Sweat equity is an ownership interest in a business that was due to labor, rather than the investment of funds. Sweat equity recognizes the amount of work contributed to a business. A common form of sweat equity arises when an investor buys a run-down property and then personally spends a substantial amount of time renovating the project. In this case, the investor’s efforts translate into a substantial increase in the value of the real estate. In a startup company, some of the original partners are awarded shares in exchange for invested funds, while others are awarded shares in exchange for their efforts in running the business.
A variation on the concept is when the owners of a business pay their employees in stock, rather than cash. This reduces the firm’s cash outflow, giving it a longer runway before it runs out of cash, while giving employees the opportunity to participate in the valuation of the business.