Definition: Sweat Equity Shares refers to the equity-linked instrument which a company issues to its employees or directors for providing their knowledge and expertise or making available the intellectual property rights or value addition to the business. Such shares are issued at a discount or for consideration other than cash.
It is like compensation to the top management executives, promoters, and technocrats of the company given as a reward at a concessional rate or free of cost, for making valuable contributions in the intangible asset of the company that helps in arriving at some benefit.
In simple words, sweat equity shares are issued to the selective employees and directors, as an appreciation, for their contribution and hard work, as they give their blood and sweat for the growth of the organization.
Important: Every unlisted and private limited company is required to conform to Rule 8 of the Companies Rules, 2014 for the issue of sweat equity shares. On the other hand, the listed companies are required to follow SEBI regulations.
Rule 8 of the Companies Rules. 2014
- For the issue of sweat equity shares, a special resolution must be passed by the Company in its Annual General Meeting (AGM). Further, the allotment has to be made within 12 months from the date on which the resolution has been passed. This means that the resolution is valid for 12 months only.
- A company shall not issue sweat equity shares exceeding 15% of already issued paid-up equity share capital in a year or shares of the issue value of Rs. 5 crores, whichever is higher. Subject to the issue of sweat equity shares in the company shall not be more than 25% of the paid-up equity share capital at any time.
- Allotment of equity shares under sweat equity have a locked-in or non-transferable for a period of 3 years from the date of allotment, which acts as an effective incentive model. Furthermore, the share certificates are under lock-in and the expiry of the lock-in period should be stamped in bold or specifically highlighted in any other prominent fashion.
- A registered valuer should determine the price for the sweat equity shares to be issued, as the fair price providing justification for such valuation.
- The valuation of intellectual property rights or know-how or value addition for which the shares are to be issued must be performed by a registered valuer, who must furnish a genuine report to the Company’s Board of Directors (BOD), along with the justification for such valuation.
- When the shares are issued for consideration other than cash based on the valuation report submitted by the registered valuer, shall be treated in the manner given below:
- When the consideration other than cash takes the form of an asset that is subject to depreciation or amortization, it must be carried to the balance sheet of the company as per the accounting standards or,
- If the above clause is not applicable then the same should be treated as an expense, as given in the accounting standards.
- The amount of issue of sweat equity shares should be treated as a part of managerial remuneration.
SEBI Regulations, 2002
All the listed companies and the unlisted companies bringing IPO and looking for a listing of their shares on the stock exchange must adhere to the regulations. SEBI Regulations are given as under:
- For the issue of sweat equity shares to the employees or directors, the special resolution needs to be passed at the Annual General Meeting (AGM). However, when the sweat equity shares are issued to promoters, an ordinary resolution is required to be passed at the AGM
- The resolution must state the number of shares, current market price, consideration (if any), and the people to whom they are issued are also specified. The resolution must also state the class or classes of employees or directors to whom the shares are being issued.
- Every transaction relating to the issue of sweat equity shares is required to be voted by a separate resolution.
- The resolution is valid for a period of 12 months from the date it has been passed.
- It is locked in for a period of 3 years from the date of allotment.
- The price of sweat equity shares are offered should not be lower than, the higher of these two:
- Average of the week-wise high and low of the closing prices of the concerned equity shares, in the last six months immediately preceding the relevant date or
- Average of the week-wise high and low of the closing prices of the concerned equity shares, in two weeks immediately preceding the relevant date.
The term ‘relevant date‘ refers to the date which is 30 days before the date on which AGM is held.
- In case the sweat equity shares are offered on a non-cash basis, it needs to be treated in the given manner in the company’s account books:
- If the non-cash consideration is in the form of depreciable or amortizable asset, it must be taken to the Balance Sheet and treated as per the concerned accounting standards.
- If the above clause is inapplicable then it should be expensed, as per the relevant accounting standards.
- At the general meeting, after the issue of sweat equity shares, the company’s BOD should provide the shareholders, a certificate from auditors stating that the issue has been made as per the regulations and also as per the resolution made.
Points to Note
- It must be ensured that on the date of issue of sweat equity shares, one year should have been completed since it has commenced its business.
- The company may only issue sweat equity shares of a particular class of shares that are previously issued by the company.
- All restrictions, limitations, and provisions which are applicable to equity shares shall be applicable to sweat equity shares issued. Further, the holder of these shares should rank ‘pari passu‘ (on equal footing) with other equity holders.
- Also, the sweat equity shares can be issued at a price lower than the face value of the shares, which is the only exception given in the Companies Act, 2013. Otherwise, the issue of shares at a price below its face value is prohibited.
A word from Business Jargons
Sweat Equity Shares are provided to the employees of the company on favorable terms, as a form of recognition of the work performed by them in the organization. It allows the company to retain employees, by offering these shares as a reward for the services provided by them.