Is Sweat Equity Real?

Larry Grypp

Larry Grypp, President of the Goering Center
May 2016

What is “fair value?”  That was the question in play at a recent Goering Center program where family business owners and successors worked through various formulas and considerations when pricing a business that was to be acquired by the next generation.

However, it was the question posed at the end of that session that stirred the most controversy and deeply held sentiments:  “What else does anyone have on their mind about how to value a business?”

Like water pouring over a dam, the next generation family members spilled out some frustration about whether their time working at the company ought to be counted somehow in discounting the purchase price of the business. After all, as family members working in the business, how is it fair that they should expect to pay the same as an outside buyer?  They considered it a form of sweat equity.  Or why should family members not working in the business get the same shareholder deal as someone working in the business? 

Interestingly, the first generation family owners, who were in a different room, were considering the same question, wondering if they owed it to their sons or daughters to discount the purchase price as a way to recognize their contribution.

Oddly, attempts to be fair can actually create some real unfairness across the board.

For example, how do you fairly determine the “value” of a family member working in the business and how can that ever be factored into a purchase price that everyone - including non-employed family owners - can agree is “fair?” It is the management position itself - not the person - that needs to be priced according to its value to the business and its comparable value in the open market. Paying below market salary in return for some future discount on purchase price invites discord, just as would over-paying them simply because they are family. Likewise, if a successor is paid market compensation for a management role, it doesn’t create sweat equity toward the purchase price.

“Fairness” is a foundational value to a successful family. The only way to foster that is to stick with the business facts in compensation and purchase/sale prices.