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Two Methods:Determine how special or unique a person's contribution to a product, outcome, or venture has been.Account for sweat equity.

Sweat equity is a term used to describe the personal effort contributed to an entity, such as the renovation of a house or the start of a business. For example, if $250,000 is invested to start up a business, then, it should be immediately worth that figure. However, if the business is also the result of the passion, commitment, and ideas of one or a few, you should determine its' worth at more. As an intangible asset, it is, therefore, not easily grasped or calculated. Nonetheless, sweat equity is a real thing, and you would do well to learn how to account for sweat equity.

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EditMethod 1 of 2: Determine how special or unique a person's contribution to a product, outcome, or venture has been.

  1. Account for Prepaid Expenses Step 1.jpg
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    Examine the person's level of commitment to the venture and its continuation.
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  2. Account for Bonds Step 2.jpg
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    Define in what way(s) the contribution is unique and irreplaceable.
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    Determine if this contributor shares the vision, goals, and objectives of the other contributors.
    • Clearly, depending on whether this venture is a business start-up or building a deck onto your house, these criteria will be more or less measurable; consider a checklist of these qualities that you can keep as a record.

EditMethod 2 of 2: Account for sweat equity.

  1. Account for Bonds Step 1.jpg
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    Understand that sweat equity is not the same as the market value of the venture, the value it would bring if sold immediately.
    • Sweat equity is a more illusive component than cash, real estate, equipment, and capital, so it is, at best, only one component of the market value.
    • For example, if you restore a vintage motorcycle, the new pipes, the custom seat, and the special handlebars all come at an expense that is part of the equity, but your expertise and hours spent on the restoration make up the sweat equity.
    • As another example, when you add a deck to the back of your house, the wood, nails, cement, etc. will carry as equity in the house, but you also want to measure your contribution in hours and lost wages; the market when you sell will ultimately decide the value of your contribution.
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    Understand that compensation for employees, managers, and officers may have been sacrificed to keep costs low, but this sweat equity is only a baseline for negotiating value.
    • It is smart to decide on a consistent approach to determining the wages that were not paid to help the venture get off its feet; a consistently applied scale can reduce tensions and turnover.
    • For example, partners or key personnel may have deliberately paid their wages on the low side to reduce overhead in the early days of a start-up business; it would help if, at the start, there were some agreement on what the compensation structure was and how it would be remedied in the form of sweat equity later.
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    Consider using equity stock as supplemental compensation.
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    Establish, early in the life of the business, just how much shares of equity will be worth.
    • This decision should be firm, consistent, and collaborative to some extent.
    • A guide to fairness in determining the value of sweat equity shares is the amount it would take to keep an invaluable contributor in place.
    • Because this asset is intangible, the purpose here is to establish benchmarks from which parties and investors can negotiate value.
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  • It should be noted that, since the value of stock fluctuates, the value of the equity shares at an given moment will be more or less valuable; still, there can be tax advantages to this deferred compensation.

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Categories: Finance and Business

Recent edits by: Maluniu, VermontGal, Nicole Willson

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