Sweat Equity valuation in new Venture: a tricky task

By Olivier Dellacherie, Executive Chairman, Talent4Boards Inc.

1. Intellectual Property (IP) created to date 
2. The sweat of the founders 
3. Cash invested 

While each cash dollar invested can easily be valued, IP and sweat cannot. Assigning a value to the founders’ sweat requires setting equivalence between the cash contributed and the sweat contributed. But non-cash contributions must be discounted before comparing them to cash contributions, as a dollar in cash is worth more than a dollar of unpredictable, to-be-delivered effort, and because cash is capitalized on an after-tax basis, while sweat must be considered as a contribution before tax, such as wages.

Furthermore, sweat is often contributed to the margin by people who may have other jobs. The opportunity cost of their time is not usually money, but rather non-work time, spent with family or recreationally; this is generally estimated worth less than wages at work. Sometimes, the opportunity cost is disproportionate, particularly when valued by consultants who are used to billing on an hourly rate basis and tend to value their opportunity time at their standard rate. Of course, there are unusual circumstances in which this is possible. For instance, in the case where seasoned experts are needed on a team unconditionally, and who would be able to charge each of their available hours elsewhere at the standard rate. More typically, an expert or a consultant commits to working out of his regular work time, and those hours are rarely valued at a consultancy standard billing rate. A rule of thumb with consultants is to sometimes evaluate their input at half of their standard billing rates.

Depending on factors in each specific situation, an adjustment factor will have to be applied to convert a non-cash dollar of the opportunity cost of sweat contributed to a dollar of cash invested. To be rational, the equivalence between cash and sweat will be determined by an agreement between the individuals providing these different contributions.

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