed to financial equity, where every member of the party supports a project, financially.
What is a Sweat Equity Agreement?
When you are establishing a partnership in business, you are agreeing for both of you to reach a common goal as partners.
Partnerships can be more efficient by sharing knowledge and resources so that you can reach a goal much faster and far more effective than going in solo.
In a partnership, each party puts up capital in resources or property to achieve the project, but sweat equity agreements are a little different. Rather than capital, each party pledges the value of an amount of work rather than capital values.
Regardless of the terms of a Sweat Equity Partnership Agreement, you always need to make sure you have a WRITTEN Sweat Equity Agreement in writing to make sure your terms are protected with your sweat equity partners.
What To Include In This Business Agreement?
Vesting Period – This includes the time duration of the work efforts from partners so they can claim ownership of a business.
Performance criteria – You should be able to write specific clarification of the roles and responsibilities of the partner in case each partner is required to wear multiple hats.
Type of equity – If you’re working for gaining stock in return for your efforts, you’ll need to mention in the agreement about the type and quantity of shares you’ll be receiving.
Type of business entity – Is it an LLC, S Corporation, or C Corporation? To avoid any ambiguity in the future, you should specify this in the equity agreement.
Separation Criteria – At times, there might be situations in business that may not be in your favor. To avoid any such issue, specify the conditions in which you agree to eliminate your role from the business. If even the worst is in writing, it’s wise to be clear beforehand.
Though I’ve mentioned some of the essential components to be included in your sweat equity agreement, you can even add more (depending on the specific situation and structure of your business). To make sure you don’t end up making any mistake, it’s always better to refer to a sample sweat equity agreement before beginning to create one.
If you’re still unsure of how to draft your Sweat Equity Agreement, email me and I will draft it for you.
How To Negotiate Equity Partnership
Before you determine the sweat equity value, you should assess the following characteristics in your potential business partner:
Long-term commitment – Does he possess the spark to stay committed to the business for several years without giving up?
Contribution – Is he equipped with specialized knowledge, vast experience, leadership abilities, and noticeable skills that could skyrocket business growth?
Passion – Does he share a similar vision as yours so he can take the company to new heights without splitting up?
If you think the answer to all these three questions is “Yes,” then it’s time to go forward with deciding the value of your partner’s contributions in terms of numbers.
If you would like to draft your Sweat Equity Agreement drafted or to have it reviewed, email me at email@example.com
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