How to Add a Partner to a LLC Using Sweat Equity

By Brette Sember

How to Add a Partner to a LLC Using Sweat Equity

By Brette Sember

After you've set up a limited liability company (LLC), you may be ready to add additional partners. Bringing a new partner on in exchange for sweat equity can benefit both your LLC and the new partner.

Definition of Sweat Equity

Sweat equity is basically work in exchange for ownership in the company. This is done rather than having the individual buy into the company or the company paying them for their work.

For example, if you need a marketing manager but don't have the funds to hire one, you could offer a partnership to a marketing professional in exchange for their work and experience. How much the individual works and how much ownership they earn as a result, as well as numerous other factors, can be negotiated by both parties.

Pros and Cons of Sweat-Equity Agreements

Bringing a new partner on through sweat equity comes with both benefits and drawbacks. Benefits include:

  • Reduced expenses. Adding a partner via sweat equity means your company gets labor and services it needs without paying up front for them, which can be important if you are short on cash flow.
  • Company development. Adding skilled partners who work to earn equity both improves your pool of talent and increases your company's abilities and reach.
  • Employee motivation. Earning equity in exchange for work provides incentive to those who work for your company and increases their performance.

Drawbacks of sweat-equity partnership include:

  • Valuation problems. It can be challenging to determine how to value the work that is provided in exchange for equity. Some companies use the value of what the salary for the position would be, while others look to the value the person's work adds to the company. Either method is fine, but the existing partners must come to an agreement about what works for them.
  • Increased conflict. Because valuation can be difficult to assign and track, employees providing work in exchange for equity may feel confused or cheated if they aren't given as much as they feel they deserve. This can also lead to conflict at upper management levels.

 

Creating a Sweat-Equity Agreement

Before you offer a sweat-equity agreement, you need to check your LLC's operating agreement. If the document prohibits this kind of partnership, you must first amend the operating agreement before you can take further action. If the operating agreement does allow sweat-equity partnership, check to see how many members must consent to adding the new partner. A majority vote is generally required.

The next step is to work out the details of the new partnership. Your agreement with the new partner should include the following:

  • How sweat equity will be calculated—for example, using a comparable salary another company might pay—and the amount of time required by the new partner
  • When and how the equity will vest and what kind of performance metrics will be used
  • How profit-sharing for the sweat-equity partner will work
  • What percentage of ownership the sweat-equity partner will have
  • The kinds of voting rights the sweat-equity partner will have
  • How the agreement can be terminated
  • Signatures of the sweat-equity member as well as an existing LLC member or manager authorized to sign for the LLC

Once you've added a partner via sweat equity, check your secretary of state's requirements for LLCs to see if you need to amend your Articles of Organization to list the new partner. You may also need to amend your filing to indicate if you've gone from a single-member LLC to a multiple-member LLC. If you are making a change about which members are managing the company, such as having existing members but not the sweat-equity member continue to manage, you may need to update this information with the state as well.

Using sweat equity to add new members to your LLC can be a smart way to grow your business. Careful planning and negotiation is key in making this addition to your LLC a success.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.