Sweat Equity

What does it mean

Sweat Equity is the term for the Equity that is built into a project (typically a construction project) by the construction company who does their own work.

Why does it matter

Sweat Equity matters to a banker because if you ever hear the term come up it is because the borrower either does not have or does not want to put cash into a project.  In lieu of putting in their own cash (which lowers a banks risk) the borrower who is constructing a project for themselves will forgo the profit margin they typically bill to a third party customer in exchange for this unreceived revenue being recognized as a cash equity contribution equivalent.

This does have a few risks for a bank:

1. The borrower has less "skin in the game" on a particular project which may influence their decisions and willingness to push through tough situations because they have less at risk
2. The sweat equity only turns into equity once the project is fully finished; so there is a risk if the project doesn’t get completed
3. There is a risk on whether or not the borrower can cover its normal overhead expenses during the time when they are focusing their resources on this project while only receiving enough to reimburse their direct costs.  If they cannot, then it may impact their ability to complete the project and realize the sweat equity.  

Other Relevant Terms

• Capital
• Equity
• Return to Terminology Library