What are Sweat Equity Shares?

As per Section 2(88) of the Companies Act, 2013, Sweat equity shares are the equity 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 and have 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 corporate, will reward them and offer certain incentives by way of Sweat Equity/ESOP to make them feel a sense of belonging towards their job.

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 condition has been foregone and any company can now issue them.

Whom can these shares be issued to?

Sweat Equity Shares can only be issued to:

1. Permanent employees of the company, who have been working in India or outside India, for at least one year, or
2. Directors of the company, who may be whole-time directors or part-time, or
3. 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 labor. Rule 8 of the Companies (Share and Debentures) Rules, 2014, have 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 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 giving 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.

1. The release of sweat equity shares is to be authorized by a special resolution passed by the company to this effect;
2. 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;
3. Such resolution is valid for making the allotment, only for a period of twelve months from the date of passing it.
4. In 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)
5. 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 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.
6. 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.
7. Lastly, the details of such share shall be included by the Board of Directors in the Directors’ Report of the company for that year.