Sweat equity

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Sweat equity refers to work one does to build up value without a salary. This ownership interest, or increase in value, is created as a direct result of hard work by the owner. For example, homeowners who renovate or repair their house themselves are investing in sweat equity that increases the value of their home. Or it could be a non-monetary benefit that a company's stakeholders give in labour and time, rather than a monetary contribution, that benefit the company. In some cases, sweat equity may be rewarded in the form of sweat equity shares. These are shares given out by a company in exchange for labour and time rather than a monetary amount. [1]

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Sweat equity in real estate

Sweat equity has an application in business real estate, for example, where the owners put in effort and toil to build the business, in real estate where owners can perform D.I.Y. improvements and increase the value of the real estate, and in other areas such as an auto owner putting in their own effort and toil to increase the value of the vehicle.

The term sweat equity explains the fact that value added to someone's own house by unpaid work results in measurable market rate value increase in house price. The more labor applied to the home, and the greater the resultant increase in value, the more sweat equity has been used. The concept of sweat equity was first employed in the United States by the American Friends Service Committee in the Penn Craft self-help housing project beginning in 1937. The AFSC began using the term in the 1950s when helping migrant farmers in California to build their own homes. It is perhaps most popularly associated today with a successful model used by Habitat for Humanity, in which families who would otherwise be unable to purchase a home contribute sweat equity hours to the construction of their own home or the homes of other Habitat for Humanity partner families, or by volunteering to assist the organization in other ways. Once living in their new home, the family then make interest-free mortgage payments into a revolving fund [2] which then provides capital to build homes for other families.

Sweat equity in U.S. private business

Private businesses in the U.S. make up 60% of yearly business net income. [3] Recent data has shown the sweat equity in the private business sector equals 1.2 times the U.S. GDP. Theories have been put out to the public to say that lowering income tax rates on private businesses is significantly understated when considering smaller firms' sweat equity effects. [3]

Sweat equity shares

Sweat equity shares are discounted shares issued by a company to its employees or directors. The shares are given in exchange for a value-add by an employee or director. Sweat equity shares are essential when creating a startup with low amounts of funding. [1]

Sweat equity shares can be used as motivation for the startup's employees and will create a more level playing field against large corporations. In a startup company formed as a corporation, employees may receive stock or stock options, becoming part-owners of the firm, in exchange for accepting salaries that are below their respective market values (this includes zero wages). [4] The term used to refer to a form of compensation by businesses to their owners or employees.

The term is sometimes used to describe the efforts put into a start-up company by the founders in exchange for ownership shares of the company. This concept, also called "stock for services" and sometimes "equity compensation" or "sweat equity," can also be seen when startup companies use their shares of stock to entice service providers to provide necessary corporate services in exchange for a discount or for deferring service fees until a later date; see, e.g., "Idea Makers and Idea Brokers in High Technology Entrepreneurship" by Todd L. Juneau et al., Greenwood Press, 2003, which describes equity for service programs involving patent lawyers and securities lawyers who specialize in start-up companies as clients. The “Slicing Pie” model, outlined in Mike Moyer's 2012 book Slicing Pie: Funding Your Company Without Funds, outlines a formula based entirely on sweat equity by observing the relative value of each person's unpaid fair market compensation and reimbursement.

Valuing sweat equity

There are many ways to value sweat equity. A Venture Capital way of measuring sweat equity is to look at the entrepreneur's initial cash investment plus anything personally guaranteed and allocate 20% of that as sweat equity. Venture capitalists will also consider what industry you are in and how much growth potential there is. Although VCs have their way of sorting out the sweat equity brought into a company, it is essential to note that this world is not perfect. [5] There are no ways to measure one's sweat equity. A few things should be brought up when giving sweat equity, and that's the importance of keeping people happy and not losing relationships. Sometimes splitting up equity in a business is vital to continuing it, and sweat equity should be considered. Think about the work the employer or partner put in, not only the cash value put up.

Risks

The risks of sweat equity come with larger rewards. [6] For instance, a person who is willing to take less pay in exchange for stock options or ownership in the company can later make more money. This obviously comes with higher risks because the company may not be as profitable yet to pay you the money that comes of it. Nevertheless, an entrepreneur/founder can use this as an advantage to incentivize their employees or incoming hires that may be getting offers from larger companies.

See also

Related Research Articles

Business is the practice of making one's living or making money by producing or buying and selling products. It is also "any activity or enterprise entered into for profit."

A startup or start-up is a company or project undertaken by an entrepreneur to seek, develop, and validate a scalable business model. While entrepreneurship includes all new businesses, including self-employment and businesses that do not intend to go public, startups are new businesses that intend to grow large beyond the solo founder. At the beginning, startups face high uncertainty and have high rates of failure, but a minority of them do go on to become successful and influential.

In the field of finance, private equity (PE) is stock in a private company that does not offer stock to the general public. Private equity is offered instead to specialized investment funds and limited partnerships that take an active role in the management and structuring of the companies. In casual usage, "private equity" can refer to these investment firms rather than the companies that they invest in.

<span class="mw-page-title-main">Venture capital</span> Form of private-equity financing

Venture capital (VC) is a form of private equity financing that is provided by firms or funds to startup, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth. Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the companies they support will become successful. Because startups face high uncertainty, VC investments have high rates of failure. The start-ups are usually based on an innovative technology or business model and they are usually from high technology industries, such as information technology (IT), clean technology or biotechnology.

<span class="mw-page-title-main">Public company</span> Company that offers its securities for sale to the general public

A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public company can be listed on a stock exchange, which facilitates the trade of shares, or not. In some jurisdictions, public companies over a certain size must be listed on an exchange. In most cases, public companies are private enterprises in the private sector, and "public" emphasizes their reporting and trading on the public markets.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be tangible book value.

Preferred stock is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferred stocks are senior to common stock but subordinate to bonds in terms of claim and may have priority over common stock in the payment of dividends and upon liquidation. Terms of the preferred stock are described in the issuing company's articles of association or articles of incorporation.

Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or ordinary shares in the UK and other Commonwealth realms. This type of share gives the stockholder the right to share in the profits of the company, and to vote on matters of corporate policy and the composition of the members of the board of directors.

<span class="mw-page-title-main">Employee stock option</span> Complex call option on the common stock of a company, granted by the company to an employee

Employee stock options (ESO) is a label that refers to compensation contracts between an employer and an employee that carries some characteristics of financial options.

The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The initial sale of the security by the issuer to a purchaser, who pays proceeds to the issuer, is the primary market. All sales after the initial sale of the security are sales in the secondary market. Whereas the term primary market refers to the market for new issues of securities, and "[a] market is primary if the proceeds of sales go to the issuer of the securities sold," the secondary market in contrast is the market created by the later trading of such securities.

Business valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Here various valuation techniques are used by financial market participants to determine the price they are willing to pay or receive to effect a sale of the business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest.

Stock dilution, also known as equity dilution, is the decrease in existing shareholders' ownership percentage of a company as a result of the company issuing new equity. New equity increases the total shares outstanding which has a dilutive effect on the ownership percentage of existing shareholders. This increase in the number of shares outstanding can result from a primary market offering, employees exercising stock options, or by issuance or conversion of convertible bonds, preferred shares or warrants into stock. This dilution can shift fundamental positions of the stock such as ownership percentage, voting control, earnings per share, and the value of individual shares.

Restricted stock, also known as restricted securities, is stock of a company that is not fully transferable until certain conditions (restrictions) have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award. Restricted stock is often used as a form of employee compensation, in which case it typically becomes transferable ("vests") upon the satisfaction of certain conditions, such as continued employment for a period of time or the achievement of particular product-development milestones, earnings per share goals or other financial targets. Restricted stock is a popular alternative to stock options, particularly for executives, due to favorable accounting rules and income tax treatment.

Stock appreciation rights (SAR) is a method for companies to give their management or employees a bonus if the company performs well financially. Such a method is called a 'plan'. SARs resemble employee stock options in that the holder/employee benefits from an increase in stock price. They differ from options in that the holder/employee does not have to purchase anything to receive the proceeds. They are not required to pay the (options') exercise price, but just receive the amount of the increase in cash or stock.

Phantom stock is a contractual agreement between a corporation and recipients of phantom shares that bestow upon the grantee the right to a cash payment at a designated time or in association with a designated event in the future, which payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation's stock. Thus, the amount of the payout will increase as the stock price rises, and decrease if the stock falls, but without the recipient (grantee) actually receiving any stock. Like other forms of stock-based compensation plans, phantom stock broadly serves to align the interests of recipients and shareholders, incentivize contribution to share value, and encourage the retention or continued participation of contributors. Recipients (grantees) are typically employees, but may also be directors, third-party vendors, or others. Business owners may offer phantom stocks as a way to reward and retain employees, however employees can only own phantom stock during the duration of their employment with the company.

A venture round is a type of funding round used for venture capital financing, by which startup companies obtain investment, generally from venture capitalists and other institutional investors. The availability of venture funding is among the primary stimuli for the development of new companies and technologies.

A series A round is the name typically given to a company's first significant round of venture capital financing. The name refers to the class of preferred stock sold to investors in exchange for their investment. It is usually the first series of stock after the common stock and common stock options issued to company founders, employees, friends and family and angel investors.

<span class="mw-page-title-main">Stock</span> Shares into which ownership of the corporation is divided

Stocks consist of all the shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporation in proportion to the total number of shares. This typically entitles the shareholder (stockholder) to that fraction of the company's earnings, proceeds from liquidation of assets, or voting power, often dividing these up in proportion to the amount of money each stockholder has invested. Not all stock is necessarily equal, as certain classes of stock may be issued, for example, without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders.

Compensation and benefits (C&B) is a sub-discipline of human resources, focused on employee compensation and benefits policy-making. While compensation and benefits are tangible, there are intangible rewards such as recognition, work-life and development. Combined, these are referred to as total rewards. The term "compensation and benefits" refers to the discipline as well as the rewards themselves.

<span class="mw-page-title-main">Carta (software company)</span> American software company

eShares, Inc., doing business as Carta, Inc., is a San Francisco, California-based technology company that specializes in capitalization table management and valuation software. The company digitizes paper stock certificates along with stock options, warrants, and derivatives to allow companies, investors, and employees to manage their equity and track company ownership. The company also operates CartaX, a private stock exchange.

References

  1. 1 2 "Sweat Equity Shares." Court Uncourt, vol. 7, no. 6, 2020, p. 21-22. HeinOnline, https://heinonline.org/HOL/P?h=hein.journals/counco7&i=264
  2. Habitat for Humanity, International. "Fund for Humanity".
  3. 1 2 "Sweat Equity in U.S. Private Business | Federal Reserve Bank of Minneapolis".
  4. Grow Venture Community
  5. "What is your Sweat Equity worth and how do you calculate it?". 15 February 2020.
  6. "Sweat equity – is it worth it?". 24 January 2019.

Further reading