Procedure for Issue of Sweat Equity Shares

Issue of Sweat Equity:

Governing provisions: Sec 2(88) & 62(1)(b) of Companies Act, 2013

Rule 8 of Companies (share capital and debentures) rules, 2014

Note: This article is mainly focusing on how an unlisted company can issue sweat equity shares. A listed company is required to comply SEBI regulations on Sweat Equity.

According to Section 2(88) of the Companies Act, 2013, Sweat Equity Shares means such equity shares issued by a company to its directors or employees at a discount or for consideration, other than cash, for their providing know- how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

Sweat equity shares are different from shares issued by a company under Employee Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme (ESPS).

The rights, limitations, restrictions and provisions applicable to equity shares shall be applicable to sweat equity shares and holders of such shares shall rank pari- passu with other equity shareholders.

Before going further, let us check out the definition of the word “employee” in this reference:

Employee means:-

(a) A permanent employee of the company who has been working in India or outside India; or

(b) a director of the company, whether a whole time director or not; or

(c) an employee or a director as defined in sub-clauses (a) or (b) above of a subsidiary, in India or outside India, or of a holding company of the company;

Note: Earlier there was a restriction that the Company has to work or commence the Business at least one year prior to become eligible to issue Sweat Equity but now the restriction has been removed vide The Companies (Amendment) Act, 2017 -Amendment Effective from 7th May 2018.

Procedure for Issue of Sweat Equity Shares:

1. Convene a Board meeting to discuss the matter in board meeting and to  approve notice of general meeting.

2. Issue notices in writing or through electronic mode, at least clear twenty one days before the date of meeting along with the explanatory statement as required u/s 102.

3. The explanatory statement to be annexed to notice and the resolution for approving the sweat equity shall inter alia contain the following information:

(a) the date of the Board meeting at which the proposal for issue of sweat equity shares was approved;

(b) The reasons or justification for the issue;

(c) The class of shares under which sweat equity shares are intended to be issued;

(d) The total number of shares to be issued as sweat equity;

(e) The class or classes of directors or employees to whom such equity shares are to be issued;

(f) The principal terms and conditions on which sweat equity shares are to be issued, including basis of valuation;

(g) The time period of association of such person with the company;

(h) The names of the directors or employees to whom the sweat equity shares will be issued and their relationship with the promoter or/and Key Managerial Personnel;

(i) The price at which the sweat equity shares are proposed to be issued;

(j) The consideration including consideration other than cash, if any to be received for the sweat equity;

(k) The ceiling on managerial remuneration, if any, be breached by issuance of such sweat equity and how it is proposed to be dealt with;

(l) a statement to the effect that the company shall conform to the applicable accounting standards; and

(m) Diluted Earnings Per Share pursuant to the issue of sweat equity shares, calculated in accordance with the applicable accounting standards.

4. The sweat equity shares issued to directors or employees shall be locked in/non transferable for a period of three years from the date of allotment and the fact that the share certificates are under lock-in and the period of expiry of lock in shall be stamped in bold or mentioned in any other prominent manner on the share certificate.

5. The sweat equity shares to be issued shall be valued at a price determined by a registered valuer as the fair price giving justification for such valuation.

6. The valuation of intellectual property rights or of know how or value additions for which sweat equity shares are to be issued, shall be carried out by a registered valuer, who shall provide a proper report addressed to the Board of directors with justification for such valuation.

7. A copy of gist along with critical elements of the valuation report shall be sent to the shareholders with the notice of the general meeting.

8. Where sweat equity shares are issued for a non-cash consideration on the basis of a valuation report in respect thereof obtained from the registered valuer, such non-cash consideration shall be treated in the following manner in the books of account of the company-

(a) where the non-cash consideration takes the form of a depreciable or amortizable asset, it shall be carried to the balance sheet of the company in accordance with the accounting standards; or

(b) where clause (a) is not applicable, it shall be expensed as provided in the accounting standards.

9. The amount of sweat equity shares issued shall be treated as part of managerial remuneration for the purposes of sections 197 and 198 of the Act, if the following conditions are fulfilled, namely.-

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

(b) they are issued for consideration other than cash, which does not take the form of an asset which can be carried to the balance sheet of the company in accordance with the applicable accounting standards.

10. Hold the general meeting and pass the Special Resolution.

11. The special resolution authorizing the issue of sweat equity shares shall be valid for making the allotment within a period of not more than 12 months from the date of passing of the special resolution.

12. The company shall not issue sweat equity shares for more than fifteen percent of the existing paid up equity in a year or shares of the issue value of rupees five crores, whichever is higher. The issuance of such sweat equity shares in the company shall not exceed twenty five percent of the paid up equity capital of the company at any time.

However, a startup company may issue sweat equity shares not exceeding fifty percent of its paid up capital upto five years from the date of incorporation or registration. (Notified in Notification no. GSR 180(E) dt. 17.02.2016)

13. File the special resolution with the concerned ROC with explanatory statement in Form MGT. 14 along with the fees within 30 days of passing of the special resolution.

14. If the shares of the company are listed with the stock exchange, then forward copies of the notice and a copy of the proceedings of the general meeting.

15. If the shares are listed with any of the recognized stock exchange, then issue of the sweat equity shares shall be in accordance with SEBI (Issue of Sweat Equity) Regulations, 2002.

16. In respect of sweat equity shares issued during an accounting period, the accounting value of sweat equity shares shall be treated as a form of compensation to the employee or the director in the financial statements of the company, if the sweat equity shares are not issued pursuant to acquisition of an asset.

17. If the shares are issued pursuant to acquisition of an asset, the value of the asset, as determined by the valuation report, shall be carried in the balance sheet as per the Accounting Standards and such amount of the accounting value of the sweat equity shares that is in excess of the value of the asset acquired, as per the valuation report, shall be treated as a form of compensation to the employee or the director in the financial statements of the company.

It is clarified that the Accounting value shall be the fair value of the sweat equity shares as determined by a registered valuer.

Post Sweat Equity Shares issuance compliances

18. Once the allotment is made, the company shall within 30 days of allotment, file with the Registrar a return of allotment in Form PAS.3, along with the fees.

19. The Board of Directors shall, inter alia, disclose in the Directors’ Report for the year in which such shares are issued, the following details of issue of sweat equity shares namely:-

(a) the class of director or employee to whom sweat equity shares were issued;

(b) the class of shares issued as Sweat Equity Shares;

(c) the number of sweat equity shares issued to the directors, key managerial personnel or other employees showing separately the number of such shares issued to them , if any, for consideration other than cash and the individual names of allottees holding one percent or more of the issued share capital;

(d) the reasons or justification for the issue;

(e) the principal terms and conditions for issue of sweat equity shares, including pricing formula;

(f) the total number of shares arising as a result of issue of sweat equity shares;

(g) the percentage of the sweat equity shares of the total post issued and paid up share capital;

(h) the consideration (including consideration other than cash) received or benefit accrued to the company from the issue of sweat equity shares;

(i) the diluted Earnings Per Share (EPS) pursuant to issuance of sweat equity shares.

20. The company shall maintain a register of Sweat Equity Shares in Form SH.3 at the registered office or such other place as the Board may decide. The entries in the register shall be authenticated by the Company Secretary of the company or by any other person authorized by the board for the purpose.

21. Deliver the share certificates of allotted shares within a period of 2 months from the date of allotment.

22. Intimate the details of allotment of shares to the Depository immediately on allotment of such shares.