What Is Sweat Equity Share? Its meaning, Why it is important?

Selected Sweat personnel and directors shall be offered the right to an equity share as a reward for their contribution to the company. It shall be defined in Section 2,88 of the 2013 Companies Act. For an employee's or director's extraordinary contribution and hard work in completing a project, sweat equity shares shall be offered to the employees or directors.

In addition, sweat equity is issued in the share market for a discount or other consideration other than cash. They allow the employees and directors to participate in part of the company's profits as a return on investment.

Sweat Equity Shares Meaning

Sweat equity shares are shares that are given to specific employees of an organisation when they have made outstanding contributions to the accomplishment of a task or project, when an employee displays expert technical expertise in a particular subject, or when an employee has significantly contributed to the company and earned ownership of intellectual property, as per Section 2(88) of the Companies Act, 2013.

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Why Do The Companies Issue Sweat Equity Shares?

The reasons behind companies issuing sweat equity shares in the share market are listed below:

1. Discounted Shares: 

Allotting shares at a discount is known as sweat equity. This aspect of holding shares is generally preferred over ESOPs, which are a right of the employee rather than an obligation to him to buy some firm shares at a predetermined price to be assigned in the future while being reliant on share price volatility.

2. Retain Employees:

The principal purpose of issuing these shares is to increase employee attraction. If the company has no known future growth path, it would benefit from offering its shares at this point. Moreover, since employees are entitled to vote and receive dividends, having such shares gives them a sense of ownership. The fact that these shares are not transferable and have a lock period of three years.

3. Recognize directors' efforts: 

If the company wants to hire an extraordinary director who is a good advocate for expanding its business, it can issue equity. These directors can be given sweat equity to reward their efforts and retain an interest in participating for the foreseeable future.

How Does The Sweat Equity Work?

Sweat equity shares in the share market describe the number of shares offered as a contribution without reaping monetary benefits. If a company lacks capital, it uses an equity structure to compensate for the assistance of individuals or entities participating in its activities.
 

Most companies now provide this kind of equity to ensure that they have the best people managing their business and making it profitable. The startup offers them sweat equity shares because they do not have sufficient capital to cover their contributions. Equity makes them more willing to support the company, increasing its valuation. The holding shares also rise in value with increased valuation, allowing gains when retained. 

Sweat Equity, as opposed to a financial investment, can also refer to the increase in property or land values resulting from improvements and renovations carried out by the owner.

Calculation Of Sweat Equity Shares

When calculating sweat equity for contributions, there is no monetary aspect. The only way to calculate the gift is by considering the time the founders, directors, or employees spend since the equity does not represent an economic value.

Take this example of sweat equity as an example. A software company founder can value the time spent on the original software before starting the company at Rs 5,00,000. The value depends on how much time and effort the founder devoted to developing software based on his own experience and its contribution to the company's success.

Similarly, contributions made by other employees to the company may be valued at a monetary value, which the company may not be able to pay. However, by matching its contribution to the existing valuation of the company, it can provide equity in the company. After establishing their value, a percentage of the company's shares shall be assigned to an employee or service provider.

Importance Of Sweat Equity Shares

The following vital reasons illustrate the importance of sweat equity;

1. Company Success: 

Employees or service providers can gain a sense of ownership and pride in a company's success through Sweat equity. It can stimulate a strong culture of cooperation and collaboration and create a sense of shared purpose and vision.

2. Shortage of Cash: 

Frequent losses or a temporary lack of cash during the business cycle can result in an entity running out of funds. The financial burden on the company to pay staff salaries or reimburse founders for contributions may arise due to this cash flow problem. In such a case, companies may use sweat equity to compensate employees and founders for company shares instead of using cash or equivalents.

3. Motivation:

Sweat equity may be a crucial motivator for staff members and service suppliers, offering them concrete financial rewards for putting in extra effort to advance the business.

What Are The Maximum Number Of Sweat Equity Shares A Can Company Issue?

The value of sweat equity shares may be issued by a company based on several conditions:

1. The company can issue a maximum of 15% of the company's paid-up capital or Rs. 5 crore. 

2. At any one time, sweat equity must not represent more than 25% of the paid-up capital of the issuing company. 

3. For startups, not less than five years from the date they were incorporated or registered, companies can issue sweat equity shareholdings up to 50 % of their paid-up capital.

Conclusion

The company, therefore, provides directors and staff that have significantly contributed to its growth with sweat equity shares. These are granted to employees who have provided technical knowledge, acquired intellectual property rights, or added value to their employer.

In India. Sweat equity shares are issued at certain conditions per the share market laws. If you are willing to give sweat equity shares or want to understand what sweat equity shares are, get a stock market update with blinkX.  You can also download blinkX share market app for better reach and more profitable investment.