how sweat equity works
sweat equity originally referred to the value enhancing improvements generated from the sweat of one s brow so when people say they use sweat equity they mean their physical labor mental capacity and time to boost the value of a specific project or venture the term is commonly used in the real estate and construction industries sweat equity can be used by homeowners to lower the cost of homeownership real estate investors who flip houses for profit can also use sweat equity to their advantage by doing repairs and renovations on properties before putting them on the market paying carpenters painters and contractors can get extremely pricey so a do it yourself renovation using sweat equity can be profitable when it comes time to sell sweat equity is also an important part of the corporate world creating value from the effort and toil contributed by a company s owners and employees in cash strapped startups owners and employees typically accept salaries that are below their market values in return for a stake in the company which they hope to profit from when the business is eventually sold cash strapped businesses may provide compensation for an employee s sweat equity in another form such as shares in the company special considerationsin many cases people have to use sweat equity their time and effort to contribute to the success of a company that s because there s very little capital to pay salaries unless you re the owner everyone expects to be paid for their time and energy after all no one wants to work for free while a company may not yet have enough capital to pay its employees it can provide compensation in other forms for instance startups may provide key employees with an equity stake in the company other more established companies may provide their employees with shares in the corporation as a reward for their sweat equity example of sweat equityhabitat for humanity homeowners must contribute from 200 to 400 hours of labor to build their own homes as well as those of their neighbors before they can move in 12 besides increasing home affordability the program also gives homeowners a sense of accomplishment and pride in their community sweat equity can also be found in the relationship between landlords and their tenants in exchange for maintenance work building owners and landlords may provide an equity stake in the property or in the case of a superintendent free housing but what about the business world let s say an entrepreneur who invested 100 000 in their start up sells a 25 stake to an angel investor for 500 000 which gives the business a valuation of 2 million or 500 000 0 25 their sweat equity is the increase in the value of the initial investment from 100 000 to 1 5 million or 1 4 million shares may be issued at a discount to directors and employees to retain talent while performance shares are awarded if certain specified measures are met such as an earnings per share eps target return on equity roe or the total return of the company s stock in relation to an index typically performance periods are over a multiyear time horizon for instance private equity pe firms may reserve a significant minority stake in acquired companies to incentivize management and align their interests with the pe investors 