The term sweat equity refers to a person or company's contribution towards a business venture or other project. Sweat equity is generally not monetary and, in most cases, comes in the form of physical labor, mental effort, and time. Sweat equity is commonly in the corporate world - especially for startups.
These Shares may be issued to directors and employees to retain talent, while performance shares are awarded if certain specified measures are met, such as earnings per share (EPS) target, return on equity (ROE) or the total return of the company's stock in relation to an index. Typically, performance periods are over a multiyear time horizon
As per the Indian Companies Act
Section 2(88) of Companies Act, 2013 defines “Sweat equity shares” as such equity shares as are issued by a company to its Directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
Issue of Sweat Equity Shares for a Private Limited Company
The issuing of sweat equity shares for a private company used to be regulated by Section 79A and Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003 under Companies Act, 1956. Now the same is regulated by Section 54 and Chapter 4 under Companies Act, 2013.
Essentials of Sweat Equity
1. Eligibility to receive Sweat Equity
Sweat Equity Shares may be issued only to –
- A Permanent employee of the Company who has been working in India or outside India; or
- A Director of Company-Whole time director or not; or
- An employee or a director as defined in sub-clauses (a) or (b) above of a subsidiary (in India or outside India) or of a holding Company
2. Value Addition
Value addition means 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 for which the consideration is not paid or included in the normal remuneration payable under the contract of employment, in the case of an employee..
3. Authorization by shareholders
A company cannot issue sweat equity shares to its directors or employees, unless the issue is authorized by a special resolution passed by the company in a general meeting.
4. Time limit for issuing Sweat
The special resolution authorizing the issue of sweat equity shares shall be valid for making the allotment within a period of not more than twelve months from the date of passing of the special resolution.
If no issue was brought within twelve months a new Special resolution will be required.
5. No requirement for Time Gap
Companies Act, 2013 had a condition that in order to issue sweat equity shares not less than one year has, at the date of such issue, elapsed since the date on which the company had commenced business.
But in the promotion of Ease of Doing Business and facilitate Indian Start-ups this condition was omitted with effect from 7th May 2018 by the Companies (Amendment) Act, 2017.
In the issuance of sweat equity shares, shares as well as non-monetary consideration are required to be valued.
As per Companies Act, 2013,
The sweat equity shares to be issued shall be valued at a price determined by a registered valuer as the fair price giving justification for such valuation.
The valuation of intellectual property rights or of know how or value additions for which sweat equity shares are to be issued, shall be carried out by a registered valuer, who shall provide a proper report addressed to the Board of directors with justification for such valuation.
7. Notice of General Meeting
The critical elements of Valuation Report shall be sent along with the Notice. The particulars like class of shares, price, consideration, key terms of conditions, employees to whom sweat is proposed are required to be mentioned in the explanatory statement.
8. Limit on sweat equity
The company shall not issue sweat equity shares for more than fifteen percent of the existing paid up equity share capital in a year or shares of the issue value of rupees five crores, whichever is higher.
Further, the issuance of sweat equity shares in the Company shall not exceed twenty-five percent, of the paid-up equity capital of the Company at any time.
But this limit has been increased to fifty percent of the paid-up Capital for Start-up Companies only for 10 years from the date of its incorporation.
9. Mandatory lock-in period
The sweat equity shares shall be locked in (non-transferable) for a period of three years from the date of allotment.
10. Accounting Treatment of Non-Cash Consideration
If the non-cash consideration takes the form of a depreciable or amortizable asset, it shall be carried to the balance sheet of the company in accordance with the accounting standards; or
In other cases, it shall be expensed as provided in the accounting standards.
11. Accounting value of sweat equity
If sweat equity shares are not being issued for the acquisition of an asset, the accounting value of sweat equity shares shall be treated as a form of compensation to the employee or the director in the financial statements of the company.
If sweat equity shares are being issued for the acquisition of an asset, the value of the asset, as determined by the valuation report, shall be carried in the balance sheet as per the Accounting Standards and such amount of the accounting value of the sweat equity shares that is in excess of the value of the asset acquired, as per the valuation report, shall be treated as a form of compensation to the employee or the director in the financial statements of the company.
Note: The amount of sweat equity shares issued shall be treated as part of managerial remuneration for the purposes of sections 197 and 198 of the Act, if the following conditions are fulfilled, namely.-
- the sweat equity shares are issued to any director or manager; and
- they are issued for consideration other than cash, which does not take the form of an asset that can be carried to the balance sheet of the company in accordance with the applicable accounting standards.
12. Disclosure in Directors Report
In the Directors' Report for the year in which such shares are issued, the following details shall be disclosed:-
- the class of director or employee to whom such shares were issued;
- the class of shares issued as Sweat Equity Shares;
- the number of sweat equity shares issued to the directors, key managerial personnel or other employees showing separately the number of such shares issued to them, if any, for consideration other than cash and the individual names of allottees holding one percent or more of the issued share capital;
- the reasons or justification for the issue;
- the principal terms and conditions for issue of sweat equity shares, including pricing formula;
- the total number of shares arising as a result of issue of sweat equity shares;
- the percentage of the sweat equity shares of the total post issued and paid-up share capital;
- the consideration (including consideration other than cash) received or benefit accrued to the company from the issue of sweat equity shares;
- the diluted Earnings Per Share (EPS) pursuant to issuance of sweat equity shares.
13. Register of Sweat Equity Shares
A register in Form No. SH.3 shall be maintained containing details of sweat shares. It shall be maintained at the registered office of the company or such other place as the Board may decide. Entries in the register shall be authenticated by the Company Secretary of the company or by any other person authorized by the Board for the purpose.
Note: This article is purely for academic purpose and shall not be acted upon as a professional advice. The provisions of law referred to in this article may be amended at any time. Thus, I assume no responsibility for the consequences of use of such information without any professional advice. In no event, shall I be liable for any direct, indirect or incidental damage arising in connection with the use of information herein contained.
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