Concept of Sweat Equity Shares and its uses
In today's highly competitive and innovation-driven business age, businesses are constantly seeking means of retaining the brains and rewarding individuals who significantly contribute to their expansion. Among the most efficient tools employed for this purpose is Sweat Equity Shares. They are not normal shares but hold great importance for both budding and established businesses.
In this article, we are going to describe Sweat Equity Shares, legal provisions provided under the Companies Act, 2013, and how they are used in real life for companies.
What Are Sweat Equity Shares?
Sweat Equity Shares are the equity shares made by a company to its directors or employees at a discount or for non-cash consideration. The shares are made in appreciation of the effort put in by these individuals in terms of know-how, intellectual property, or value addition to the company.
That is, sweat equity shares are a compensation vehicle for individuals who have "sweated" for the company — not in cash, but in innovation, skill, or labour.
Legal Definition under the Companies Act, 2013
Section 2(88) of the Companies Act, 2013 defines sweat equity shares as follows:
"Sweat equity shares issued by a company to directors or employees at a discount or for consideration other than cash, for sharing their know-how or making available rights in the nature of intellectual capital or value additions."
Apart from this, issue of such shares is regulated under Section 54 of the Act, read with Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014.
Major Conditions for Issue of Sweat Equity Shares
For issuing sweat equity shares, the following conditions are required to be satisfied by companies:
- Authorization of Articles of Association (AoA): AoA of the company needs to authorize the issue of sweat equity shares. Otherwise, it should be altered as per requirements.
- Special Resolution: A special resolution of the shareholders in a general meeting is to be adopted. The resolution will state the number of shares, market value at present, consideration, and class of directors/employees who are to receive the same.
- Time Condition: Sweat equity shares may be issued by an unlisted or private company at any time. However, with a listed company, it must comply with SEBI guidelines.
- Lock-in Period: The shares so issued in sweat equity need to be locked in for 3 years from the allotment date.
- Valuation: The value of intellectual property or know-how has to be valued by a registered valuer so that valuation is transparent and fair.
- Cap on Issue: In case of an unlisted company, sweat equity shares granted in a year shall not be more than 15% of the then paid-up equity share capital or 15% of the shares of a face value of ₹5 crore, whichever is greater. The aggregate shall not be more than 25% of the paid-up capital at any given time. The limit for startups is raised to 50% for 10 years from the incorporation date.
Who are Eligible to Receive Sweat Equity Shares?
Sweat equity shares can be given to:
- Permanent staff of the company (either Indian or foreign),
- Directors (whole-time or part-time),
- Directors or staff of a holding or subsidiary company.
Applications and Advantages of Sweat Equity Shares
- Talent Acquisition and Talent Retention
- Incentivizing Innovation and Retention
- Preservation of Cash Flow
- Increase Incentivization and Employee Ownership
- Value Creation Beyond Capital
Startups and SMEs are unable to provide competitive compensation packages in most situations. Sweat equity shares facilitate easier attraction of talented professionals with a keen interest in the growth and prosperity of the firm in the future.
These shares are a method of rewarding good performers for intellectual properties, innovative inputs, and long-term association with the business organization.
Issuing stock instead of giving them high salaries or consultancy fees allows companies to retain their capital structure without robbing the workers of fair returns.
When workers own the company, they are more attuned to the firm's financial objectives and are more inclined toward its success. It gives them the sense that they are part of the firm and are accountable for the firm.
The classic equity returns the investment in the form of capital. Sweat equity appreciates the investment in the form of time, effort, and expertise, particularly in knowledge-based industries such as IT, biotech, and fintech.
Compliance and Reporting Requirements
Issuance of sweat equity shares, the companies have to:
- File necessary Return with the Registrar of Companies (RoC) in relation to change in capital.
- Have a Register of Sweat Equity Shares in Form SH-3.
- Disclose sweat equity shares in the Board's Report.
Default will be penalized and attract regulatory problems, so record it correctly and follow the norms to avoid this.
Sweat equity shares are a very powerful management tool at the command of organizations to bring together the interests of employees and business objectives, recognize superior effort, and retain top performers. If employed prudently and in line with the Companies Act, 2013, they can significantly contribute to the long-term success of an enterprise.
Whether you are an entrepreneur seeking to inspire your workforce or an entrepreneur asking questions about different forms of compensation, you need to be informed about sweat equity shares in the contemporary business environment.