How to Account for Sweat Equity
Original post by Carol Deeb of Demand Media
Accounting for your sweat equity during the start-up phase of your business can be complicated. Sweat equity is the work that you do to launch your business. You are not paid for it at the time and it may not cost money. However, it has value because you don't have to pay someone else to do it, and you may be creating a new product or service that takes time to complete. If partners are involved, then each of your sweat equity may be valued at different amounts based on the tasks you perform and their worth.
Place the estimated amount of hours and its value in your business plan before you start. Ask the advice of an accountant to help you address it in the early phases of business development. After a period of time, such as six months, this figure can be adjusted to reflect the actual time and value of your sweat equity.
Account for sweat equity carefully because it adds value to your business. If needed cash investments are low for your industry, but time requirements are high, your business has the value of the work that you and your partners have performed to get it off the ground.
Determine the value of your time during your start-up phase. You and your partners must agree on how each one's work will be valued. They may want to use their hourly wages from jobs that they left to work at the company. Alternatively, if providing a service, such as a computer system design, you can value what it would cost to have hired someone to create the same program.
Decide if you will offer company shares in exchange for the effort that the partners and possible employees have placed in the business. Calculate how many shares each receives for every hour worked and how much they are worth.
Track accumulated hours and receive compensation for them at a later date or when the company is profitable. After you have determined the worth of your sweat equity, you may agree to be paid a flat fee for the accumulated hours rather than in stock options or ownership percentages. Ask your accountant for the tax implications of different types of compensation.
Do not overestimate the value of your sweat equity. If you have allotted a high dollar value to your work, investors may be dissatisfied with the return on their investments in regard to the worth of your time. Also, your balance sheet will reflect a loss or liability, if you owe yourself money to be paid later, and it may have the impact of devaluing your company.
- Angel Investor Report: What Is Your Sweat Equity Worth?
- "Entrepreneur"; What is Sweat Equity Worth?; Asheesh Advani; 2007
- Bplans; Ask the Expert -- Sweat Equity; Tim Berry; 2010
- MIT; Practical Advice for Entrepreneurs; Joe Hadzima
- PBworks; Allocating Equity to Founders; Karl Ulrich; 2009
About the Author
Carol Deeb has been editing and writing professionally since 1988. Her work has appeared in "The Bugle," "Be" magazine, "Canticle" and a book on education. In addition, she is a real-estate investor and business owner. She also has professional work experience in human resources. Deeb holds a Bachelor of Arts degree in English from San Diego State University.