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What are Sweat Equity Shares?

Created on 22 Aug 2018

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Updated on 10 Nov 2023

What are Sweat Equity Shares? - Insider by Finology

Sweat equity shares are a powerful tool that can be used to align the interests of employees and the company. It is the shares that a company gives to its directors or employees for their contributions in the form of knowledge, intellectual property, or other value additions instead of cash.

As per Section 2(88) of the Companies Act, 2013, “sweat equity shares are the shares issued by a company to its director or employees at either discount or any consideration, except for cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions by whatever name called.”

Supposedly, if one were very resourceful, possessed great technical expertise, achieved their objectives effectively, and rendered many economic benefits to the company. So, the company, in order to retain their presence and inflow of fresh flair in the corporation, will reward them and offer certain incentives by way of Sweat Equity/ESOP to make them feel a sense of belonging towards their job.

Hence, sweat equity shares can be a valuable asset for employees, as they can increase their net worth and give them a stake in the company's success.

Now that we understand the meaning of sweat equity shares let's see…

Who can Issue Sweat Equity Shares?

Sweat equity shares can be issued by any company registered under the Companies Act 2013. Earlier, the sweat equity shares could only be issued by those companies which had commenced business at least one year prior to the disbursement of such shares. However, with the amendment to the Companies Act 2013 in the year 2017, such conditions have been foregone, and any company can now issue them.

To whom can these shares be issued?

Just as the name suggests, sweat equity shares are provided to the employees who have made profound contributions to the company. Sweat Equity Shares can only be issued to:

  • Permanent employees of the company who have been working in India or outside for at least one year or
  • Directors of the company, who may be whole-time directors or part-time, or
  • Any such employee or director who is working under a subsidiary or a holding of the company, within or outside India.

What are the essential attributes of sweat equity shares?

Sweat equity means the varied inputs by way of earnest efforts and raw talent. Therefore, the rationale behind the circulation of such shares is different than that of issuing equity shares because these shares are issued to reward such diligent and conscientious labour. Rule 8 of the Companies (Share and Debentures) Rules, 2014, has detailed numerous attributes which have to be followed compulsorily.

Value Addition

Rule 8 of the Companies (Shares and Debentures) Rules, 2014 has defined “Value addition”, as actual or anticipated economic benefits derived or to be derived by the company from an expert or a professional for providing know-how or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued.

Disbursement of sweat equity

In a year, the sweat equity shares cannot account for more than 15% of the existing paid-up equity share capital or shares having an issue value of rupees 5 crores, whichever is higher. Even so, the issuance of such shares cannot exceed 25% of the paid-up capital of the company at any time. But a start-up company, up to 5 years from the date of its incorporation, can issue such shares not exceeding 50% of its paid-up equity share capital.

Locked-in period

The sweat equity shares issued to directors or employees shall be locked in/non-transferable for a period of three years from the date of allotment. It should be mentioned in a prominent manner on the share certificate.

Valuation of sweat equity

These shares are valued at a price determined by a registered valuer, as the fair price gives justification for such valuation. For this, the worth of intellectual property rights, technical know-how and value additions are estimated by the registered valuer, who provides a proper Report of the same to the Board of Directors, along with its justifications.

Rights of such shareholders

The rights, limitations, restrictions, and provisions applicable to equity shares shall be applicable to sweat equity shares and holders of such shares rank ‘pari passu’ with other equity shareholders.

What is the procedure for the issuance of such shares?

Section 54 of the Companies Act 2013 deals with the issuance of sweat equity shares. It has replaced Section 79A of the Companies Act, 1956 and has stipulated numerous prerequisites for the circulation of these shares.

  • The release of sweat equity shares is to be authorized by a special resolution passed by the company to this effect;
  • The resolution shall specify the number of shares, the current market price, the consideration for which the shares will be purchased and the class or classes of directors or employees to whom such equity shares are to be issued;
  • Such a resolution is valid for making the allotment only for a period of twelve months from the date of passing it.
  • In the case of listed companies, the sweat equity shares are to be issued in accordance with the rules and regulations as prescribed by the Securities and Exchange Board of India (SEBI).
  • The company shall send a notice of the general meeting, pursuant to Section 102, to which an explanatory statement must be annexed stating particulars of the sweat equity shares. Details pertinent to mention here are the date of the Board meeting when such a decision was taken place, its reason or justification, the total number of sweat equity shares and the class of shares under which they are intended to be issued, its proposed price, etc.
  • The company shall also send a gist, along with the critical elements of the valuation report, to the shareholders with the notice to the general meeting.
  • Lastly, the details of such shares shall be included by the Board of Directors in the Directors’ Report of the company for that year.

Sweat Equity Shares Vs ESOPs

Another way to reward employees for their tremendous hard work and talent, many companies also provide ESOPs (Employee Stock Ownership Plans). ESOPs are more or less the option that allows employees to purchase the company's shares at a specified price on a future date.
However, there are some key differences between the two:

Sweat Equity Shares

ESOPs

Non-cash

Cash

At the time of the employee's contribution

At any time

Determined by the company's board of directors

Typically set at a discount to the fair market value of the company's shares

Taxable as income from salaries in the year of allotment

Taxable as perquisites on salary in the year of exercise


If you want to learn about What are the types of Equity Shares? then click on the link.

The Bottom Line

When employees have a stake in the company's success, they are more likely to be motivated and productive. It is also a method for employers to retain talent and hence maintain swift operations with the expertise of deserving employees.

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Isha Gulati

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Isha is an LL.M. student at the University of California, Berkeley, and is currently pursuing a dual specialization in law and technology, and business law. She is a media enthusiast, an advocate for free speech and a ferocious dog lover.

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