What is 'Sweat Equity'

Sweat equity is the non-monetary investment that owners or employees contribute to a business venture. Startups and entrepreneurs often use this form of capital to fund their businesses, by compensating their employees with stock rather than cash — which also helps to align risk and rewards. In real estate, it refers to value-enhancing improvements made by homeowners to their properties.

BREAKING DOWN 'Sweat Equity'

Sweat equity is often used to refer to the effort and toil a company’s owners and employees contribute to a project or enterprise – and the value it creates. 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.

For example, 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 (i.e., $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.

Sweat equity — which is a form of non-cash capital — is also known as equity compensation, and can take the form of stock options, restricted stock units (RSUs) and performance shares. 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 multi-year time horizon.

For example, private equity (PE) firms may reserve a significant minority stake in acquired companies to incentivize management and align their interests with the PE investors.

For more on stock compensation, read Equity vs. Salary: What You Need To Know

Real Estate and Other Property

The term sweat equity originally referred to the value-enhancing improvements generated from the sweat of one's brow. And this is still what is meant by sweat equity in real estate, or automobile and boat restoration projects. Sweat equity can be used to lower the cost of home ownership, as Habitat for Humanity does. Habitat for Humanity homeowners have to contribute at least 300 hours of labor, building their own and their neighbors' homes, before taking up residency. Besides increasing home affordability, the program also gives homeowners a sense of accomplishment and pride in their community. Landlords are sometimes willing to trade equity in a property, in return for maintenance work.

  1. Equity Participation

    Equity participation refers to the ownership of shares in a company ...
  2. 100% Equities Strategy

    A 100% equities strategy is an investment strategy for an individual ...
  3. Entrepreneur

    An entrepreneur is an individual who founds and runs a small ...
  4. Private Equity

    Private equity is a non-publicly traded source of capital from ...
  5. Equity Market Capitalization

    Equity market capitalization is the measure of the total market ...
  6. Employee Contribution Plan

    An employee contribution plan is an employer-sponsored savings ...
Related Articles
  1. Small Business

    Is Equity Financing the Right Choice for Your Business?

    Discover the benefits and drawbacks of equity financing for a small business, and learn when equity financing should be used instead of debt financing.
  2. Investing

    Home Improvement’s $64,000 Question: To Borrow, or Not to Borrow?

    With the surge in home prices, homeowners are gaining more equity. This not only stimulates more people to want to invest in their homes, but it also gives them easier access to home equity loans ...
  3. Tech

    The Risk And Rewards Of Investing In Startups (GOOG)

    Investing in startups is a very risky business but can reward investors greatly if and when they do pay off.
  4. Investing

    Flipping houses: Is it better than the buy-and-hold strategy?

    Real estate investors can choose flipping or buying and holding a property. Find out the pros and cons of each, and which real estate investment strategy may best for you.
  5. Small Business

    Deferred Compensation Plans for Small Business Owners

    Find out the best tax-qualified options business owners can use to defer their compensation and accumulate capital for their retirement.
  6. Investing

    How to Invest in Private Equity

    Private equity might be a pricey investment, but the payoff could be big. Here's why and where you should invest in private equity.
  7. Investing

    Private Equity Real Estate Funds vs. REITs

    REITs and Private Equity Real Estate Funds are two different ways to invest in real estate.
  8. Managing Wealth

    How to sell stock in your company

    Read about options and important steps to consider when you're selling, even a small part of your business.
  9. Retirement

    A Guide to Employee Stock Option Plans

    Stock option plans are among the ways employers can compensate employees. Here's how they work.
  1. Why would a company use a form of long-term debt to capitalize operations versus ...

    Learn about the different consequences of using long-term debt versus equity to raise capital for business activity, and ... Read Answer >>
  2. How Is Equity and Shareholders' Equity Different?

    A company's equity typically refers to the ownership of a public company. Shareholders' equity is the difference between ... Read Answer >>
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center