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CS Executive – SECURITIES LAWS & CAPITAL MARKETS SWEAT EQUITY SHARES

CS Executive - SECURITIES LAWS & CAPITAL MARKETS SWEAT EQUITY SHARES

SWEAT EQUITY SHARES : DEFINITION & ISSUE

The term “Sweat Equity Shares” simply means a reward given to employees by way of discount or consideration. Sweat equity shares refer to equity shares given to the company’s employees on favorable terms, in recognition of their work.

Sweat Equity Shares are one of the modes of making share-based payments to employees of the company. The issue of sweat equity shares allows the company to retain the employees by rewarding them for their services. Suppose an employee ‘A’ has contributed towards making software for his/her company for the betterment and expansion of the company and as a result of it the company was rescued from paying the cost of the software, he ought to benefit. In this case, due to ‘A’ immense contribution towards the welfare of the company, the Sweat Equity Share is issued in lieu of ‘A’.

From the perspective of the ownership mindset, sweat equity shares enable greater employee stake and interest in the growth of an organization as it encourages the employees to contribute more towards the company in which they feel they have a stake.

Unlike the term sweat equity seems to be more complex but in reality, it is just compliance with requisite provisions to issue sweat equity shares. Let’s understand the key areas in sweat equity shares and their issue to employees and directors.

 

SWEAT EQUITY SHARES MEANING

Section 2 (88) of the Companies Act, 2013 defines “Sweat Equity Shares” which means 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 like intellectual property rights or value additions, by whatever name called.

It should be noted that the intellectual property right, know-how or value additions arise as of now mainly in the case of Information Technology related companies and Pharmaceutical companies. Categories of industries that are eligible to issue sweat equity shares have not been indicted by the Government either in the Act or otherwise.

To understand the Sweat Equity Shares through video

 

REGULATORY FRAMEWORK

The Issue of Sweat Equity shares are governed by the following laws:

  • Listed Company – Companies Act, 2013 and SEBI (Issue Of Sweat Equity) Regulations, 2002
  • Unlisted Company – Companies Act, 2013

UNDER COMPANIES ACT, 2013

Companies Act, 2013 is a common provision for both listed and unlisted company let’s get to know it first. Section 54 of the Companies Act, 2013, deals with the issue of sweat equity share by a company.

As per the provisions contained in the section, a company may issue sweat equity shares of a class of shares already issued, if the following conditions are fulfilled:

  • The issue is authorized by a special resolution passed by the company in the general meeting.
  • The resolution specifies the number of shares, current market price, consideration if any and the class or classes of directors or employees to whom such equity shares are to be issued.
  • 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 SEBI in this regard and if they are not listed the sweat equity shares are to be issued in accordance with the rule 8 of Companies (Share Capital and Debenture) Rules, 2014.

Note: Where the equity shares of the company are listed on a recognized stock exchange, sweat equity shares should be issued in accordance with regulations made by the Securities and Exchange Board of India in this regard.

Herein Companies Act, the process for an unlisted company to issue sweat equity shares are simple and less complex in terms of pricing, valuation, lock-in, etc.,

 

ISSUE OF SWEAT EQUITY SHARES – REGULATIONS UNDER SEBI

When it comes to the issue of sweat equity shares by a listed company to its employees, directors, or promoters compliance with these regulations is the foremost compliances to be in line with. These Regulations are brought in basically to streamline the process of issue of sweat equity shares.

At the end of the study, we would be aware of the Regulations, its applicability, non-applicability, issuance of Sweat equity shares to employees & directors, Special Resolution, Pricing, Valuation, and Ceiling on Managerial Remuneration, Lock-in, and Listing, etc. These regulations are divided into Four Chapters and a Schedule. Chapter I deal with Preliminary & Important Definitions, Chapter II deals with the Issue of Sweat Equity by a Listed Company, and Chapter III deals with General Obligations of the company and Chapter IV deal with Penalties and Procedure.

For our study purposes, Chapter II deals with the Issue of Sweat Equity by a Listed Company. Clauses 4 to 14 extensively provide for the provisions of the issue of sweat equity as follows:

 

Clause 4 – Sweat equity shares may be issued to

A company whose equity shares are listed on a recognized stock exchange may issue sweat equity shares in accordance with Section 54 of Companies Act, 2013 and these Regulations to it-

  • Employees
  • Directors

 

Clause 5– Explanatory Statement with respect to Special Resolution

The clause requires the Board of Directors at the time of sending a notice to the shareholders for the purposes of passing a special resolution under Section 54 of the Companies Act, 2013, shall send additional information for approving the issuance of sweat equity shall, inter alia, contain the following information:

  • The total number of shares to be issued as sweat equity.
  • The current market price of the shares of the company.
  • The value of the intellectual property rights or technical know-how or other value addition to be received from the employee or director along with the valuation report/basis of valuation.
  • The names of the employees or directors or promoters to whom the sweat equity shares shall be issued and their relationship with the company.
  • The consideration to be paid for the sweat equity.
  • The price at which the sweat equity shares shall be issued.
  • A ceiling on managerial remuneration, if any, which will be affected by the issuance of such sweat equity.
  • A statement to the effect that the company shall conform to the accounting policies as specified by SEBI.
  • Diluted Earnings Per Share pursuant to the issue of securities to be calculated in accordance with International Accounting Standards/standards specified by the Institute of Chartered Accountants of India.

 

Clause 6–Issue of Sweat Equity to promoters

This clause envisages the Issue of sweat equity shares to promoters, in case of such issue the same shall also be approved by a simple majority of the shareholders in General Meeting.

However, there are few other conditions that must also be fulfilled such as:

  • the promoters to whom such Sweat Equity Shares are proposed to be issued shall not participate in such resolution
  • a separate resolution shall be passed for each transaction of the issue of Sweat Equity.
  • the resolution shall be valid for a period of not more than twelve months from the date of passing of the resolution
  • the explanatory statement shall contain the disclosures as specified in the Schedule.

 

Clause 7–Pricing of Sweat Equity Shares

As per the provisions of this clause, The price of sweat equity shares shall not be less than the higher of the following:

  • The average of the weekly high and low of the closing prices of the related equity shares during the last six months preceding the relevant date.

OR

  • The average of the weekly high and low of the closing prices of the related equity shares during the two weeks preceding the relevant date.

“Relevant date” for this purpose means the date which is thirty days prior to the date on which the meeting of the General Body of the shareholders is convened, in terms of clause (a) of subsection (1) of section54of the Companies Act, 2013.

Further to the above key provisions the following shall also be essentially have complied-

  • If the shares are listed on more than one stock exchange but quoted only on one stock exchange on the given date, then the price on the stock exchange shall be considered.
  • If the share price is quoted on more than one stock exchange, then the stock exchange where there is highest trading volume during that date shall be considered.
  • If the shares are not quoted on the given date, then the share price on the next trading day shall be considered.

 

Clause 8–Valuation of Intellectual property

This clause provided that

The valuation of the intellectual property rights or of the

  • the know-how provided or other value addition shall be carried out by a merchant banker.
  • The merchant banker may consult such experts and valuers, as he may deem fit having regard to the nature of the industry and the nature of the property or other value addition.
  • The merchant banker shall obtain a certificate from an independent Chartered Accountant that the valuation of the intellectual property or other value addition is in accordance with the relevant accounting standards.

Clause 9–Accounting Treatment 

As far as the accounting treatment of the issue of sweat equity shares, where the sweat equity shares are issued for non-cash consideration, such non-cash consideration shall be treated in the following manner in the books of account of the company- 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 relevant accounting standards; or
  • in any other case, where the above provision is not applicable, it shall be expensed as provided in the relevant accounting standards.

 

Clause 10–Auditors Certificate in the subsequent AGM

The Board of Directors at the General meeting subsequent to the issue of sweat equity shall place before the shareholders, a certificate from the auditors of the company that the issue of sweat equity shares has been made in accordance with the Regulations and in accordance with the resolution passed by the company authorizing the issue of such Sweat Equity Shares

Clause 11–Ceiling on Managerial Remuneration

This clause provides that the amount of Sweat Equity shares issued shall be treated as part of managerial remuneration for the purpose of sections 197 of the Companies Act, 2013 if the following conditions are fulfilled:

  • the Sweat Equity shares are issued to any director or manager; and
  • they are issued for non-cash consideration, which does not take the form of an asset which can be carried to the balance sheet of the company in accordance with the relevant accounting standards.

Clause 12 – Lock-In 

The Sweat Equity shares shall be locked in for a period of three years from the date of allotment.

Further, if a company makes a public issue after it has issued sweat equity the provisions of SEBI (ICDR) Regulations, 2018 on the public issue in terms of lock-in and computation of promoters’ contribution shall apply.

Clause 13 – Listing

TheSweatEquityissuedbyalistedcompanyshallbeeligibleforlistingonlyifsuch issues are in accordance with these regulations.

Clause 14 – Applicability of Takeover 

Any acquisition of Sweat Equity Shares shall be subject to the provision of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.

Also Read:
Transfer of Property Act
NBFC (Non Banking Financial Company)

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July 9, 2020

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