What is 'Sweat Equity'
Sweat equity is contribution to a project or enterprise in the form of effort and toil. Sweat equity, in the context of real estate, refers to value-enhancing improvements made by homeowners to their properties.
In business, for example, an entrepreneur who invested $100,000 in her startup sells a 25% stake to an angel investor for $500,000, gives the business a valuation of $2 million (i.e. $500,000/0.25), of which the entrepreneur's share is $1.5 million, subtracts her initial investment of $100,000, and has a sweat equity of $1.4 million.
BREAKING DOWN 'Sweat Equity'Sweat equity is the non-monetary contribution individuals make when developing a project, such as rehabilitating homes for resale or starting a new business venture. For example, a person fixing up and selling homes spends time repairing and renovating the properties. A newly formed company’s founders, advisors and board members contribute their time building the business.
Importance of Sweat Equity
Sweat equity is as valuable as cash equity. In the case of real estate, sweat equity is realized when selling a home for a profit. In the case of startups, sweat equity is typically rewarded through distributing stock or other types of equity in a new business.
Sweat equity is essential when cash is not plentiful. When fixing up and selling homes or forming a new company, people typically have more time than money. They must work hard leveraging their time so they increase their revenues. Increasing the money supply means owners may continue focusing on income-producing activities while delegating other tasks to paid workers. Therefore, sweat equity must be carefully measured in terms of the long-term value of an individual’s efforts, the commitment of participants and the value each adds to the overall goal of the business.
For example, two women start a computer consulting company. Rather than paying for advertising, they provide services for family and friends, make cold calls to potential clients, and work off referrals for building their client base. The women make themselves available at all times so they can help their clients with all their computer needs. After three years, the owners sell their business to a larger consulting company for $4 million. The owners built most of their company through sweat equity and made a very large profit because of it.
Example of Sweat Equity
Habitat for Humanity uses sweat equity as a means of reducing labor costs and setting their organization apart from other affordable housing providers. Homeowners must be accepted into the program and contribute at least 300 hours of building their own homes and their neighbors' homes before taking up residency. Investing sweat equity helps empower new homeowners by building camaraderie and self-worth for every person involved in the process. The time homeowners spend building homes helps instill a sense of accomplishment and pride in their community.