What Are Sweat Equity Shares?
Sweat equity shares are equity shares issued by a company to its employees or directors at a discount or for consideration other than cash, in recognition of:
- Intellectual Property Rights (IPR)
- Technical or professional expertise
- Value additions contributing to business growth
Who Can Issue Sweat Equity Shares?
A company can issue sweat equity shares if it:
- Is incorporated under the Companies Act
- Has completed at least one year since incorporation
- Is a startup recognized by DPIIT (for relaxed limits)
Eligible Recipients
Sweat equity shares can be issued to:
- Permanent employees of the company
- Directors of the company (executive or non-executive)
- Employees or directors of holding/subsidiary companies
Step-by-Step Process to Issue Sweat Equity Shares
Step 1: Check Articles of Association (AOA)
Ensure that the company’s AOA authorizes the issue of sweat equity shares.
If not, amend the AOA before proceeding.
Step 2: Identify Eligible Employees or Directors
Finalize the list of employees or directors who have provided:
- Intellectual property
- Technical knowledge
- Significant business value addition
Step 3: Determine Valuation
Obtain a fair market valuation from a registered valuer for:
- Equity shares
- Intellectual property or value addition being exchanged
Valuation must be justified and documented properly.
Step 4: Convene Board Meeting
Pass a Board Resolution to:
- Approve sweat equity issuance
- Fix number of shares
- Approve valuation report
- Decide date of Extraordinary General Meeting (EGM)
Step 5: Issue Notice for EGM
Send EGM notice to shareholders with an explanatory statement disclosing:
- Number of shares to be issued
- Class of shares
- Pricing and valuation basis
- Details of recipients
- Consideration involved
Step 6: Pass Special Resolution in EGM
Obtain shareholders’ approval by passing a Special Resolution authorizing the issue of sweat equity shares.
Step 7: File MGT-14 with ROC
File Form MGT-14 within 30 days of passing the special resolution along with:
- Certified resolution
- Explanatory statement
- Valuation report
Step 8: Issue Sweat Equity Shares
Issue sweat equity shares to approved employees or directors:
- Update Register of Members
- Update Register of Sweat Equity Shares
- Issue share certificates within prescribed time
Step 9: File PAS-3 (Return of Allotment)
File PAS-3 with ROC within 30 days of allotment, attaching:
- List of allottees
- Valuation report
- Board and shareholder resolutions
Limits on Sweat Equity for Startups
For DPIIT-recognized startups:
- Up to 50% of paid-up capital can be issued as sweat equity
- Allowed for up to 10 years from incorporation
For non-startups:
- Maximum 15% in a year
- Overall cap of 25% of paid-up capital
Tax Implications
- Sweat equity is taxed as perquisite income in the hands of employees/directors
- Valuation on allotment date is considered for tax purposes
- Capital gains apply when shares are sold later
Common Mistakes to Avoid
- Issuing without proper valuation
- Missing ROC filings
- Not updating statutory registers
- Issuing beyond permitted limits
- Ignoring tax planning for employees
Why Choose Saving Mantra?
Saving Mantra provides end-to-end sweat equity advisory, including:
- Legal structuring
- Valuation coordination
- ROC filings
- Startup compliance support
- Tax impact planning
Disclaimer
This blog is for informational purposes only and does not constitute legal, tax, or financial advice. Regulations may change, and applicability depends on specific facts and circumstances. Readers are advised to consult Saving Mantra professionals before implementing any equity issuance strategy.