The term “sweat equity shares” refers to shares that a firm issues to its directors or workers in exchange for contributing intellectual property rights, know-how, or any other kind of value addition in exchange for non-cash consideration or at a discount. Owners and employees often agree to lower compensation in cash-strapped companies in exchange for a stake in the business.
According to Section 2(88) of the Companies Act, 2013, sweat equity shares are shares that are distributed to certain employees of a given company when they have made exceptional contributions to the successful completion of a project or assignment, when an employee has demonstrated expert technical skill in a particular subject or when an employee has contributed significantly to the company and earned intellectual property rights.
- Recognising Hard Work: Offering employees sweat equity shares is a way to appreciate their hard work and dedication. Such appreciation encourages them to remain with the company for a longer period.
- Replace Cash Rewards: Most startups in the early stages cannot give their staff cash bonuses or other financial incentives. Therefore, rewarding employees with sweat equity shares makes it reasonable. This is not just restricted to startups, and well-known companies also engage in this.
- Provide Compensation: They can be used to make up for any wage reductions that any employees may have experienced. Employees and directors in some companies generally agree to a lower salary in return for a stake in the company.
- Retain Employees: The primary goal of granting these is to increase employee attraction and retention. Offering such shares is beneficial in the early stages when the company’s potential growth trajectory is unknown. Additionally, having such shares offers employees a sense of business because they are eligible to vote and get dividends. It is also important to note that these shares are non transferable and have a lock in period of three years. This makes the strategy effective in more ways than one.
- Acknowledge Director’s Efforts: When the company wishes to award an exceptional director who goes above and beyond for the business expansion, they can issue sweat equity shares. Such directors may be given sweat equity to reward their efforts and maintain their interest in the engagement for the foreseeable future.
- Discounted Shares: Sweat equity is the allotment of shares at a discount. This feature of holding shares is frequently preferred over ESOPs (Employee Stock Option Plans), which are a right of the employee and not an obligation to him to purchase some shares of the company at a pre-decided price to be allocated in the future while being dependent on share price volatility.
Under Section 2(88) of the Companies Act of 2013, employees covered by this plan include directors and employees. Rule 8(1) of the Companies (Share Capital and Debentures) Rules, 2014 defines that an “Employee” is someone who has been employed by the organisation permanently or at least a year from outside India or a director of the corporation, whether or not such director serves full-time or an employee or director of the holding company or a subsidiary of the entity in or outside of India.
These shares are taxable in the hands of employees when distributed or transferred if the following criteria are satisfied:
- Section 2(h) of the Securities Contract (Regulation) Act of 1956 defines the shares that the employee owns.
- If these shares are distributed or transferred on or after April 1, 2009. Before April 1, 2009, any securities issued or exchanged are subject to the Fringe Benefit Tax.
- These shares can be directly or indirectly given to current or former employees.
- When an employer or previous employer gives such shares.
- When shares were given away for free or at a discounted price.
They will be taxed in the employee’s hands in the year that the equity shares were allocated or transferred if any of the above conditions are met.
Frequently Asked Questions
One person company, a public company, a private company, or a listed or unlisted company can issue sweat equity shares. A specific resolution passed by the company is required to authorize the issuance of sweat equity shares.
A company is allowed to issue 15% of its current paid-up equity share capital in a year or shares equal to the value ₹ 5 crores. Additionally, at no time shall the sweat equity shares exceed 25% of the issued company’s paid-up equity capital. For startups, there are several exceptions. From the time of incorporation or registration, they have 5 years to issue up to half of their paid-up capital.
A registered valuer is hired to determine the worth of the intellectual property rights, know-how, and value additions produced concerning the company that desires the issue of sweat equity shares. The registered valuer of sweat equity shares establishes their fair market worth and they are also required to justify their valuation.
- RSU vs ESOP
- What are Equity Shares?
- What are Preference Shares?
- Equity Shares vs Preference Shares
- Valuation of Shares