Issue of sweat equity shares

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Nabeela (Querist)

21 January 2011 What is the accounting entry for issue of sweat equity shares to directors for consideration other than cash?

Arun Iyer

Arun Iyer (Expert)

01 February 2011 Sweat equity is a term that refers to a party's contribution to a project in the form effort --- as opposed to financial equity, which is a contribution in the form of capital.

In a partnership, some partners may contribute to the firm only capital and others only sweat equity. Similarly, in a startup company formed as a corporation, employees may receive stock or stock options, becoming thus part-owners of the firm, in return for accepting salaries that are below their respective market values (this includes zero wages).[1]

The term used to refer to a form of compensation by businesses to their owners or employees.

The term is sometimes used to describe the efforts put into a start-up company by the founders in exchange for ownership shares of the company. This concept, also called "stock for services" and sometimes "equity compensation" or "sweat equity" can also be seen when startup companies use their shares of stock to entice service providers to provide necessary corporate services in exchange for a discount or for deferring service fees until a later date, see e.g. "Idea Makers and Idea Brokers in High Technology Entrepreneurship" by Todd L. Juneau et al., Greenwood Press, 2003, which describes equity for service programs involving patent lawyers and securities lawyers who specialize in start-up companies as clients.

The term can also be used to describe the value added to real estate by owners who make improvements by their own toil. The more labor applied to the home, and the greater the resultant increase in value, the more sweat equity that has been used.

In a successful model used by Habitat for Humanity, families who would otherwise be unable to purchase their own home (based on qualifying factors including need, ability to pay, and willingness to partner) contribute sweat equity hours to the construction of their own home, the homes of other Habitat for Humanity partner families or by volunteering to assist the organization in other ways. (The amount and type of sweat equity varies by affiliate or office.) Once moved into their new home, the family makes monthly, interest-free mortgage payments into a revolving "Fund for Humanity" which provides capital to build homes for other partner families.

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