Sweat Equity for Startups

How do you issue sweat equity for your start-up in Malaysia?

It is not easy to get a new business off the ground. It's also difficult to keep a good team together and attract new talent, especially when you're bootstrapping with limited funds. Sweat equity shares are a powerful tool for retaining talent and attracting others in the ecosystem or industry who can add long-term value to your entrepreneurial journey as a start-up founder.

The most common blunder

When offering shares to a potential hire, many start-up founders prefer to offer or issue a fixed upfront percentage of shares in your company.

To begin with, using a percentage isn't a bad idea. The issue with using a fixed percentage is that it is tied to the valuation. Your 10% equity in your company could be worth a lot more in six months or even a year. To summarise, the 10% may be worth different amounts as the company grows (assuming the value of the company goes up of course).

In other words, it may be worth the effort to calculate or quantify the value of the work that the person you're onboarding in your start-up will do.

How to Obtain Sweat Equity

As a result, my preferred option is for you to calculate the value of the work that the talent brings to the company.

Assume you need a landing page with a nice catchy 'call to action' button for your new business.

You've done some research and discovered that the average cost of hiring a web designer is around RM5,000 for a functional landing page. So long as the work is completed, I can offer the web designer RM5,000 in shares in my venture. The agreement can be laid out in a simple developer agreement, with the fee paid through the issuance of shares from your start-up instead.

Usual issues that arise when issuing sweat equity

In practise, many Malaysian company secretaries may be unfamiliar with the sweat equity concept, so don't be surprised if you get a flat "no" when you tell your secretary that you want to give some shares to a CTO or a business development person in your company.

Once you have issued shares to a person, you should immediately retain the services of a start-up lawyer to draught a shareholders agreement outlining the rights and obligations of the existing shareholders, as well as the new person who has received shares in your start-up.

In addition, the company secretary must prepare the paperwork, which includes a board resolution authorising the allotment and issuance of new shares to the sweat equity shareholder, as well as the issue price.

A sweat equity holder's rights as a shareholder

A sweat equity shareholder has the same rights and duties as other existing shareholders under company law. As a shareholder, the sweat equity holder is entitled to a waiver of the pre-emptive right (also known as the right of first refusal) when the company issues new shares in the future. This also includes any share transfers made by existing shareholders (usually by an existing co-founder).

In practise, a clause in the shareholder's agreement stating that the sweat equity shareholder agrees to waive his pre-emptive right in the future may be possible (generally, every shareholder should be entitled to this pre-emptive waiver right as a matter of practice). So, if you want to issue shares to anyone, make sure you put everything in writing so that everyone understands their respective rights and obligations. Other clauses such as co-sale obligations, tag-along and drag-along rights, and so on are also included.

In most equity crowdfunding campaigns, crowdfunding investors agree to waive their pre-emptive rights to subscribe for new shares if the issuer, or the company, raises new funds in a new equity crowdfunding campaign. This could be included in the shareholders' agreement to avoid the logistical nightmare of having to get each and every crowdfunding investor to sign off on their respective waivers every time a company wants to raise new funds.

Want to read our write up on the common clauses for a startup shareholders agreement? Click here.

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