Sweat Equity Clause – Useful Tool For Founders and Small Business Owners

by | Mar 8, 2023 | Business, Contracts, Featured, Law

A sweat equity clause in a shareholders’ agreement is a provision that allows a shareholder to earn equity in a company through their labor or services, rather than by purchasing shares outright. It is commonly used in startup companies, where founders may not have the financial resources to invest in the company, but can contribute to its growth through their work and expertise.


The sweat equity clause typically specifies the terms and conditions under which the shareholder can earn equity. This may include the nature and duration of the services to be provided, the valuation of the services, and the percentage of equity to be awarded. The clause may also include provisions for vesting and forfeiture of equity, to ensure that the shareholder continues to provide value to the company.


Here are some examples of how a sweat equity clause might work:


1. Founders A and B start a tech company, but they don’t have the funds to invest in the company. They agree to a sweat equity clause that allows them to earn equity based on their services. Founder A is a software developer and agrees to work full-time on the product for two years. Founder B is a marketer and agrees to develop and implement the company’s marketing strategy for two years. The sweat equity clause specifies that Founder A will earn 40% equity and Founder B will earn 30% equity, vested over the two-year period.


2. A startup hires an experienced CEO, but doesn’t have the funds to pay a market-rate salary. The CEO agrees to a sweat equity clause that allows them to earn equity in the company based on their performance. The clause specifies that the CEO will earn 10% equity per year, based on achieving certain performance milestones. If the CEO fails to achieve the milestones, the equity will be forfeited.


3. A small business owner wants to bring on a partner to help grow the business, but doesn’t want to give up too much equity. The owner agrees to a sweat equity clause that allows the partner to earn equity based on the revenue they generate for the business. The clause specifies that the partner will earn 5% equity for every $100,000 in revenue they generate, up to a maximum of 20% equity.


In summary, a sweat equity clause in a shareholders’ agreement can be a useful tool for founders and small business owners to incentivize and reward contributors to the company who may not have the financial means to invest upfront. It is important to clearly define the terms and conditions of the sweat equity arrangement to avoid misunderstandings and disputes down the line.

Nik Erman Nik Roseli Commercial Lawyer


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