As an entrepreneur or a wanna-be founder you probably know that one of the main challenges you will need to face in the early stages is how to allocate equity between co-founders and their very different types of contributions. A difficult task, indeed, but obviously not an impossible one.
Whenever you hear the word equity your mind immediately makes a connection with financial equity – the money with which each one contributed to the project in the beginning. But then what is sweat equity? If you try to translate it literally it is the sweat (aka the hard work) with which each of the founders or shareholders contributed to the company. If we want to be more academic, sweat equity is defined as the human contribution to the business and it’s measured in time and effort.
How can you determine the value of sweat equity?
When it comes to valuing sweat equity I suggest you can take into consideration the following 3 parameters:
- Unique role in the start-up – As your start-up’s initial needed work is probably not about nuts and bolts, I imagine that each one of the founders’s work should first of all be assesed in terms of quality. If you have chosen your co-founders well they probably have a certain range of skills that you don’t. Think about each person’s unique set of skills, expertise, know-how and try to evaluate the importance of these in the actual start-up. Then think about the average cost per hour for each skill in order to determine which is the most difficult to acquire. When you know the importance of each skill in the start-up, the average cost per hour of the skill and the commitment needed for it you will have a pretty clear idea about each person’s role value.
- Commitment to the start-up – How much time can your co-founders allocate to the start-up? Do they have another full-time or part-time job? Are they willing to sacrifice part of their spare time in order to make things happen? Try to have a clear approximate figure regarding the amount of time each co-founder can really spend working for the start-up.
- Motivation and long run personal objectives – This may not seem as important to you in the beginning, but you may realise on the long run that this is actually crucial in evaluating the intensity of one’s work. Try to figure out your co-founders’ motivations and career and life dreams. It is always a good idea to ask and listen. If a person is not motivated enough to work in a certain business, they may have all the time and skills they need. Their contribution will never be the same as that generated by a powerful motivation.
- Intangibles contribution – However, there are still many other intangible assets with which a founder contributes to the start-up. Think about that person’s reputation – maybe his personal brand will bring some initial public interest to the start-up – and connections. Endorsement coming from a VIP is obviously worth a lot more than your average friend’s endorsement.
Common mistakes that you should avoid
- Time is money. But not everyone’s time is worth the same. – The most common mistake that entrepreneurs make is take into consideration only one of the above 3 factors. And that factor is obviously time. The other too are the same important if not more important. And they may change the balance in an unexpected way. It is very important to see the efficiency, quality and motivation that each one combines with tthe spent time in order to be able to fairly evaluate each person’s share to success.
- Think on the long run. – I can imagine that there are always times when an entrepreneur feels that he is the only one working for success of the start-up. This may be true… but sometimes only for a short while. Try to see things in perspective. If your partner hasn’t worked as much as you did last week should this be taken as a general rule?
- Cash is king. – You may imagine that cash is much more important than sweat equity only because you don’t have it or because you want it so much. But is that really true? Time is money, motivation is money, work is money. Think about the money each one of the co-founders would win if they would be working for some other paid job instead of for your start-up. The opportunity cost is worth real money.
Experts advise you…
All in all, you should pay real attention to the evaluation process when trying to determine the shares that each founder is entitled to. Paying attention to the whole scenery is vital.