It’s not uncommon for one member of a company to contribute services as their capital contribution, while the other partner throws in the cash. For example, Tom throws in the $80,00 to fund startup costs and expenses. His partner, Steve, is a marketing wiz and agrees to do all the marketing for the company in exchange for his membership interest in the company.
Is this scenario risky?…Somewhat, yes! Can it be complicated to hammer out the details? It sure can be tricky, no doubt! But, so often, both parties to this arrangement are suuuuper in favor, trust each other, are friends, and just want it to work out. So, who are we, as lawyers, to spoil all the fun?!
What goes into a sweat equity agreement?
- The total amount of equity that may be earned and what type. You might want to limit it to 50% if you have a two member LLC. You also might want to set a minimum amount.
- The rate at which equity accrues. One option is to use the sweat equity partner’s usual rate of pay to calculate equity.
- Conversion rates. Will the hard work convert to equity each month, every two months, every six months…this matters a lot.
- Vesting period. You might not want the person performing sweat equity to immediately start gaining equity, especially if they are new to the business. You could set a schedule where they start off being compensated in cash, and then, after vesting begins, they begin to earn equity at a rate both are comfortable with.
- Tax issues…the partner doing the sweating for equity will be taxed on the amount of equity earned. There are ways to lessen this, but it is a tax burden that should be discussed and understood before entering into the sweat equity agreement.
- And, finally, performance criteria. You need to be very clear about the responsibilities of the sweat equity partner.
In my example above where Steve wants equity in the company in exchange for his marketing efforts…we need to know exactly what Steve will be doing, how often he will do certain tasks, what he will not be doing, and ideally some way to measure Steve’s efforts. Will Steve be doing Facebook lives, is Steve posting on Instagram, if so, how often? Is Steve writing all the copy for the website? What about blogs and videos? The truth is that if you don’t take the time to think about it and write this down and talk, talk, talk, this arrangement is likely to go sideways. The expectations must be understood.
This post just scratches the surface of what should be included in a good sweat equity agreement. Rest assured, sweat equity is something that is common and can work fantastically for all involved if drafted and timed the right way!
Ok, friends, are you stoked to get some legal help with this process!? Great! I am equally as stoked to help you! Call me! 614-572-6366. Email me! firstname.lastname@example.org.
Wick Law, LLC is a small business legal practice, representing owners, investors, and entrepreneurs in all aspects of commercial, corporate, and business law, estate planning, contracts and negotiations, business litigation, and real estate. For more information: Contact 614-572-6366, visit www.mwicklaw.com, or email us at email@example.com. Wick Law, LLC is located in Columbus, Ohio.
(Materials in this article have been prepared by Wick Law, LLC for general informational purposes only. This list is for educational purposes and is not to be considered exhaustive. More items could be added to this checklist based upon the type of transaction or industry standards. These materials do not, and are not intended to, constitute legal advice. The information provided is not privileged and does not create an attorney-client relationship with Wick Law, LLC or any of the firm’s lawyers. This checklist is not an offer to represent you. You should not act, or refrain from acting, based upon any information in this checklist. Wick Law, LLC maintains offices in Columbus, Ohio, and has lawyers licensed to practice in Ohio and in the United States District Court, Southern District of Ohio. The firm does not intend to practice law in any jurisdiction where the firm is not licensed.)