Sweat equity

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Sweat equity has been in the news recently. Sweat equity shares are equity shares issued by a
company to its employees or directors at a discount, or as a consideration for providing
know-how or a similar value to the company. 

A company may issue sweat equity shares of a class of shares already issued if these conditions
are met: 

The issue of sweat equity shares should be authorized by a special resolution passed by the
company in a general meeting The resolution should specify the number of shares, current
market price, consideration, if any, and the section of directors /employees to whom they
are to be issued. As on the date of issue, a year should have elapsed since the company was
entitled to commence business. 

The sweat equity shares of a company whose equity shares are listed on a recognized stock
exchange should be issued in accordance with the regulations made by the Securities and
Exchange Board of India (SEBI). 

In the case of a company whose equity shares are not listed on any recognized stock exchange,
sweat equity shares can be issued in accordance with such guidelines as may be prescribed. 

In the case of unlisted companies, sweat equity shares cannot be issued before one year of
commencement of operations. Moreover, there is a cap of 15 percent on the number of sweat
equity shares that can be issued without a specific central government approval. 

Sweat equity shares are no different from employee stock options with a one year vesting period.
It is essential when a company is formed, to assure the financial investors that the knowhow
providers will stay on, or for a start-up with limited resources to attract highly-qualified
professionals to join the team as long-term stakeholders. 

These shares are given to a company's employees on favourable terms, in recognition of their
work. Sweat equity usually takes the form of giving options to employees to buy shares of the
company, so they become part owners and participate in the profits, apart from earning
salary. 

Section 79A of the Companies Act lays down conditions for the issue of sweat equity shares. For
listed companies, there are regulations made by the SEBI. The SEBI also prescribes the
accounting treatment of sweat equity shares. Thus, sweat equity is expensed, unless issued in
consideration of a depreciable asset, in which case it is carried to the balance sheet. 

Sweat equity is a device that companies use to retain their best talent. Usually, it is given as part
of a remuneration package. However, start-ups sometimes use sweat equity to retain talent. If
the company fails, its employees may end up with worthless paper in the form of sweat equity
shares. 

Unlisted companies cannot issue more than 15 percent of the paid-up capital in a year or
shares with a value of more than Rs 5 crores - whichever is higher - except with the prior
approval of the central government. If the sweat equity is being issued for consideration
other than cash, an independent valuer has to carry out an assessment and submit a
valuation report. 

The company should also give 'justification for the issue of sweat equity shares for consideration
other than cash, which should form a part of the notice sent for the general meeting'. 

The board of directors' decision to issue sweat equity has to be approved by passing a special
resolution at a shareholders' meeting later in the year. The special resolution must be passed by
75 percent of the members attending voting for it.

Sweat equity
From Wikipedia, the free encyclopedia

Sweat equity is a term used to describe the contribution made to a project by people who
contribute their time and effort. It can be contrasted with financial equity which is the money
contributed towards the project. It is used to refer to a form of compensation by businesses to
their owners or employees. The term is sometimes used in partnership agreements where one or
more of the partners contributes no financial capital. In the case of a startup company, employees
might, upon incorporation, receive stock or stock options in return for working for below-market
salaries (or in some cases no salary at all).

The term is sometimes used to describe the efforts put into a start-up company by the founders in
exchange for ownership shares of the company. This concept, also called "stock for services" and
sometimes "equity compensation" or "sweat equity" can also be seen when startup use their
shares of stock to entice service providers to provide necessary corporate services in exchange
for a discount or for deferring service fees until a later date, see e.g. "Idea Makers and Idea
Brokers in High Technology Entrepreneurship" by Todd L. Juneau et al., Greenwood Press,
2003, which describes equity for service programs involving patent lawyers and securities
lawyers who specialize in start-up companies as clients.
The term can also be used to describe the value added to real estate by owners who make
improvements by their own toil. The more labor applied to the home, and the greater the
resultant increase in value, the more sweat equity that has been used.

In a successful model used by Habitat for Humanity, families who would otherwise be unable to
purchase their own home (because their income level does not allow them to save for a down
payment or qualify for an interest-bearing mortgage offered by a financial institution) contribute
up to 500 hours of sweat equity to the construction of their own home, the homes of
other Habitat for Humanity partner families or by volunteering to assist the organization in other
ways. Once moved into their new home, the family makes monthly, interest-free mortgage
payments into a revolving "Fund for Humanity" which provides capital to build homes for other
partner families.

SWEAT EQUITY SHARES

SWEAT EQUITY SHARES PROVISIONS IN COMPANIES ACT ON SWEAT EQUITY

Section 79A of the Companies Act, 1956 authorizes the issue of sweat equity shares subject to
certain conditions. Section 79A: (1) Notwithstanding anything contained in section 79, a
company may issue sweat equity shares of a class of shares already issued if the following
conditions are fulfilled, namely- (a) the issue of sweat equity shares is authorized by a special
resolution passed by the company in the general meeting; (b)the resolution specifies the number
of shares, current market price, consideration, if any, and the class or classes of directors or
employees to whom such equity shares are to be issued; (c)not less than one year has, at the date
of the issue, elapsed since the date on which the company was entitled to commence business;
(d)the sweat equity shares of a company, whose equity shares are listed on a recognized stock
exchange, are issued in accordance with the regulations made by the SEBI in this behalf:
Provided that in the case of a company whose equity shares are not listed on any recognized
stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be
prescribed. (2) All the limitations, restrictions and provisions relating to equity shares shall be
applicable to such sweat equity shares issued under sub-section.

TO WHOM SWEAT EQUITY COULD BE ISSUED :

TO WHOM SWEAT EQUITY COULD BE ISSUED Sweat equity shares by definition could be
issued only to the ‘employees or directors’ of the company incorporated under the Companies
Act, 1956. it could also be issued to the directors or employees of the foreign subsidiary of an
Indian incorporated company a foreign subsidiary is incorporated outside India and can at best
be covered by the definition of ‘body corporate’ and not a ‘company’ under the Companies Act,
1956, the section has made a fiction of including such a body corporate as a company for the
purposes of issue of sweat equity shares. While the section mentions only ‘employees or
directors’ the SEBI regulations also mentions issue of sweat equity to ‘promoters’. The
Consideration for Issue of Sweat Equity The allotment of sweat equity should be ‘at a
discount’ or ‘consideration otherwise than cash’. Sweat equity could be issued in
consideration of providing know-how or making available rights in the nature of intellectual
property or for value addition contributed by such employee or director.

THE PRICE AT WHICH THE SWEAT EQUITY COULD BE OFFERED:

THE PRICE AT WHICH THE SWEAT EQUITY COULD BE OFFERED The SEBI regulations
state that the price shall not be less than the higher of the following- The average of the weekly
high and low of the closing prices of the related equity shares during last six months
preceding the relevant date; or The average of the weekly high and low f the closing prices
of the related equity shares during the two weeks preceding the relevant date. The
regulations for unlisted companies provide that the price should be “fair price calculated by an
independent valuer” and separate consideration is given for issue of sweat equity in case of
‘consideration other than cash’ CLASS OF SHARES WHICH COULD BE ISSUED AS
SWEAT EQUITY Sweat equity shares can issued only of a class of shares already issued it must
be only an ‘equity’ shares and not a ‘preference share’.

ISSUING OF SWEAT EQUITY SHARES:

ISSUING OF SWEAT EQUITY SHARES GENERAL PRINCIPLES IN ISSUE OF SWEAT
EQUITY The issue shall be authorized by a special resolution. The issue of sweat equity shares
by a listed company shall be in accordance with the SEBI (Issue of Sweat Equity shares)
Regulations, 2002. In case of an unlisted company, issue of sweat equity shares shall be subject
to Unlisted Companies (Issue of Sweat Equity shares) Rules, 2003. Sweat equity shares is
treated as any ordinary equity shares issued by the company in all respects except in
certain cases the issue is for consideration other than cash. The voting rights and rights as to
dividend etc. will be paripasu with the existing class of equity shares. In terms of section 77A (5)
(d) it is possible for the company to buy back sweat equity issued to employees of the company
pursuant, inter alia, to a scheme of sweat equity.

SWEATY EQUITY SHARES AND UNLISTED COMPANIES:

SWEATY EQUITY SHARES AND UNLISTED COMPANIES Under The Proviso To Clause
(D) To Sub-section (1) Of Section 79A, It Is Provided That In The Case Of A Company Whose
Equity Shares Are Not Listed On Any Recognized Stock Exchange, The Sweat Equity Shares
Should Be Issued In Accordance With The Guidelines As May Be Prescribed. Unlisted
Companies (Issue Of Sweat Equity Shares) Rules, 2003 Have Been Introduced To Whom Sweat
Equity Could Be Issued Price At Which Sweat Equity Could Be Issued Authorization By Special
Resolution Restriction on Issue of Sweat Equity Shares for more than 15% of total paid up equity
share capital in a year or shares of the value of 5 crores of rupees, Register of Shares Lock-in of
Sweat Equity Shares Certificate from Auditors

SWEAT EQUITY SHARES AND LISTED COMPANY :

SWEAT EQUITY SHARES AND LISTED COMPANY 79A (1)(d), sweat equity shares in
cases of companies listed on a recognized stock exchange must be in accordance with the
regulations made by the SEBI. SEBI has issued the SEBI (Issue of Sweat Equity Shares)
Regulations, 2002, laying down the guidelines for the issue of sweat equity shares by listed
companies. Applicability To Whom Sweat Equity Could Be Issued Pricing of Sweat Equity
Shares Valuation of Intellectual Property Authorisation By Special Resolution Promoters &
Sweat Equity Shares It is not clear whether sweat equity could be issued to ‘promoters’ as
defined in these Regulations, unless such promoter is also either an employee or a director.
Promoters could also be shareholders. in case of issue of sweat equity to promoters both the
requirement of special resolution (at which the promoter also could vote) as also an
ordinary resolution (wherein the promoter do not participate) shall be passed. In addition the
resolution could be passed by postal ballot. ISSUE OF SWEAT EQUITY SHARES TO
PROMOTERS- SOME ISSUES

ADVANTAGES AND DISADVANTAGES OF SWEAT EQUITY:

ADVANTAGES AND DISADVANTAGES OF SWEAT EQUITY
 Advantages of Sweat Equity Shares Highly efficacious in extracting the employees
efficiency
 Promotional in nature as it a means of receiving shares without spending money
 Cost efficient for company as it can save on the employee’s to be given salary
 Receiving of sweat equity is a long term investment
 More income to the employees
 Receiving the right to participate in the company’s management for employees

Disadvantages of Sweat Equity Shares

 More of dilution of power as share is being issued
 Can lead to inefficiency of employees when the feeling of being in power creeps in
 Can also lead to irregularity in income for the employees
 Consideration in the nature of share can be heavy on otherwise low income employees
 During recession or liquidation, the sweat equity share holders may face larger troubles
as their effort go non-benefitted to them.
 Excessive issue of sweat equity shares can also lead to overcapitalisation which in turn
would be heavy for the company

Companies Act, 1956 :

Sweat equity :
1. Issue of sweat equity shares is governed by the provisions of S. 79A of the Companies Act.
Explanation II to the said Section defines the expression ‘sweat equity shares’ to mean equity
shares issued by the company to employees or directors at a discount or for consideration other
than cash for providing the know-how or making available rights in the nature of intellectual
property rights or value additions, by whatever name called. It is, therefore, necessary for the
issue of sweat equity shares that the concerned employee either provides the know-how,
intellectual property rights or other value additions to the company.

2. In terms of the said Section, a company may issue sweat equity shares of a class of shares
already issued, if the following conditions are satisfied :

(a) such issue is authorised by a special resolution of the company in the general meeting;

(b) such resolution specifies the number of shares, current market price, consideration, if any,
and the class or classes of the directors or employees to whom such shares are to be issued;

(c) such issue is after expiry of one year from the date on which the company was entitled to
commence business; and

(d) in the case of an unlisted company, such shares are issued in accordance with the prescribed
guidelines.

3. The guidelines referred to in S. 79A are the Rules issued by the Central Government, which
need to be followed by unlisted companies. The Rules inter alia provide the procedure to be
followed by a company issuing sweat equity shares for consideration other than cash. Rule 9 of
the Rules provides that where a company proposes to issue sweat equity shares for consideration
other than cash, it shall comply with the following :

(a) the valuation of the intellectual property or of the know-how provided or other value addition
to consideration at which sweat equity capital is issued, shall be carried out by a valuer;

(b) the valuer shall consult such experts, as he may deem fit, having regard to the nature of the
industry and the nature of the property or the value addition;

(c) the valuer shall submit a valuation report to the company giving justification for the
valuation;

(d) a copy of the valuation report of the valuer must be sent to the shareholders with the notice of
the general meeting;

(e) the company shall give justification for issue of sweat equity shares for consideration other
than cash, which shall form part of the notice sent for the general meeting; and
(f) the amount of sweat equity shares issued shall be treated as part of managerial remuneration
for the purposes of S. 198, S. 309, S. 310, S. 311 and S. 387 of the Act, if the following
conditions are fulfilled :

(i) the sweat equity shares are issued to any director or manager;

(ii) they are issued for non-cash consideration, which does not take the form of an asset which
can be carried to the balance sheet of the company, in accordance with the relevant accounting
standards.

4. Rule 8 of the Rules prescribes that the issue of sweat equity shares to employees and directors
shall be at a fair price calculated by an independent valuer.

5. Rule 2(v) of the Rules defines the expression ‘value addition’. The said Rule reads as under :

"(v) ‘value addition’ means anticipated economic benefits derived by the enterprise from an
expert and/or professional for providing the know-how or making avail-able rights in the nature
of intellectual property rights, by such person to whom sweat equity is issued for which the
consideration is not paid or included in :

(a) the normal remuneration payable under the con-tract of employment, in the case of an

employee, and/or

(b) monetary consideration payable under any other contract, in the case of non-employee."

The term ‘know-how’ is not restricted to technical know-how but can extend to practical
knowledge, skill and expertise. Hence, imparting practical knowledge to the company would be
considered as value addition.

6. Rule 6 of the Rules restricts the issue of sweat equity shares in a year to 15% of the total paid-
up equity share capital or shares of a value up to Rs.5,00,00,000/- (Rupees five
crores only), whichever is higher. If this limit is to be exceeded, the same is required to be done
with the prior approval of the Central Government.

7. For issue of sweat equity shares, the following broad procedure needs to be followed :

(i) Convene and hold a board meeting to consider the proposal of issue of sweat equity shares
and to fix up the date, time, place and agenda for general meeting and to pass a special resolution
for the same;

(ii) Issue notices in writing for general meeting with suitable explanatory statement containing
the particulars required as per Rule 4 of the Rules;
(iii) Pass a special resolution; and

(iv) Allot sweat equity shares.