Michelle Rodger: Sweat equity: where hard work is its own reward

Published on Saturday 19 December 2009 18:23

WE ALL know that business success comes in direct proportion to effort. Blood, sweat and tears coupled with talent, passion and ambition create a powerful combination.

True, some entrepreneurs have these characteristics in spades but, unfortunately, it's sometimes not enough.

However, it is possible to harness the combined forces of other individuals to leverage your own business success – it's called "sweat equity".

Sweat equity came to the fore during the dotcom boom, when fledgling entrepreneurs with not a penny to their business launched companies with apparently enormous revenue potential. They needed to attract intelligent investors who could bring expertise, contacts and experience to the table, but they didn't have the money to pay them. So these investors were offered shares in the company in lieu of payment – sweat equity.

Opportunity-driven back then, sweat equity is now making a recession-driven return but it is still just as beneficial for business owners who need additional expertise and experience without having to pay through the nose for it.

To put it simply, sweat equity is any situation where someone gets shares in a business in return for their work, rather than a cash payment.

Indeed, it tends to be quite common in many small businesses where there is almost always an element of sweat equity, even if the owner doesn't recognise it as such.

Tom McCallum has experienced the value of sweat equity on numerous occasions, most commonly when bootstrapping a business – raising it to a new level without inputting additional capital. Many owners pay themselves little or nothing. It is often new investors who insist they pay themselves a salary, to quantify the value of their contribution as founders.

McCallum, an expat and GlobalScot living and working in the Cayman Islands, says the key point to a successful sweat equity deal is that entrepreneurs need to be flexible. At any point, but particularly in these straitened times, flexibility is essential in terms of valuing their own input, and also in providing a shareholding in the business to people who may provide time, expertise and energy in lieu of cash or capital – especially given how restricted access is to money these days.

It would be usual, indeed sensible, to pay a small fee of some sort combined with a sweat equity deal. I mean, who really gives 100 per cent to a business that won't pay them anything for at least three years, if even then?

McCallum agrees. He says sweat equity must be accompanied by at least some cash. You must have "skin in the game", or to put it another way, it can't just be the latter-stage investors who have cash to lose.

Where the business just can't afford to pay at all, it becomes trickier, a much higher risk strategy but, as long as the expert believes in the value to be had from the business in the future, it can still work.

However, sweat equity isn't just a recessionary tool employed by businesses as a means to replace hard-to-find capital. Considered tactically, it can also be a strategic part of a longer-term rapid-growth plan.

The best money to have invested in your business is "smart money", according to serial entrepreneur Alan McCafferty. If you need money for growth then better to have that money alongside the expertise your company needs to take it to the next level.

Sweat equity from an expert, partnered with a cash injection and geared towards a three to five-year exit at the point that a venture capitalist enters the fray is, he says, so much more valuable than a cheque.

McCafferty, who sits on the board of the Entrepreneurial Exchange, says it's important to have talented individuals giving the benefit of their expertise at an early stage in the company's growth curve. To be able to approach potential significant investors or venture capitalists and say "so and so is on our board" can often lend additional, much-needed credibility and perhaps even tip the balance in your favour.

But you need to work at it. For sweat equity to have the desired impact on your business, it's crucial to agree at the outset what the objectives of the relationship will be, and establish the milestones for any earn out.

"You've got to make them sweat for their equity," advises McCafferty. "They can possibly open doors, make contacts or generate sales for you, but the best ones are the ones that have been it, seen it, done it all before and make a significant strategic impact on your business."