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What is your Sweat Equity worth and how do you calculate it?  

By Venture Giants

A pre-money start up or early stage valuation is definitely the most difficult to value (vs. an established business) but there are some rules. For example, at the very minimum, a business is worth at least 100% of the invested capital. £100,000 cash invested = 100%. You can dilute from there keeping the same percentages as post money starts to come in.

On the other extreme, one can make an argument that a business is worth what it "should" generate through future earnings. For example, if an entrepreneur makes the argument that their business will generate £1 million in sales and £250,000 in profit each year over the next 3 years (or any number of years), and an investor comes in at £250,000 for 50% equity, they will see a return of 50% per year based on their investment.

Will it actually happen?

That's the tough part, maybe and maybe not but that is speculation and all part of the game.

In the middle of all this is some estimate of cash invested, future earnings, sweat equity, future rounds of finance, etc, etc. It can get very complicated and subjective. Be VERY cautious about future earnings because if they happen, they happen because of BOTH the founder AND angel investor's investment and if they are taking common stock in the company just like you, you both go up and down as things move along. If an Angel investor can bring other things to the equation such as physical involvement, industry contacts and leads, overhead infrastructure, etc. they might argue to start deducting this from their proposed equity offering.

So how much time and money have you invested so far as the founder and what percentage of the total investment you are seeking would you say your sweat equity is worth? Some considerations that may want to take is that almost every business in start up or early stages has a founder that has invested a great deal of time.

Your business is likely no exception and your sweat equity is worth something. Coming up with an exact figure or percentage sometimes requires further investigation but as a loose rule under most circumstances, you should have no problem making the argument that 20% of the total capital invested to date (personal, angels or angel investment, banks and Government funding) would be reasonable as the founder's value of their sweat equity.

Venture Giants Insider Edge:

A good rule is to look at and base things on the initial cash investment from the entrepreneur (plus anything you have personally guaranteed because you are on the hook for this as well), and allocate 20% of this total as sweat equity.

Further Articles on Venture Giants that are related to Sweat Equity and the calculation of it is how much Equity is enough? No surprise that most entrepreneurs will over-value their companies in the start-up stages and either ask for more than they need, can afford or offer less shares than is reasonable (based on real world numbers and facts). Understanding what your sweat equity is really worth (using the formula listed above as an example) is the first step towards being in a real position to working out the amount of equity you should offer in return for an angel investment.

Most Angel Investors will want to know the rationale supporting your claims when it comes to calculating your yearly growth projections and the figures that you have placed in your business plan. It is extremely important that you can demonstrate a clear understanding of the size and scope of the industry in which you are focused on. How do your projections compare with the yearly revenues and overall growth forecasted by industry experts? Placing too ambitious yearly growth projections in your business proposal may leave your sweat equity figures under scrutiny as well - so the key here is to be very realistic on your yearly growth projections especially if you have invested a significant amount of time and cash into your business. Think about it, if you state that your proposal has a 1000% ROI Year 1 and then state that your sweat equity is worth 25% of the business, the chances are the angel investor sitting in front of you will not take much notice of your figures unless you can substantiate them. The key here is credibility and stating a reasonable yearly growth projection will place you in a position of strength especially when it comes down to what you state as your % level of sweat equity.  

When calculating a reasonable sweat equity for yourself, please also take time to consider what type of industry you are in as choosing your industry will affect your chances of raising angel investment. Certain industries have garnered more attention than others over the past few years. The most interest has been in software, followed closely by healthcare, biotech, business products and services, consumer products and services, hardware, media and entertainment. Identifying the industry that you are in will help you get potential angel investors attention since most angel investors will like to invest in areas where they have some interest, knowledge or experience. At the very least if your industry has significant growth future potential - this will maximise the chances of you asking for a higher percentage level of sweat equity on the initial cash investment that you have made into the business (plus anything you have personally guaranteed).

If your business is not positioned in a growing industry, or perhaps you have not invested as much cash as you have personal time into your business during the early stages then looking over how much Angel Investment Capital you actually need could save you a significant amount of equity in proportion to the Angel Investment you receive. It is very common for entrepreneurs to ask for more angel capital than they actually need to create a profitable business! So if you are asking for £50,000.00 angel investment look into how you intend to invest this. Creating a detailed excel spread sheet with how you would invest this and really spending some time thinking about on what can yield some very fruitful results! As an entrepreneur it is your job to cut down the costs to a minimum when you are running a business - so you are obligated to do this when you are asking for investment! 

So seriously look at your investment requirements. Can you cut it down to £35,000.00? Calculating the amount of angel funding that your business ACTUALLY requires is one of the most important steps in the process - too little and you are undercapitalised - too much and you could look opportunistic. The link above explores how to balance out the amount of Angel Funding that you are asking for.







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