Sweat Equity Shares

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Under section 79 A of the 1956 Act equity shares can be issued to employees or directors of a company at a discount or for consideration other than cash, in recognition of their contribution for providing know-how or making available intellectual property rights or value additions to the benefit of the company. The contribution made by the employees/directors generate increased profits to the company for a number of years and sweat equity provides a new form of compensation to them by way of adequate return in the form of discounted share or shares for consideration other than cash. Sweat equity may be issued by a company incorporated under the 1956 Act or its subsidiary incorporated in a country outside India. Under sub-section(2), these are equity shares for all intents and purposes and all limitations or restrictions and provisions made under the Act relating to equity shares also apply to sweat equity shares. The sweat equity shares must be of the same class of equity shares as already issued by the Company. For issuing sweat equity shares, authorization in the articles of association is not a pre-condition.

Meaning of Sweat equity under the Companies Act, 2013

Promoters and employees who contribute to the formation of the company may like to get compensated against their hard word or “sweat”, in form of equity either free of cost, or on favorable terms as compared to other forms of equity. This is what is termed as sweat equity. Accordingly, section 2(88) of the 2013 Act defines “sweat equity shares” to mean “such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever called”.  Sweat equity may be issued to an employee or a director for providing technical know-how, drawings, design, development technology, software etc., to the company. The company will be benefited by use of improved technical know-how and research provided by them. If the promoters issue capital against tangible or intangible assets, such intellectual property rights, patents, etc., that may be a case of issue of shares for consideration other than cash. Where no concrete or identifiable asset is being acquired by the company, or the value of the asset being less than the nominal value of shares, it would be a case of issue of shares at a discount. Therefore, under section 54 of the 2013 Act equity shares can be issued to employees or directors of a company at a discount or for consideration other than cash, in recognition of their contribution for providing know-how or making available intellectual property rights or value additions to the benefit of the company. The contribution made by the employees/directors generate increased profits to the company for a number of years and sweat equity provides a new form of compensation to them by way of adequate return in the form of discounted share or shares for consideration other than cash.

Issue of Sweat Equity Shares

Conditions for issuing sweat equity shares under Companies Act, 2013

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Section 54 of the 2013 Act stipulates the following essentials for issuing sweat equity shares:

  • The sweat equity shares must be of the same class of equity shares as already issued by the company.
  • Issue of the sweat equity is authorized by a special resolution passed by the company; for issuing sweat equity shares, authorization in the articles of association is not a pre-condition. Further, in case of an unlisted company, the special resolution shall be passed in a general meeting only. In case of listed companies, the special resolution need not be passed in a general meeting. The 1956 Act required every company issuing sweat equity shares to pass special resolution in a general meeting.
  • The special resolution shall specify the number of sweat equity shares to be issued, current market price of equity shares of the company, consideration, if any, payable on such shares and the class or classes of directors or employees to whom the same is proposed to be issued.
  • There must be a gap of at least one year from the date on which the company is entitled to commence business before issue of sweat equity shares.
  • The companies having their equity shares listed on stock exchange shall follow regulations made by SEBI; other companies shall follow the rules prescribed by the Central Government, in this behalf.

At the same time, it must be noted that sweat equity shares are equity shares only; therefore, the rights, limitations, restrictions and provisions as are for the time being applicable to equity shares shall be applicable to the sweat equity shares issued under section 54 of the 2013 Act and the holders of such shares shall rank with other equity shareholders [sub-section (2) of section 54 of the 2013 Act). The Rules as applicable to unlisted companies impose additional conditions on the companies.

Entitlements to sweat equity shares under companies Act, 2013

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 A company may issue sweat equity shares to directors or employees. The term ‘director’ has been defined under section 2(34) of the 2013 Act. The term employee has not been defined under the 2013 Act. However, for the purpose of section 54 of the 2013 Act and the related rules, Rule 8 of the Companies (Share capital and Debentures) Rules, 2014 defines “employee” so as to mean:

  • a permanent employee of the company who has been working in India or outside India, for at least the last one year; or
  • a director of the company, whether a whole time director or not; or
  • an employee or a director as defined in sub-clauses(a) or (b)above of the subsidiary, in India or outside the India, or of the holding company of the company.

Issue of sweat equity shares to employees/directors  of the holding or the subsidiaries

Section 79 A(1) of the 1956 Act included in a  subsidiary incorporated outside India within the meaning of ‘company‘  for the purpose of the said sub-section. Therefore, under  the 1956 Act, sweat equity might be issued by a company incorporated under the 1956 Act or its subsidiary incorporated in a country outside India. However, such an explanation has been omitted under the 2013 Act, and since ‘company’ under section 2(20) means a company incorporated under the 2013 Act or any previous company law; it appears that a foreign subsidiary cannot issue sweat equity to its Indian holding. The 2013 Act is silent on whether a company may issue such shares to employees/directors of its subsidiary or its holding – there is no such explanation including subsidiaries/holding within the ambit of “Company“. However, Explanation to Rule 8 of the companies (share capital and debentures) Rules, 2014 defines “employee” to include employee or director of a subsidiary whether in India or outside India; and employee or director of a holding company of the company. As such the company registration may issue sweat equity shares to employees or directors of its subsidiaries or holding company subject to fulfillment of other conditions.

Issue of sweat equity not preferential issue

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Regulation 2(1)(z) of SEBI (ICDR) Regulations, 2009 gives the meaning of a preferential issue and excludes an issue of sweat equity shares there from. Further, Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 excludes issue of sweat equity shares from the definition of ‘preferential offer’.

Intellectual property rights

Sweat equity may be issued to an employee or a director for making available rights in the nature of intellectual property rights. These are exclusive property rights of which the owners can prevent them from being used by others without their authorization. Such rights are:

  • Patent for an invention;
  • Copyright in selected rights, including works in the literary, artistic and scientific domain;
  • Trademark Registered under the Trademarks Act, 1999 or trademarks in respect of which application is pending for company registration before the Registrar of Trade Marks;
  • Industrial design;
  • Layout design of integrated circuit;
  • Undisclosed information;
  • Any other such right;

Swear equity may be issued to an employee/director for providing technical know-how, drawings, designs, technology, software, etc., to the company.

Value additions

Increase in the value of the company’s products, in economic terms, which is attributable to the efforts of an employee or a director, may be in any form. Value addition in tangible form can have this meaning that the employee’s contribution brings about a better surplus in working results. There is, in consequence, a greater profitability which can be shared with employees by issuing sweat equity. Clause (2) of Explanation to sub-rule (1) of Rule 8 of the Companies (share capital and debentures) Rules, 2014 issued under the 2013 Act defines “value additions” to mean actual or anticipated actual benefits derived or to be derived by the company registration from an expert and/or a professional for providing know-how or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued for which the consideration is not paid or included in (a)the normal remuneration payable under the  contract of employment, in the case of an employee; and/or (b) monetary consideration payable under any other contract, in case of non-employee.

Issue of Sweat Equity at discount

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Section 79 of the 1956 Act provides for issue of shares at a discount with the approval of Company law Board. Section 79 A of the 1956 Act starts with a non-obstinate clause and accordingly, sweat equity shares may be issued at a discount as per the provisions of section 79 A without recourse to section 79 of the 1956 Act and the approval of the Company Law Board. Similarly, though section 53 of the 2013 Act prohibits issue of shares at a discount, section 54 starts with a non-obstinate clause and accordingly, sweat equity shares may be issued at a discount in accordance with the provisions of section 54 of the 2013 Act.

Issue of Sweat Equity for consideration other than cash

Shares may be issued for consideration other cash for consideration other than cash for acquisition of an asset – tangible or intangible. Sweat equity shares are issued by a company to compensate the employees/directors for contributing an intangible asset which is for the benefit of the company registration for a long period in the form of technical know-how , intellectual property rights or value additions. There can be a provision for allotment of shares under right issue for payment in kind.

Rules concerning issuance of sweat equity shares

Provision to clause (d) of section 79 A(1) provided that in case of a company registration whose equity shares or not listed on any recognized stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be prescribed. Rule 5 of the these rules provides for maintenance of a register of sweat equity shares issued under section 79 A of the 1956 Act in the form of specified in the schedule annexed to the said Rules. Paragraph 28 of the Secretarial standards SS4 on registers and records issued by the ICSI, provides for maintenance inspection, authentication and preservation of register of sweat equity shares. Rule 6 of the Rules requires for maintenance of the register of sweat equity shares issued under section 79 A of the 1956 Act is the more than 15% of the total paid up equity share capital in a year or shares of the value of 5 crores of rupees, whichever is higher, to appear prior approval of the central government . This application is to be electronically filed in e-form No. 65 as an attachment under “others”. Details of issue of sweat equity shares should be disclosed either in the Director’s report or in the annexure to the Director’s Report . Rule 7 of the said Rules specifies these details from (a) to (f). Rule 8 and 10 of the said Rules provide for pricing and lock-in of sweat equity shares. Price of such shares should be  a fair price calculated by an independent valuers.  Such shares should be locked in for a period of three years from the date of allotment. Rule 9 of the Rules as mentioned provide for compliance with conditions specified in (a) to (f) before issuing sweat equity shares for consideration other than cash. Rule 12 provides for treatment in the books of account such as non-cash consideration  of sweat equity shares.

Register of Sweat Equity Shares

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Rule 8(14) of the companies (Share capital and Debentures) Rules, 2014 provides for maintenance of a register of sweat equity shares issued under this section in Form No. SH.3. Paragraph 28 of Secretarial Standards SS4 on registers and records issued by ICSI provides for maintenance inspection, authentication, and preservation of register of sweat equity shares.

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