What is the ratio of equity received for sweat equity vs. cash investment in a new venture?
There is no specific ratio between “sweat equity” and cash in a venture, and that’s actually not a good way to think about the issue. The bottom line is that cash is cash is cash, and everything else is “not cash”. The reason is that cash is fungible, which means it can be interchanged for everything else, from programming skills to vacations on the Riviera. Other things, such as your particular time and effort, are not.
A better way to think about this is to separate two aspects of the “sweat” that one puts into a new venture. These are critically different, and have very different economic attributes attached to them.
The first is the entrepreneurial value of the founder(s) in a new venture. This is what happens when someone starts an enterprise and creates something of value. So if you start a company, and then raise a round of angel investment at, say, a $2,000,000 valuation, the entrepreneurial value of the time and effort it took you to get to that point is…$2,000,000. The point is that the value created has absolutely nothing to do with a quantified effort that it took to get there. You might have created that value by slaving 18 hours a day, seven days a week for five years (in which case the value of the sweat equity is $8.70 per hour), or you might have created that value by having a brilliant concept, execution plan and team that you pulled together in two weeks of leisurely work (in which case the value of the sweat equity is $25,000 per hour).
The second component is the replacement cost of the specific skills and effort that are involved in the particular work. So if the same specific tasks could have been achieved by paying a programmer (or marketer or part-time CFO), say $2,000 on a short term contract, then that is exactly what the replacement cost value of the work would be.
In practice, once a company has been funded and a valuation established, “sweat equity” contributed after that point is usually compensated based on only the replacement cost number, either 1:1 (that is, the nominal salary, what you would have been paid if the cash had been on hand) is simply accrued, or some other ratio (say, 25% or 50% extra), in recognition of the fact that you’re willing to take the risk that it will never be paid if things don’t work out.
*original post can be found on Quora @ : http://www.quora.com/David-S-Rose/answers *
Written by David S. Rose
You might also be interested in
One of the most common questions we get is: What are the biggest challenges and rewards of angel investing? High net worth individuals become angel investors for a number of reasons, but the opportunity to work with entrepreneurs and provide guidance to founders is typically high on the list. In this video, angel investor Chenoa Farnsworth explains why, interestingly, both the biggest
Entrepreneurs seem genuinely surprised to find that investors in Peoria or Little Rock are not willing to invest in startup companies at Silicon Valley prices. After all, they just read in TechCrunch that investors funded a company similar to theirs at an $8 million pre-money valuation!
The valuation of startup companies shouldn’t be impacted by location, should they? Guess again!
The first question you need to ask is “What country are you in?” and the second is “Are you an Accredited Investor by that country’s standards?”
If we’re talking about the US and you are NOT at the Accredited level ($1 million in investable assets, or $200,000 annual income), then for the moment you are actually not allowed to invest in privately held startups
First, it’s important to understand that the four platforms you list fall into two very distinct groups.
Kickstarter and IndieGoGo are project-based crowdfunding platforms through which anyone can contribute money, either as a donation or with the promise that they will receive a tangible ‘reward’ of some kind if the project is successful.
Gust and AngelList are equity-based platforms, used by Accredited Investors to facilitate the investment of money for an ownership interest in
Here, in a completely unsourced, purely anecdotal and totally subjective answer with numbers pulled out of the air, is my guess:
*original post can be found on Quora @ http://www.quora.com/David-S-Rose/answers *