What is Sweat Equity?
Sweat Equity refers to the non-cash contribution of a person to the Company. According to the Companies Act, sweat equity are equity shares that a company issues to an individual in consideration of his/her services, know-how or any other value addition that the company has benefited from. In other words, it is the equity given to a company’s executives to reflect the value the executives have added and will continue to add to the company.
For instance, if a person works for creating patents for a company, then the company can issue equity (shares) to him, instead of paying cash.
It could be issued for many other things too such as the person providing technical know-how, brand rights or similar value additions to the company.
All the limitations, restrictions and provisions relating to equity shares are applicable to such sweat equity shares.
These equity shares can be issued free of monetary consideration or at a concession to their prevailing value.
A company may issue sweat equity shares if the following conditions are fulfilled:
(a) The issue of sweat equity shares is authorized by a special resolution passed by the company.
(b) The resolution specifies the number of shares, current market price, monetary 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 Securities and Exchange Board of India (SEBI) in this behalf.
Are “sweat equity” the same as “stock options”?
Not exactly. They are similar to the extent that both are means of providing non-cash incentive or compensation to individuals. However, sweat equity, as widely understood, are real shares allotted to individuals upfront.
Stock option, on the other hand, is merely a right given to an individual to acquire shares of the company at a future date at a pre-agreed price.
SEBI has issued separate guidelines for sweat equity and stock options.
In a broader sense, sweat equity can be issued to anyone who has rendered services to the company. Sweat equity can be issued to an employee, consultant or a vendor. That is the reason start-up companies use sweat equity as currency to pay for services that they cannot pay for in hard cash.
However, in India, as per SEBI regulations, sweat equity shares can be issued only to employees or directors.