Many start-ups are finding it difficult to raise capital in the current economic climate, and as such they need to resort to other ways of getting the first employees to get the product developed and ready to sell. A common and very popular option is offering sweat equity instead of a salary. This means people are asked to dedicate their time for free, in exchange for a share in the budding business.

Sweat Equity for Business Owners

If you are a start-up owner wondering how to get money to start a business, sweat equity may sound like a great option. You get somebody to share in the risk, and you don’t need to pay them a salary! You can also count on that person giving their best, as he will be as invested on the company as you are. Getting somebody to work for sweat equity also means they are less likely to just abandon ship when something else comes up, as they would lose their investment if the venture fails. Sounds good, doesn’t it?

The reality is, however, different. Finding somebody willing to work for free in exchange for potential, future gains demands a lot of trust on your unproven business idea, and will require a lot of convincing on your side. You may need to release higher amounts of equity than expected in order to sweeten the deal, or your potential employee may ask to have a say on how the business will be run. You may also find that hiring somebody full time without a salary is nearly impossible, as people need to pay their bills. This can cause delays and increase the time it takes to get the product to market and start producing revenue.

In order to make it work, it’s important to remember that your new employee will be as much an investor as an employee, and so convincing him to take the job will require a similar strategy. You will need a business plan, market research and clear estimates of when your start-up will become profitable, and to which degree. You need to develop trust with your potential partner, and make sure your personalities are compatible: You will both be risking a lot on your enterprise, and that can cause friction if things don’t go well.

You may also find that people willing to work for sweat equity require a higher compensation in the long run that if you were just paying them a salary. You may need to offer equity equivalent to a full time salary in exchange for part time work. Generally speaking, start-ups that hire people through sweat equity reserve this for key employees that wouldn’t be affordable otherwise on a limited budget.

Sweat Equity for Employees

If you have been working on the world of IT for any extended period of time chances are somebody has already approached you about working for equity for their brand new start-up. While working on something that could be the new Facebook or Google may sound really exciting, it’s also a risk. You will be putting in a certain amount of work, in exchange for a share of the business, and depending on your contract you may have more or less input in the running of the venture.

Working for a start-up in exchange for sweat equity is challenging, but it can also be wildly profitable both in terms of pure economic rewards and your professional development. As part of a small team you will have a lot of opportunities to take decisions that will shape the product, and you may be able to experiment with cutting edge technologies that more established businesses consider too risky. If you are willing to dedicate the time it can be a great learning experience, but it’s also hard to work two jobs, one of them unpaid and you must be clear about how much time you can commit. Wear a critical hat when evaluating proposals: Many self employed job ideas sound great in principle, but won’t work when they are put in place due to inadequate market research or other fatal flaws that weren’t anticipated.

As somebody working wholly or partially for sweat equity you are investing on the company, and as such you will be even more motivated to work at your best and make sure it is a great success. However, this can also take its toll if you feel that your efforts are being blocked by other elements of the business. In order to successfully work for sweat equity you need to trust the other members of the team and the business model, so avoid committing yourself fully before having all your questions answered and ensuring that you believe 100% on the project and the people involved.

Sweat Equity for Everybody

One of the most important things you need to keep in mind when entering a sweat equity contract is that it has great potential for disagreement, and disagreements can be extremely disruptive if you are a small start-up with a few key employees. So it’s worth spelling everything out, including what is expected of each party in terms of both time contribution and decision power. This way nobody will feel that their investment is going down the drain because of bad business decisions they have no control over, or because a key player is not pulling his weight.

It’s also important to be clear about the way the sweat equity will translate into actual money. Are you talking about stock options, or real equity? What happens if the person working for it decides to sell his shares to somebody else? All those questions and more are better suited to be answered by a lawyer, so make sure to put in place a good contract revised by an attorney to ensure everything is crystal clear from the start.

Most people considering working on a start-up at no salary will demand to see confidential information such as detailed business plans, market research and proof that the new business has an edge over existing competitors. To avoid problems on both sides an NDA or non-disclosure agreement will be helpful. While sketching things up while having a coffee sounds great, a sweat equity agreement is every bit as serious as any other investment and all the legal safeguards should be in place to protect both the entrepreneur and the employee.