How to calculate sweat equity based on contribution?
Answers
Answer:
Valuing the Business
You cannot track what you cannot measure. For small-business owners, this can be a difficult and sobering realization. Even if your business has a value, that value means nothing if you can't find a buyer. In this way, the value of the business is generally a function of cash flow. The more cash a company can generate, the more it will be worth. It is the estimate of business value that will drive the value of sweat equity.
Business Valuation
There are several ways to value your business without an injection of equity funding. You can monitor the sales price of similar businesses on the market. You can look at the value of book assets and add a premium based on your own best judgement. You may even be able to hire an appraiser to help quantify the value of intangible assets such as brand, copyrights and trademarks. Use all three methods to help validate your best estimate. In the end, however, it is the offer that will dictate the business value, not your best estimate.
Sweat Equity Example Calculation
Assume you invested $1 million in your business, and a friend wants to invest another $500,000 for a 20 percent total equity stake. If you sold your friend a percentage that is equal to only your invested capital, which is $1 million, 50 percent would be equal to $500,000, but in this case the investor only gets 20 percent of the total equity stake. That means you've created some additional value in the company.
Calculation
To calculate the exact amount of sweat equity you need, divide the amount of the investor's investment by the percentage of equity it represents. In this case, the calculation is $500,000 divided by 20 percent or $2.5 million. The investor's stake is $500,000, so your stake is worth $2 million. Since you only invested $1 million, the sweat equity is the remaining $1 million. Every stage of the calculation is driven by the amount the investor was willing to pay for a stake in the business.