Sweat equity checklist for startups in Malaysia

As a startup lawyer, I get asked a lot on how to structure sweat equity where the company issues new shares to someone (usually with certain skills or expertise) in exchange for his or her contribution to the company. 

Whether you’re planning to give out sweat equity shares to an experienced adviser or mentor or a new cofounder candidate for your startup, it is crucial to structure it correctly and formalise it in writing. 

Therefore, I have made a checklist covering the usual common structuring sweat equity issues that we have come across in our past experience. We usually go through these questions so that we can understand better before giving a client further advice on the next steps. I hope that the checklist will make your decision making process a little bit easier. Click on the link below to download the free checklist.

What is “sweat equity”?

The phrase “sweat equity” is not mentioned anywhere in the Companies Act 2016, the law governing companies in Malaysia, but rather a loose phrase we use to refer to shares that are issued by a company to a recipient (can be an individual or a company). Unlike normal shares that gets issued in exchange for new cash injection, sweat equity shares are issued in exchange for “non- cash consideration”, where the recipient contributes things like land, or promised services like social media management services, or even intangible things like IP assets like assignment of software at an agreed value. 

Considering that it is more common for shares to be issued in exchange for cash investment, don’t be surprised that many in the industry such as company secretaries may be unfamiliar with sweat equity. In my past experience, we have had to step in to guide on the necessary paperwork needed to ensure compliance to the regulations.

How does the “ sweat equity” scheme work?

Generally, the company may decide to give sweat equity upfront, or instead, the shares are issued progressively (usually using vesting schedules) or based on certain milestones or performance basis (this is my usual preference). 

Who can be the sweat equity recipient?

Sweat equity recipients can be made to an individual (like an existing employee of the company or an external party like a consultant or adviser that may be engaged on a freelance / or independent contractor basis) or even a company (like a digital marketing agency or a software development house).  

Defining the sweat equity value and percentage 

I also realise that first time founders like to use shares percentages when offering sweat equity offers to a recipient. In practice, the shares percentages need to be based on the value of the sweat equity i.e. the total contribution by the recipient against the company’s valuation. For this, we like to advise the founders to do research on the seniority of the recipient in the relevant industry. This will help a lot in coming up with a value of the contribution and determine a fair sweat equity percentage.

Considering that the sweat equity is based on certain skill set or contribution by the recipient, founders should be as precise as possible on the list of things that they may want to expect the recipient to perform for the company. For instance, it is much better to write: “Attending at least 1 hour weekly virtual/ physical meeting with the Company’s representatives” rather than “Attending to meetings with the Company’s representatives”.  

Think of the recipient of sweat equity the same way you will apply when you’re coming up with a job ad post which usually has all the detailed responsibilities and services for a new employee.

Sweat equity can be a great way to attract talent, but it’s important to weigh the pros and cons and customise the final package based on the identified candidate and your company’s situation. You may likely need to combine other equity compensation options like salary and shares options, alongside sweat equity.

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