What It Means to Have Sweat Equity in Your Business
As seen on Modern Restaurant Management
Remember back to the first restaurant you opened? It probably took everything you had to scurry up the funds required to sign the lease, build the store out and get it ready for opening day. Those unanticipated cost overruns didn’t help either. If you’re like most first-time restaurateurs, you most likely went to friends, family members, and your own personal savings to patch the initial funding together. An experience you probably won’t ever forget, and assuredly one you aren’t anxious to repeat.
So how is it that a number of notable restaurateurs are able to have so many locations and expand their brands? Did they have an endless source of personal funds? Family members with deep pockets? Lottery winnings? No, they eventually came to master the art of “sweat equity”, a concept that has become a standard in the world of restaurant finance.
"Yes – you can actually get paid to do the thing you love to do best, develop a restaurant concept."
What is sweat equity you ask? Simply put - it’s the concept of monetizing your personal skill sets and talent. Wikipedia defines it as “a party’s contribution to a project in the form of effort and toil…” Yes – you can actually get paid to do the thing you love to do best, develop a restaurant concept. However this payment is in the form of equity, not compensation. The difference being that it’s a non-cash concept. Similar to getting stock options if you went to work for a big corporation, sweat equity allows you to benefit tomorrow from your efforts today.
Successful people attract attention. Everyone wants to be their partner and ride on the coat-tails of their success. Notable restaurateurs have grasped that concept and monetized it in expanding their brands, and so can you. Here’s a simple example of how it works. Assume you need to raise $2,000,000 to open your next concept. There’s now a buzz on the street, as folks already know that your first venture was a hit, and presumably you’re on your way to a repeat of that success. Rather than rewind and repeat the process of dipping into your own personal funds again, the concept of sweat equity has arrived. Other people get to put the entirety of those funds up. In exchange, they get the lion’s share of initial ownership in the new concept. Let’s say 80 percent, but they realize that your talents are worth something too and hinged upon your prior success comes your own intrinsic value. Your talent is worth that other 20 percent. That equity interest is yours for no cost but your own personal efforts in developing, establishing, and bringing that concept to life. Voila!
Any downside? As a sweat equity partner, you have to be patient. Typically, the profit distributions are first allocated to the investors until they have recovered their initial capital. This is what makes the deal equitable and fair. By no means is this a requirement, but it is a consideration when attracting investors.
There are ways to structure this type of equity position to either lessen or avoid the tax burden. You will need your financial and legal advisors to assist you with this, so do not just make the assumption that you are receiving a gift for your past success. You have earned this equity and the last thing you want is for the IRS to consider it taxable earnings. Taxes need to be considered before you accept the first dollar from an investor; proper planning is just as important, if not more, than attracting investors.
Make no mistake, your intrinsic value will rise and fall just like the value of that stock option on the open market. Your market is the success of your brand(s). That success is what has allowed many a restaurateur to gain iconic status, and that iconic status can be further leveraged into a larger sweat equity stake in the next great concept. How large a stake you ask? We have seen sweat equity stakes as high as 50 percent upon formation.
So go out there and be successful, but also be smart about your brand, your intrinsic value, and how to best monetize it with a sweat equity model.
Written by: Nick Florio and Stacy Gilbert