What is sweat equity?

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 authorised 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 recognised 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 recognised 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 oneyear 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.