Sweat Equity Shares

Sweat equity shares are given to employees for their hard work and commitment to the organisation. While, many people confuse Employee stock options with sweat equity shares, the two are different and target different stakeholders. Let us understand the mechanics behind sweat equity shares.

What are sweat equity shares?

Talented and highly skilled employees are assets for any organisation. They are essential for any company’s success. Therefore, companies resort to transferring ownership of their shares to show their appreciation for work done or contributions made by such employees. One such way of transferring these shares is by issuing sweat equity.

Sweat equity as, equity shares provided by a corporation to its directors or workers at a discount or for any consideration besides cash in exchange for sharing their know-how (technical, practical knowledge or skill) or making available rights in the form of intellectual property rights or value additions, under whatever name they are known. A company can only issue sweat shares of a class already issued. The rights, limitations, and restrictions applicable to such shares are the same as those of equity shares.

People Also Read This: What To Do When Wrongfully Terminated From Employment?

The companies are regulated by Section 54 of the Act and Rule 8 of Companies (Share Capital and Debentures) Rules (“the Rules”), 2014 while issuing such equities. Furthermore, a listed company must also comply with the relevant SEBI regulations and guidelines.

Whom are sweat equity shares issued to?

As noted above sweat equity shares are issued to employees or directors at a discount (to market price) or for providing know-how or making available rights like intellectual property rights or value additions.

Director- includes a whole-time director and other directors of the company and its subsidiary or holding company, in India or outside India. Whereas, Rule 8 of the Rules, defines 'employee' as a permanent employee who has been serving in India or outside of India for at least one year. Furthermore, it also includes an employee of a subsidiary in India or outside India or a holding company of the corporation. Thus, sweat shares cannot be issued to any temporary employee or an employee of another entity providing service to the relevant company to discharge his/her duty in his /her original company.

As per Section 54, such shares can only be issued after receiving authorisation by a special resolution. Specifying “the number of shares, the current market price, consideration, if any, and the class or classes of directors or classes employees...". Furthermore, such shares are locked in for 3 years and cannot be transferred for such a period.

People Also Read This: Decoding a Fixed Term Employment Contract

Difference between ESOP and sweat equity shares. 

Another method of providing the employee with an option to gain ownership of its share equities are ESOP. However, both sweat equity shares and ESOP are quite different. An ESOP is not an issuance of share per se but an option to buy shares at a pre-determined price. Sweat equity amounts to actual issuance of shares. A sweat equity may be given to promoters but ESOPs are typically not granted to promoters of an entity. Under ESOP, no ownership passes, but only an option is granted. Typically a threshold is imposed, beyond which companies cannot issue sweat equity shares, however, no such limits bar the granting of ESOPs. Example of sweat equity shares is grant of 5% shares in the company to an employee in return for his performance. An example of ESOP is the grant of an option to an employee to buy 100 shares of the Company at a discounted rate.

How is the valuation of sweat equity shares done?

The sweat equity shares to be issued must be valued at a fair price assessed by a registered valuer. A reason for such pricing must also be provided. A registered valuer shall carry out the valuation of intellectual property rights, know-how, or value additions for which sweat equity shares are to be granted, and shall give a proper report addressed to the Board of Directors with rationale for such valuation.

The listed company may determine the price of their issue by taking into account the average of the weekly high and low closing prices of the related equity shares over the past 6 months before the relevant date, or the average of the weekly high and low closing prices of the related equity shares over the last two weeks preceding the relevant date.

People Also Read This: What Is A Non-Compete Clause In An Employment Contract?

In the case of listed companies, the SEBI regulation provides that the valuer of the issue must be a merchant banker to valuation know-how or IPR etc. The merchant banker may confer with as many specialists and valuers as he deems necessary, considering the nature of the industry and the nature of the property or other value addition. The merchant banker must take a certificate from an independent chartered account for such valuation.

An unlisted company may also issue sweat equity shares however, there are certain limits placed on the quantum of shares to be issued.

Sweat equity shares are an integral part of a company’s scaling up process. It is pertinent that companies comply with the applicable laws while issuing sweat equity shares.