Is sweat equity a good option for South African tech business startups?

Sweat equity is a term used to describe the sweat and hard work invested into a business typically during the business’ early stages of formation and growth. It’s often how South African entrepreneurs choose to finance their tech startup, but there are alternatives such as taking out loans or finding investors. Do sweat equity investments always yield great returns? This short discussion will look at sweat equity for tech startups in South Africa and explain whether you should consider other options when it comes down to choosing your financing methods!

Sweat Equity for Startups – Is sweat equity a good option?

Sweat equity is an investment of time and skills, rather than money. There are benefits but also risks involved with this type of financing method. First let’s discuss the two sides to the sweat equity deal, the two parties are:

  • the “investor” – in the tech startup context this is often the app programmer or software developer that is giving their time an skills, or ‘sweat’, in exchange for the equity rather than for a salary.
  • the entrepreneur / business owner – the person who is giving up a share in their business i.e. providing the equity in the sweat equity arrangement.

Sweat Equity Pros and Cons for the investing software developer?

On the downside, there is no monthly payment coming in to your bank and I’m assuming that you still need to live somewhere and eat etc so you still have outgoings. Outgoings can be reduced, you can sleep on the office floor and live off instant coffee and packet noodles but this is likely to lose its glamour rather quickly so it is important that you believe in the cause you have attached yourself too and that you can justify this belief to a rational other! Rather than just foregoing jam today for more jam tomorrow… you are actually foregoing jam today for the possibility of more jam tomorrow. Some things to bear in mind:

  • how much extra jam are we actually talking about i.e. if it all works out then will it have been worth it?
  • when is “tomorrow”? Literally tomorrow is just a day away but in the context of your sweat equity commitment when do you expect to start to see some of the rewards of your efforts and be able to swap your office sleeping bag for a bed in an apartment? 3 months, a year, 5 years?
  • how likely is it that the business will fly per your expectations (or close to)?

The above points feed into internal calculation about whether you want to invest your time and sweat into the startup… there are other factors too that should feed into your decision, for example opportunity cost… you can’t get your invested time back, so what are you foregoing by jumping into the sweat equity opportunity? Does it still feel like a good decision?
One other consideration is whether you think the whole being a part of a tech startup thing it would be a fun experience… being a part of a startup, even if the business fails, can be an exhilarating ride and teach you a lot about the world, about business and about yourself… life is a journey not a destination so buckle up and enjoy the ride!

Sweat Equity Pros and Cons for the tech entrepreneur?

On the down side the technology entrepreneur has to give up part of their business. Aside from just meaning they now no longer own all of the pie, meaning the will not receive all of the rewards if the venture becomes a success, this may also mean they will have to listen to the views of the other other shareholders i.e. business decisions may take a bit longer and the direction the business takes may not be fully within the control of the originating entrepreneur. While the adage says that two heads are be better than one this does not feel true when others are suggesting you revise your course!

However, on the plus side the tech entrepreneur gets access to the tech skills and time, often for zero cost, which means they have access to a resource and expertise they would otherwise have had to pay for. Not only does this save money, it also means that more of the startup funds are available for other activities critical to launch and growth of the startup such as marketing and this gives the business a far greater chance of success or of achieving this growth and success earlier than would otherwise be the case. While the entrepreneur with the idea may not want to give up a share of their business, this feeling is perfectly normal after all as it’s literally their business, this view can be short-sighted e.g. would you rather have 100% of nothing or 70% of something substantial and that is growing nicely?

Another important point is that your sweat equity investor has the exact same goals as you in terms of wanting the business to succeed and therefore moving heaven and earth to make that goal a reality. If the same person was contracted or salaried to do the same work they may not be quite so dedicated or work quite so hard. This congruence of motivations is worth a lot. Also, underlying this is the simple fact that someone other than yourself also thinks the business will fly i.e. the business model has significant value and that you are the right person to drive the business. Don’t forget this, do your best to earn the belief that others place in you.

In summary, offering sweat equity can be a great way to fund your tech startup and accelerate early business growth while your startup is running on a shoestring. Offering sweat equity can mean that your business does not have to wait to get funding to cover salaries etc, it can start to function fully today, day #1. Sweat equity in this respect can be a really useful shortcut to the business startup launch process and it also means that all the (sweat) investors believe in your vision and have a vested interest in the success of the venture – this helps too. While the sweat equity route is not the best fit for all South African startups it is critical for some startups if they are ever to get off the ground.

Next Disruptor (South Africa) want to help your tech startup fly… if you need an experienced and committed technical partner, perhaps engaged on a sweat equity basis, then reach out to see how we can help your tech startup soar.