Startup Lawyer’s Guide to Sweat Equity

Let’s say you pour “blood, “sweat and tears” into contributing your talents and time to a business, and instead of receiving money you receive equity in that business; that equity is what is known in the startup world as “Sweat Equity”.

Paying individuals cash for the work they put into the business can often be too much of a financial burden for an early-stage startup. However, with the hard work of co-founders, employees and contractors being essential components for the success of a business, Sweat Equity is a great alternative and/or bonus to cash-based remuneration and a useful means to attract top-quality talent to your business.

Sweat equity agreements

Granting Sweat Equity will require a Sweat Equity Agreement between the company and individual who performed work for the company.

In order to prepare a Sweat Equity Agreement you will need to:

• Identify the amount of equity to be granted;
• Obtain a valuation of the company to determine the value of each share;
• Determine the services to be performed and performance goals for the employee;
• Set out a termination clause that lays out the terms for either party to exit the agreement.

What is the value of the sweat equity granted?

Sweat Equity will most likely be used to ensure that an individual (probably a star performer) is able to receive market rate remuneration in a situation where the business may not be able to afford to pay a cash salary. 

When determining the amount of equity to grant, the question of “how much is fair?” will require consideration of multiple factors such as:

• The value of the individual’s contribution to the business;
• The cost of ‘losing’ that individual;
• The time spent by the individual helping your business; 
• The work already completed; 
• Future work commitments and growth potential; and 
• The passion and commitment the individual has shown to your business.

When should sweat equity be used?

Sweat Equity is primarily used when paying someone money for their time and work is not a financially viable option and when a company wants to incentivise a person to commit long term to the business.

If you are the one receiving Sweat Equity, it is important to recognise that you would only accept Sweat Equity if there was genuine belief in the potential of the startup to reach new heights and increase its value. The value and success of your Sweat Equity will be directly tied to the success of the business. 

What else should you consider?

You will have to ask the question of whether the individual entering into the Sweat Equity agreement is an employee of the startup. If the relationship someone has with a company is that of an employee, then employment legislation comes into play. This means that as an employer, the business will have to make sure they pay the employee at least the national minimum wage under the Fair Work Act 2009 (Cth).

Sweat Equity granted for the services performed cannot be a substitute for the obligations to pay employees the national minimum wage. Businesses will be breaking the law if they end up not paying an employee the national minimum wage just because a Sweat Equity Agreement is in play. Instead, it serves as a useful tool for compensating an employee beyond the national minimum wage when the employer cannot afford to pay a market-rate salary.

Additional Reading: Paying yourself a salary as a startup founder?

As a Startup founder you may think to yourself: “The priority is the establishment and growth of their business”. However, when prioritising in this way, founders tend to direct as many funds into the business as possible instead of giving themselves that fancy millionaire founder salary. 

At some point the human desire for luxury will kick in and you will want to reward yourself for your entrepreneurial feats. We break down paying yourself a salary as a startup founder!

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