Sweat Equity Shares

Introduction:

When a company needs to generate more capital or wants to take a loan but not from a bank or without any liability, it decides to divide its ownership in the general public by giving people a share or apart in the company’s ownership. Thus, people buy these small -small shares of ownership of the company by which they give the company a credit as they are investing in the company. these share buyers are then called “Shareholders” and are official creditors of the company. the company uses this money to generate more capital for the growth of the company. whilst that, the company also offers a return or interest or dividend to these shareholders at the end of the financial year.

Shares can be classified into two major types, the “Equity Shares” and “Preference shares.”   Equity shares are ordinary shares, just referred to as “shares” in layman terms. The fundamental difference in these shares leads to further distinctions. The money/amount generated from equity shares is traded and invested in the stock market while preference shares are not. Thus, the one who buys an equity share has to ensure that the company profits because only then will its investment will yield a return. Therefore, an equity shareholder gets the “right to vote” in the company and also has the right of managing and controlling the company. Further, an equity shareholder will get a dividend at the end of the financial year from the amount which is left after giving the dividend to a Preference Shareholder. An equity shareholder can sell its share in the stock market anytime he wants, however a Preference shareholder cannot. A preference shareholder neither gets voting rights nor the right to control and get involved in the management. This is because the amount generated from Preference shares by the company are not traded in the stock market hence a preference shareholder gets a dividend irrespective of the company’s profit.

Concept of Sweat Equity Shares

 Every company reserves or has the option to reserve, a certain percentage of its shares for its employees. These shares are issued to the employees under ESOP or Sweat Equity Shares scheme. As the name suggests these shares are equity shares, which are issued in reward or in exchange, or even in consideration for providing exceptional growth to the company. This exceptional contribution is called Value addition. Value addition means actual or anticipated economic benefits that are created by the employees or directors and are either derived or are yet to be derived by the company.[1] Thus the reason for issuing these shares is that the company wants to reward the employee for bringing in or creating new, unique technology, intellectual property any scientific know-how or any other similar contribution which yields more profits to the company. For example, in an FMCG company if an employee innovates a new consumer product that helps the company to increase its profits, then such employee is eligible for getting Sweat Equity Shares from the FMCG company.

As per the Companies Act, the Sweat Equity shares are issued to those employees or directors of the company at a discounted price.[2] This means if the market value of one equity share of that company is 10 rupees, then the value of one Sweat Equity share could be 7rupees. Thus, these shares are a way by which a company rewards its employees and assures loyalty and commitment.

Following are the conditions for issuing a Sweat Equity share-[3]

1. A company is eligible to issue Sweta Equity shares only after it has passed the time of one or more years, since the commencement of the business [4]
2. Issuing equity shares at a discounted price to employees or directors; or
3. Issuing equity shares to employees or directors who are a special asset for the company as they bring new technology, invent new intellectual property for the company, bring value addition which results in the growth of the company and/or profits.
4. These Sweat Equity shares have issues only after passing a special resolution in the board of directors. This resolution enlists who is being issued Sweat Equity shares for what reason along with the number of shares and at what price. Further, it also mentions what is the current value of the equity share and how will the Diluted Earnings per share will be calculated since there is an increase in the total number of equity shares now.
5. This resolution has to be passed by a 75% majority.
6. If the company’s “share” or stock is a listed stock in a recognized stock market( SENSEX & NIFTY) then the rules of the SEBI and Companies Act have to be complied with.
7. If the company’s “share” or “stock”, is not a listed stock in a recognized stock market then they have to comply with rules of the Companies Act and Rule 8 of Companies (Share Capital and Debentures) Rules, 2014.
8. These Sweat Equity shares can also be issued to the Promotors of the company provided they are an employee or director of the company. 

Who Can Issue Sweat Equity Shares?

Following companies can issue sweat equity shares:

• One person company
• Pubic company
• Private company
• Section 8 company
• Listed or unlisted company

Issuing Sweat Equity Shares [5]

Firstly, the price of the Sweat Equity share is evaluated by  RegisteredValuer who are appointed by the IBBI.[6] Next, a board meeting is conducted with the agenda of issuing Sweat Equity shares. In this meeting, the resolution is to be passed in compliance with the rules applicable and mentioned above. To issue these shares a company must have consonant provisions in their Articles of Association( AOA), as it contains the framework of the share capital of the company. Further, in the board meeting notice is drafted and issues for an Extraordinary General Meeting. It is in this meeting where a “special resolution: is passed in pursuance of issuing the shares to the said employees or directors. The allotment of sweat equity shares has to be made within a period of 12 months for the date of passing of Special Resolution.

After this, a company has to file the form of MGT-14 to the Registrar of Companies within 30 days from the date of passing of the special resolution in the Extra-Ordinary General Meeting. Added to that The Company also has to file form PAS-3 to the Registrar within a period of 30 days from the date of allotment of sweat equity shares. Pursuantly The Company has to also, issue a share Certificate under form SH-1. within a period of 2 months from the date of allotment of shares along with paying the stamp duty in accordance with the provisions of the Indian Stamp Act, 1899.

Portion of Shares Given Under Sweat Equity Share Scheme

The upper limit of issuing these shares are-

1. For a period of 1 year, not more than 15% of the existing paid-up capital
2. In general, not more than 25% of its existing paid-up capital or 5crores rupees; either of which is higher in value.
3. In the case of start-ups, up to 50% of the shares can be given under this scheme, within 5 years from the date of incorporation or registration of the start-up

Difference Between ESOP and Sweat Equity Shares

The distinction between these two schemes is the time at which they are offered. A shareholding offered under ESOP is given at the time of employment or prior to the employee’s exceptional contribution because the company believes that the employee is a fruitful asset to the company, whereas a Sweat Equity share is given to the employee after he/she has contributed to the company. Hence to keep the employee motivated to contribute to the company, he/she is issued with an equity shareholding under ESOP.

This shareholding is provided to the employee at a pre-determined price, which is less than the market rate. Hence, an employee at the time of joining the company is given a shareholding in the company at a pre-determined price which is lower than the market rate, which he/she has to pay. In comparison, a Sweat Equity shareholder may not have to pay this lowered price of the share as it has been given to him/her in exchange or in reward for his/her exceptional contribution. Further, the pricing of Sweat Equity share is determined by the registered valuer however there are no guidelines for the evaluation of shares under ESOP

 Secondly, in ESOP, there is a locking period of 1 year *, during which the shareholder cannot sell the share nor can he leave the job. in case he/she leaves the job the amount he/she paid for payment of shareholding will fall forfeit and he/she will not get it back. On the other hand, the locking period for Sweat Equity shares is 3 years.

Thirdly, under ESOP the employee has time to make the competition for payment to the number of shares so purchased at the lowered price from the market. The employee thus becomes a shareholder only when he/she make the complete payment. However, in Sweat Equity as soon as the shares are issued the employee becomes the shareholder. Moreover, the consideration under ESOP is made in cash, however, Sweat Equity shares are issued in exchange for value addition. Thus, the consideration or payment for them is noncash or partly in cash.

Fourthly, the greater benefit under ESOP is that the shares so purchased would yield more profits to the employee in future as the stocks of the company will grow and this return is assured to the employee as he/she has already purchased the shareholding at a predetermined price. For instance, if an employee buys 10 shares at the price of rupees 100 each so the total amount, he has to pay is 1000 rupees. When the company profits or open its IPO for the public the price of each share could be 500 rupees hence on each share, the employee earns a profit of 400 rupees i.e., 4000 rupees and this amount is apart from the salary he/she will get. In comparison to Sweat Equity shares, no employee is guaranteed of getting Sweat Equity shares while he/she is working for the company nor does he/she have any prior shareholding on a reduced price. The share holing under Sweat Equity is received at a discounted price from the current market price. Thus, in this case, the Sweat Equity shareholder would get the share at the price which is reduced from rupees 500/ per share, as that is the current market rate of the company’s share.

Added to that, under ESOP the value at which the shares can be sold is determined by the company. on the other hand, under Sweat Equity shares the shareholder can decide at what price he/she wants to sell the shares.

Taxation and Accounting of Sweat Equity Shares

These shares are taxed to the employees if –

1. They are issued to and by an employer or a former employer
2. Section 2(h) of the Securities Contract (Regulation) Act, 1956 defines the shares so held by the employee.
3. On or after April 1, 2009, these securities were allotted or transferred. Fringe Benefits Tax applies to any shares issued or transferred prior to April 1, 2009.
4. The shares were allotted free of cost or at a concessional rate

With respect to the employer-

1. If these shares are issued without any cash payment, then they will be put under depreciable assets, and thus would be entered in the balance sheet in accordance with respective accounting standards.
2. If the shares were issued for a cash consideration, then they would be put under expenses and thus would be dealt as so, in the balance sheet.
3. If the shares are issued under Sections 197 and 198 of the Companies act then it will be treated as “managerial renumeration”
4. If the shares are issued to an employee or director to acquire an asset ( any creation, innovation any intellectual property) then, it will be added, as it is to the balance sheet and will be treated as per the said accounting standards. In case the valuation of the shares issued in the persuasion of acquiring the asset are more than the value of that asset, then these extra shares would be termed as compensation given to the employee.
5. Moreover, in the case of issuing of these shares without acquiring any asset, but as part of the reward for value addition then also it would be termed as compensation. 

Conclusion

Conclusively Sweat Equity Shares as the name suggests are to reward the Sweat burnt out by the employee in contributing to the company. Any exceptional performer who adds value or growth to the company, or brings new technology or creates intellectual property is eligible to get these shares. The idea is to foster commitment and loyalty to the company because no company wants to lose its exceptional human resource. Further, the Sweat Equity shareholder, at the time of the company being bought by someone, are eligible to receive a huge amount of dividend from that purchase. Hence giving these Sweat Equity shares puts employees in an advantageous situation. Further, since the employee becomes a small owner of the company, he/she is also responsible for the company to grow as it will only then yield him/her extra earnings on the shares so received or bought. Thus, this further motivates an employee to perform better. Moreover, since the employee is seemed as an exceptional asset, by giving him/her Sweat Equity shares the company the employee automatically also gets voting rights and some control over the company’s management. Hence a company may also try to use the expertise and skills of such an employee in the management of the company, thus making most use/gain from that human resource. Therefore, the concept of Sweat Equity share benefits the employee as well as the company.

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References:

[1]Rule 8(1) of the Companies (Share Capital and Debentures) Rules, 2014,

[2] Section 2(88) Companies act 2013

[3] Ibid and Section 54 of the Companies act

[4] Section 54(1)( c), Companies act

[5]Rule 8 of Companies (Share Capital and Debenture) Rules, 2014

[6] See clause 247 of Companies act, and companies (Registered Valuers and Valuation) Rules, 2017