5 min read
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Published on
February 16, 2024
Jameson Pitts
Sweat Equity Best Practices

Benefits of Sweat Equity Investing

The Status Quo

Before we get into the benefits of investing through services, let’s look at the current norms of early stage venture capital investing.

Venture’s best early stage investing tools are YC’s SAFE templates—a philosophy of investing that unlocked capital in early stage VC by abstracting away from the problem of how to value an invaluable early stage company and assign ownership to an investor.

However in many ways as the SAFE Note solved this problem, it created a host of others. There is a lot to appreciate in the SAFE style of financing a company–it’s generally agreed to be fair to both sides and the very name of the instrument creates confidence in it. But as an industry, how can we be proud of the oft-lauded figure that only 1 in 10 companies make it from SAFE to exit? While the SAFE Note made it easier to raise and invest, it did nothing to improve outcomes. In light of these issues, there is an opportunity to create a more efficient and successful system for fundraising by leveraging stakeholder interests in a way that aligns everyone's interests with those of the startups.

Primary Effects

Compared to the old way of raising SAFE-style convertible debt from angel investors, and then founders allocating that capital as best they can to various expenses, financing startups through a nuanced sweat equity model has a number of benefits for all parties.

Benefits for Founders

  • Ability to hire the best team to achieve their vision, instead of being limited by the cost of premium talent
  • Increased commitment by aligning the incentives of your team not just in cash fees, but in the long-term success of the venture
  • Ability to extend runway or reduce fundraising burdens
  • Higher likelihood of success through increased runway, aligned partners, and higher quality partners

Benefits for Service Providers

  • Ability to share in the upside they create for their venture clients or employers, and be rewarded for high quality work
  • Ability to price to startups in a way that does not discount their work, but still captures value

Benefits for Investors

  • Higher ROI through higher likelihood of founder success
  • De-risked investments through sweat contributions
  • Improved diligence by subject matter experts in the form of sweat co-investors

Secondary Effects

Changing venture’s focus from raising to cash to aligning the right team around a project will have a number of beneficial secondary effects:

  • Sweat equity is a way for early stage investors to add more value than a check
  • Structuring rounds around a mix of cash and sweat will improve transparency in use of proceeds and be a natural selection for sophistication
  • Improved efficiency in use of capital across the industry as outcome rates improve  

Lynx’s Role

Our role is to reduce the friction in sweat equity deals so that the industry may more readily access these benefits.

The SWEAT (Simple Work for Equity Agreement & Terms) Note expands on the innovation of the SAFE Note by creating a structure for service providers to share in the investment and upside at the point of fundraising. Although work for equity is not a new idea, there has been no framework to streamline and govern the process of these deals under generally accepted terms. This lack of structure has handicapped the wide stream adoption of this type of investment vehicle.

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