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What is “sweat equity” and how is it valued?

On Behalf of | May 11, 2020 | Commercial Litigation |

Many entrepreneurs can attest to the value of sweat equity. Common in new businesses or partnerships, sweat equity is a way to invest in a business or project without actual currency. Many companies begin in such a way, with many sweat investors reaping financial rewards.

So how do lawyers and business partners determine the value of sweat equity and grant appropriate awards?

Define the terms with a business contract

Individuals who plan to use sweat equity to invest in a new business venture should contact a lawyer to help draw up terms. Even if an individual trusts their business partner, it is important to define the terms and expectations of all involved parties in a legally-binding document. These contracts protect investors and their interests, outline clauses for any failure to meet expectations and determine payouts for sweat equity. Payouts often include partial ownership, share in stock or another equity arrangement.

Sweat investors will want clear definitions of the following items:

  • Nature of the work: Make sure the contract defines the performance and production expectations of daily labor contributions through goals, benchmarks and criteria for measuring success.
  • Nature of the equity: Include the kind of equity reward the person sweating will receive. Do they invest their labor for a stake in ownership, stock options or another form of equity?
  • Nature of the entity: The section defining the business entity will outline the structure, as equity is different in a partnership than a Limited Liability Corporation (LLC).

Having clear expectations of labor performance and compensation goes a long way toward protecting all individuals involved from unnecessary lawsuits. A business can more accurately construct business plans and assemble market projections with a partnership agreement.

Seek legal guidance for assistance

Those looking to invest in a business through sweat equity can contact a local lawyer for more information. An attorney familiar with business litigation can answer any questions an entrepreneur might have and help draft a comprehensive sweat equity agreement.