As a new company owner in Hong Kong, you get entangled between the hurdles of maintaining your co-founders as a team and a limited budget. This is true for pre-revenue and high-growing sectors, the question is how to keep your workers on board?
Some companies deal with this issue by arranging a Sweat Equity Agreement. We will tell you about sweat equity shares, how they work, and why they are important in this article?
Sweat Equity in Hong Kong
Sweat equity in Hong Kong refers to a company or a person’s contribution to a business venture or a project.
What is sweat equity?
Sweat equity is the investment an enterprise or an individual makes into a project or business venture. It is not monetary; instead, it is the time allocation, mental skills, and physical work. Sweat equity is mostly common in the startup business industry and in real estate.
Why is sweat equity important?
If a business fails to evaluate the sweat equity, they are undervaluing the hard work of employees. If they fail to account for the non-monetary terms in a business, it could affect the value of the company. Sweat equity monitors the financial health of the business. It is a vital component of a startup because:
- Equalizer: An agreement legalizes the sweat agreement and values all types of contributions made by the founding team. This monetizes the expertise of founders beyond the financial aid. Additionally, it makes sure that all the founding team members consider themselves valued for their investments in the company.
- Equity Claim: When you start a company, there are often cash problems. You will not be able to compensate the employees like the industry standards. But your company still requires talented and skilled workers to build the business. This is the case if you can calculate the sweat equity correctly. In that case, you will be able to evaluate all the contributions and efforts of the team, and in turn, offer equity as a form of compensation. In the long run, employees benefit from owning shares in a company if they make profits and the business grows.
- High company value: If you do not know how to determine your company’s sweat equity, you will undervalue it. The value of the business when you start is higher than the funds invested into it. Using the calculation, you will be able to raise money and not risk any debt accumulation. If your company has an investment of $Y and the combined sweat equity is $Z, the value of your startup is now $Y+$Z. By selling around 20% of shares to an investor at $Y+Z, your business’s new value is now $5(Y+Z).
By using sweat equity and selling shares to investors, you create money.
How Sweat Equity Works?
Sweat equity is the improvements that enhance the value that is generated by the sweat of one. When someone says they use sweat equity, they are talking about the mental capacity, physical labor, and the time to increase the value of a business or project. This term is most commonly used in the construction industry and in real estate. Sweat equity is a thing that homeowners can use to reduce the costs of owning a home.
Generally, investors that flip properties for high profit use sweat equity as a major advantage. They do so by doing all the repair work and renovations by themselves before listing it. The cost to pay painters and carpenters is often high; this can be avoided by investing some sweat equity in the property. Sweat equity is also an important component in the business world, creating value from the efforts of the owners and workers. In startups that have limited cash to spend, they often pay their employees a lower amount than the market standard. In turn, they offer the employees shares in the company from which they can profit in the future.
Other places you can find sweat equity are between the tenants and landlords. Building owners can provide you with an equity share in the property in exchange for maintenance work or superintendent. Let us take an example to understand sweat equity better:
An investor invested $200,000 in his startup; he then goes on and sells a 25% share of the business for $1 million to an angel investor. This gives the business a valuation of $4 million or $1 million / 0.25. The sweat equity of the owner raised the value of the company from $200,000 to $2.4 or $2.5 million. The shares can be issued at a discount to the employees and the directors of the company.
How to value sweat equity?
It is vital to estimate the candidate you want to test before you dig any further, calculating the sweat equity. To calculate it, you will have to consider the work experiences of a worker and their future investment towards the company. Startups often overrate a recruit; this can lead to losses in early-stage businesses when you practice the stock options to attain investors. Here are some basic factors that you need to look for in a future employee before you determine the sweat equity:
- Enthusiasm of the employee co-visualizing the success of the startup
- The involvement capacity of the employee, like the competence, knowledge, skills, leadership, network, etc.
- The long-term commitment desire
Sweat Equity Agreement
A sweat equity share is a worker’s significant contribution to the business. It is vital that you protect their rights. A sweat equity agreement is a legal contract that is signed by the shareholders in which their equity rights are guaranteed. Additionally, the contract is used to prevent any conflict. This is especially true for businesses with multiple partners. It is advisable that you have such a contract between the partners during the early stages of the business.
Why do you need a sweat equity agreement?
The easy way to start a business is to involve two or more partners. One of the partners will provide the funds for the business, while the other will put in the hard work. Now, the next step in the business is to determine the value of the sweat equity shares. The partners can be held accountable to access stakes for company gains by the sweat equity agreement. This makes the partners responsible for any damages.
Additionally, a sweat equity contract also acts as a factor to determine the entity’s structure. If they choose to involve partners who will contribute to the business, you can use the sweat equity contract to compensate for their contribution. Through this, the sweat equity shareholders will attain shares and benefits when the company achieves success.
Manage Your Hong Kong Company Equity Effectively
A sweat equity agreement gives a business the chance to offer their best talents even when they have a limited amount of cash. The sweat equity agreement is a complex document that has to be reviewed by professionals. It is best to invest in professionals to help you out with the agreement. This is a one-time expense that will prevent future misunderstandings, conflicts, and problems.
Eqvista is a platform through which you can manage your equity shares and get a 409a valuation done by professionals. Also, if you want to incorporate a business in Hong Kong, you may need some help. Through Startupr, you can incorporate your Hong Kong Business and obtain a Hong Kong business address. Startupr also offers other services such as accounting, mail forwarding, and company secretary. Get in touch with us to find out how we can help you.