A business owner invests his time, talent and expertise in starting a business. It's often the most important asset of a new business. Whether this hard work, called sweat equity, can be included on the new company's balance sheet depends on a number of factors that must be carefully considered before placing a valuation on sweat equity and deciding how to apply it.
If the owner is a sole proprietor, the single owner of a corporation or a single-member limited liability company, sweat equity cannot be included as an asset on the company's balance sheet. Generally, only tangible property can be included as assets of the company. The contribution of cash, equipment, real estate, inventory, tools or other items with intrinsic value are balance sheet assets. The uncompensated time of a single owner is not.
A partner can receive a share of ownership in a partnership in exchange for sweat equity. For example, if two individuals decide to go into partnership and one partner contributes $50,000 in cash and the other agrees to do $50,000 worth of personal service as his contribution, his sweat equity can be recognized as partnership equity on the balance sheet, making him an equal partner. However, the sweat equity partner's $50,000 contribution must also be recognized as taxable income on his personal income tax return.
Multi-Member Limited Liability Company
Sweat equity can also be recognized as a member's contribution in a multi-member limited liability company. This contribution will be recognized as a part of members' equity on the balance sheet. The sweat-equity member must recognize the value of his non-cash contribution as income on his personal income tax return. For example, assume three members form a limited liability company and two of the members each contribute $20,000. The members agree that the value of the sweat-equity member's personal services are worth $20,000. Each member has a 1/3 equity in the company, but only the sweat-equity member must report the $20,000 as taxable income.
If there is more than one stockholder in a corporation, they can agree to accept personal services, sweat equity, in exchange for stock. The sweat equity stockholder must recognize the value of his shares as income equal to the value of the equity the stock represents. All of the stockholders cannot perform personal services in exchange for stock. At least one stockholder must purchase stock to establish equity in the corporation. The stock, whether purchased or given in exchange for sweat equity, appears in the equity section of the balance sheet.