24 Feb Sweat Equity Shares in Accordance with Companies Act 2013
In the realm of financial markets, investors traditionally received securities in exchange for their investments in a company. These securities could manifest as equity shares, preferential shares, or debentures, effectively representing ownership stakes in the company.
In its essence, ‘Sweat Equity’ denotes a contribution to a project or business in the form of effort and labor, valued equivalently to cash equity. It is often rewarded in start-ups by issuing securities or other types of shares in the new venture.
Companies, particularly in their nascent stages, are keen on retaining key personnel who bring specialized knowledge and technical expertise that enhances the firm’s valuation. To incentivize and retain such talent, organizations resort to rewarding them with sweat equity or Employee Stock Ownership Plans (ESOPs).
Sweat Equity Shares:
Sweat Equity Shares, as per the provisions outlined in the Companies Act of 2013, refer to equity shares issued by a company to its directors or employees at a discounted rate or for considerations other than cash, in exchange for providing technical expertise or allocating assets such as intellectual property.
Eligibility:
Under Rule 8 of the Companies (Share Capital and Debenture) Rules, 2014, eligible individuals include:
- Permanent company employees
- Full-time employees of subsidiary or holding companies
- Directors of the company
Conditions for Issuing Sweat Equity Shares: According to Section 54 of the Companies Act 2013, issuance of sweat equity shares necessitates:
- Passing of a special resolution authorizing such issuance
- Inclusion of specific details in the resolution such as the number of shares, current market value, consideration, and the class of employees or directors receiving the shares
- Implementation of the resolution within 12 months of its passing to avoid invalidity
- Adherence to SEBI guidelines in distributing sweat equity shares
- Subjecting sweat equity shares to the same privileges, restrictions, and requirements as equity shares
- Mandatory lock-in period of three years for sweat equity shares issued to directors and employees, highlighting their non-transferability on share certificates
Quantity and Pricing of Sweat Equity Shares:
As per Rule 8 of the Companies (Share Capital and Debenture) Rules, 2014, a company cannot issue sweat equity shares exceeding 15% of its existing paid-up equity share capital or shares worth 5 crores, whichever is greater. However, startups have the flexibility to issue sweat equity shares up to 50% of their paid-up share capital for a period of five years from their incorporation.
The pricing of sweat equity shares must be determined at a fair value by a registered valuer, justifying the valuation methodology, especially for intellectual property rights or value additions. The key points of the valuation report are shared with the board of directors and shareholders.
Director’s Disclosure Report:
The director’s report submitted at the end of each fiscal year must accurately reflect the issuance of sweat equity shares, including details such as:
- Recipients of sweat equity shares
- Type and quantity of shares issued
- Terms of the agreement governing the issuance
- Estimated number of shares to be issued
- Impact on earnings per share (EPS)
Advantages of Issuing Sweat Equity Shares:
Issuing sweat equity shares offers numerous benefits including:
- Rewarding employees
- Retaining top performers
- Cost-effective strategy
- Employee participation in management
- Tax advantages
Conclusion:
Although sweat equity serves as a form of remuneration, certain limitations must be considered, such as the threshold of sweat equity for startups capped at 50% of the paid-up capital. Nevertheless, employers can opt to remunerate employees solely through sweat equity within the prescribed limits. Additionally, the liberalization of sweat equity share issuance to 50% of the paid-up capital allows founders to structure their capital more effectively while retaining control over shareholdings amidst external funding challenges.
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