WHAT IS SWEAT EQUITY?
Many companies, especially Startups are often faced with a scarcity of cash but need Human Capital investments from skilled individuals such as employees or directors of the company to create value. Sweat Equity provides an option to such companies to preserve cash but compensate those skilled individuals for the know-how, intellectual property or value addition they bring to the company. Sweat Equities are issued at a discount to their face value.
BENEFITS OF SWEAT EQUITY FOR THE ISSUER
As mentioned before, Sweat Equity allows the company to preserve cash. For entrepreneurs, this is a helpful way to get experts from different fields onboard before raising outside capital. This helps the entrepreneurs prove the concept without raising money and then raising money later only for the growth phase at a higher valuation.
This also helps the company distribute the risk associated with the venture.
BENEFITS OF SWEAT EQUITY FOR THE RECEIVER
When Google went public, more than 1000 employees became millionaires. This also happened to many employees of tech startups. While not every startup will reach the IPO or any other successful valuation event (acquisition etc.), Sweat Equity makes it possible for the employees to share the rewards for a successful startup. Sweat Equity can be considered as growth investment by the employees where they are investing in form of their human capital i.e. skills and knowledge.
PROCEDURE FOR ISSUE OF SWEAT EQUITY
In general, companies are not allowed to issue equity at a discount (Section 53 of the Companies Act 2013) but Sweat Equity is an exception.
As per section 54 of the Companies Act 2013, the following conditions have to be fulfilled for the issuance of Sweat Equity.
1. Sweat Equity can only be issued after one year the company commenced business.
2. The company need to pass a special resolution with the number of shares, the current market price, consideration if any and the class or classes of directors or employees to whom such equity shares are to be issued.
3. If the company is listed, the issuance has to follow SEBI rules for issuance of equity.
4. All the rights, limitations, restrictions and provisions applicable to the other equity shareholders, are also applicable for the Sweat Equity holders.
WHO CAN BE ISSUED SWEAT EQUITY?
As per Section 8(1) of Companies (Share Capital and Debentures) rules 2014 defines an employee as
1. a permanent employee of the company who has been working in India or outside India,
for at least last one year
2. a director of the company, whether a whole time director or not
3. an employee or a director as defined in (1) or (2) above of a subsidiary, in India or outside India, or of a holding company of the company;
HOW MUCH SWEAT EQUITY CAN A COMPANY ISSUE?
As per Section 8(4) of Companies (Share Capital and Debentures) rules 2014, a company cannot issue more than 15% of the existing paid-up capital in a year or issue value of Rs. 5 crore, whichever is higher.
The Sweat Equity issued by the company cannot be higher than 25% of the paid-up capital at any time. A startup is an exception to this rule. Startups are allowed to issue up to 50% of the paid-up capital up to 5 years from the date of incorporation as per notification number GSR 180(E) dated 17th February 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.
SOME OTHER RULES RELATED TO SWEAT EQUITY
Sweat Equity Shares issued to directors and employees are locked to three years and cannot be transferred.
The Sweat Equity shares have to be valued by a registered valuer as for the fair price giving justification for such valuation. The intellectual property or know-how or value addition for which the Sweat Equity is being issued also needs to be valued by a registered valuer.