Sweat equity shares reward directors or employees for their time, expertise, and efforts in improving the company’s value. These shares encourage leading contributors, align their interests with business development, and aid startups in drawing and retaining talent without instant cash outflow.
In a technology startup, a software engineer may receive sweat equity shares as an alternative to a salary increase for developing a key piece of technology. This rewards the employee based on the company’s success because their shares may appreciate in value when the company grows.
Sweat Equity Shares are a common practice with companies who would like to encourage their employees and keep key talent. Sweat equity shares denote shares issued by a company to its staff at a reduced price or for consideration other than cash. The Companies Act, 2013, controls the issuance of sweat equity shares by companies in India. This article examines the issue of sweat equity shares under the Companies Act, 2013.
Overview of Sweat Equity Share
A company grants sweat equity shares to its directors or employees at a rebate or for a consideration other than cash. It offers the company employees or directors equity and ownership upside in the company. The aim is to compensate individuals for their contributions and efforts with ownership stakes in the company. The discount on the issue of sweat equity shares cannot outstrip 15% of the current market price of the shares or the price according to SEBI guidelines, whichever is higher.
The term “sweat equity” mirrors the idea that the directors’ or employees’ sweat, or labor, imparts value to the company, resembling monetary investment. These shares are usually issued to encourage and keep key directors and employees, accepting their intangible contribution, such as furnishing intellectual property rights, know-how, value accretions, or other assets. The Sweat Equity share concept is used by top companies such as Facebook, Twitter, Amazon, Uber, and Google.
Features of Sweat Equity Shares
Sweat equity shares have the specified features:
- Issued to directors, employees, or consultants who have contributed to the development and growth of the company.
- Cannot be issued for over 15% of the available paid-up share capital of the company.
- Issued at a rebated price or for no consideration.
- Must be owned for a minimum duration of three years from the date of issue.
- Can only be issued following the incorporation of the company for a minimum of one year.
- Cannot be sold or transferred for three years from the date of issue.
- Cannot be issued for greater than Rs 5 crores in a financial year.
- In addition, the issue of sweat equity shares cannot be more than 25% of the company’s paid-up equity share capital at any given point of time. Interestingly, this exception is provided to startups, enabling them to issue sweat equity shares up to 50% of the paid-up capital within 5 years from the date of incorporation or company registration.
Conditions for Issuing Sweat Equity Shares
The issue of sweat equity shares is subject to specific conditions enumerated by the Companies Act, 2013, and the Securities and Exchange Board of India (SEBI) regulations. A few of the conditions for issuing sweat equity shares are:
- Limit on issue: A company’s total number of sweat equity shares published at any time cannot exceed 15% of its paid-up share capital.
- Disclosure requirements: The Company must disclose sufficient information about the issue of sweat equity shares in its yearly report and on its website.
- Approval of the shareholders: The issue of sweat equity shares must be acknowledged by the company shareholders through a unique resolution passed at a general meeting.
- Eligibility criteria: The employees qualified for the issue of sweat equity shares must have substantially contributed to the advancement and success of the company.
- Valuation: The valuation of sweat equity shares must be performed by a registered valuer according to the guidelines outlined by SEBI.
- Lock-in period: A company’s sweat equity shares must be locked in for at least three years from the date of assignment.
Section 54 of the Companies Act, 2013 lays down the conditions for issuing sweat equity shares, covering the following significant points:
- Sweat equity shares must be assigned within 12 months from the date of approval of the special resolution.
- Listed companies must follow SEBI Regulation, 2002, for the issuance of sweat equity shares, whereas non-listed companies must observe the rules specified in Section 54(1)(d).
- The company must obtain approval through a specific resolution, approved by a minimum of 3/4th of its members.
- The company must furnish an extensive justification for the valuation of sweat equity shares.
- The special resolution must list key details, including the number of shares, current market price, consideration price, and beneficiaries such as directors and employees.
Conforming to these conditions and getting required approvals from eligible employees and the board enables the company to continue with a private offer of sweat equity shares.
Pricing of the Sweat Equity Shares
To ascertain the equitable cost and justification for the valuation, the value of sweat equity will be estimated at a rate fixed by an accredited valuer.
The registered valuer will file a detailed report with the company’s directors, together with the justification of the value.
The registered valuer must present the summary and crucial details of the valuation report, which must be dispatched to shareholders in combination with the notice of the general meeting.
Penalties for Breaches Connected to the Share Certificate
Each officer who defaults from that company will be penalized with a minimum of 10000 rupees, which can be raised up to 1 lakh rupees.
Benefits of Sweat Equity Shares
The primary benefits of sweat equity for companies comprise:
- Offer Upside and Retain employees: Sweat equity generates a bounteous reward for the employees and adds to their esteem. It inculcates a sense of possession and responsibility in them, helping to keep talent for the company.
- Saves cash: Providing sweat equity as a reward saves cash for the granting company. It is helpful for cash-deficient businesses, as presenting equity as compensation lowers the cash expenses.
- Aligns the concerns of the employees with those of the company: Sweat equity shares align the interests of the directors, employees, or consultants with those of the company. This motivates them to work for the development and growth of the company.
- Raises shareholder value: Sweat equity shares raise the worth of the company for its shareholders. This is since the directors, employees, or consultants who get sweat equity shares have a dominant interest in the success of the company.
Bottom Line
Sweat equity shares represent a precious and distinctive form of compensation for the business world, most notably for start-ups. They recognize the non-monetary value of founders and employees and cause them to share interests in the success of the firm. With the potential for capital appreciation and vesting schedules, sweat equity shares are a strong means of motivating and retaining key personnel in order to complement the overall success and growth of the company.
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