Sweat Equity Shares: A Comprehensive Guide for Entrepreneurs and Investors

Sweat Equity Shares: A Comprehensive Guide for Entrepreneurs and Investors. A successful startup is built with the sweat, blood and tears of various people. This could be developers, directors, employees working on patents, managers or promoters. Each person contributing significantly to the business deserves incentives that go beyond monetary compensation - and issuing sweat equity shares is a great way to do that. In this article, Compliance Calendar traces the features, advantages and Indian law governing the issue of sweat equity shares. To see how your startup, your investors or employees benefit from the issue of sweat equity, read on.
Sweat Equity - A return for sweaty efforts by a key person in the startup
Does your business have an employee working on a crucial patent? Or a team of experts that is helping your business secure intellectual property rights? Sweat equity is ideal for such key persons in the business.Sweat equity is a form of equity or shares issued for recognising the contribution of effort, time, and skills by an individual towards a project or business venture. In other words, it is the value added to a company or project by the work put in by an individual or team, rather than by financial investment.
What provisions govern the issue of sweat equity?
Sweat equity is often used in start-up companies, where the founders invest in the business by contributing their time and expertise to grow the company. But startups may be boot-strapped, and not have enough money to spare on hefty salaries.In India, the concept of sweat equity is governed by the Companies Act, 2013, which lays down the legal framework for the issuance of sweat equity shares by unlisted companies. For listed companies intending to issue sweat equity, the SEBI Regulations apply.What forms of work can your startup issue sweat equity for?
Sweat equity can take various forms, such as a founder investing time and effort into developing a new product or service, or an employee working long hours to build a company from the ground up and for their value addition. The Companies Act, 2013 defines value addition as “actual or anticipated economic benefits derived or yet to be derived by the company”. Thus, it clearly includes employees or directors who may be working for benefits that the company may derive in the future.
Who is eligible to receive sweat equity from the company?
» Permanent Employees - The sweat equity shares can be issued to only permanent employees, associated with the company for a period of one year or more.
» Directors: Sweat equity can also be issued to directors, regardless of whether they are whole-time or not
» Value Addition: According to the Companies Act, a company can issue sweat equity shares to its directors, employees, or other specified persons in recognition of their contribution towards the growth and development of the company. The sweat equity shares can be issued at a discount or for consideration other than cash, subject to certain conditions and restrictions.
Compliance Requirements to be met for the issue of Sweat Equity
The Companies Act also lays down certain requirements that must be met by the company issuing sweat equity shares.
» The company must have been in operation for at least one year, and the sweat equity shares must be locked-in for a period of three years from the date of issuance.
» A special resolution must be passed after requisite notices and meetings.
» Form SH-3 must be filed after the allotment of sweat equity shares. This must include furnishing details like total number of shares issued, consideration (value received by the company), diluted earnings per share after such issue etc.
Maximum limits for Sweat Equity for a Listed Company
» The maximum yearly limit of sweat equity shares that can be issued by a listed company has been prescribed at 15% of the existing paid-up equity share capital within the overall limit, not exceeding 25% of the paid-up capital at any time.
» Further, in case the company is listed on the Innovators Growth Platform (IGP) (which is a listing by SEBI of companies that deal in intensive technology use, intellectual property, data value addition), the yearly limit will be 15% and overall limit will be 50% of the paid-up capital at any time. This will be applicable for 10 years from the date of the company’s incorporation.
Maximum limits of sweat equity for a startup or unlisted company?
»The Companies Act specifies that a company can issue sweat equity shares up to 15% of its paid-up share capital in a year or shares worth Rs. 5 crores, whichever is lower. The issue of sweat equity shares is also subject to approval by the company's board of directors and shareholders.
»For startups, sweat equity amount to upto 50% value of paid-up capital can be issued within five years from the date of registration.
Lock-in Periods for Sweat Equity issued
For a holder of the sweat equity, the following can help in determining the lock-in period, or the time in years one might have to hold the shares, before being eligible to sell them.
»For unlisted companies - The lock-in period currently stands at three years. Thus, shares are non-transferable during this period.
» For listed companies - While the regular lock-in period of three years applies, the recently passed SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 has made an amendment. Under this, minimum vesting period and lock-in period for all share benefit schemes has been made one-year, in the unfortunate case of permanent incapacitation or death of employees.
Taxation of Sweat Equity Shares
The sweat equity shares, on meeting certain conditions, are taxable in the hands of the employee as a perquisite, in the year that such allotment is done. The value reckoned for tax purposes is the fair market value of such shares.Thus, sweat equity plays an important role in encouraging employees and directors by offering ownership in the company. Compliance Calendar has assisted hundreds of startups and investors in evaluating benefits of sweat equity and for their end-to-end filing procedure during and after the completion of issue of shares. Connect with our experts to make sure all your equity compliances are taken care of.

Sweat Equity Shares: A Comprehensive Guide for Entrepreneurs and Investors

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