10-Commonly-Asked-Questions-About-Sweat-Equity-Shares,-Answered
ESOP

10 Commonly Asked Questions About Sweat Equity, Answered

A company’s human resources are undoubtedly its most valuable asset; especially in its early stage when the company or the startup needs to build trust among its employees. 

But what will motivate employees to stay with the company?

The answer is good incentives and appropriate credit for their hard work. This is not always about money; there is another way of rewarding employees for going the extra mile. It is known as Sweat Equity Shares.

Answers to Some of the Commonly Asked Questions About Sweat Equity

According to the US national accounts, the value for sweat equity in the private business sector is about 1.2 times US GDP. 

Let’s take a closer look at sweat equity shares.

Q1) What are Sweat Equity Shares? 

Sweat Equity Shares are shares that a company offers exclusively to its employees or directors. These shares are offered at a discount or for free, either for their contributions (labor) and value addition to the company or in exchange for cash.

Example: An employee of a company made a project (labor = sweat) and the project will be beneficial in the growth of the business. Happy with his/her work, the company has decided to give the person a bonus but instead of cash, they have decided to issue some shares of the company.

Q2) Which type of firms can issue Sweat Equity Shares?

Answer: Almost all types of firms and companies can issue these shares. Examples include:

  • Public Company
  • Private Company
  • One person Company
  • Non-Profit (Section 8) Companies
  • Listed or unlisted Companies

Q3) Is there any law that governs the issue of Sweat Equity Shares?

Answer: Yes! Certain laws govern the issuance of the sweat equity shares, such as in the USA the Reformed Uniform Partnership Act § 403 explicitly allows for individuals to become partners through sweat equity.

Q4) Is it more profitable to accept sweat equity shares instead of cash?

Answer: Yes! It can be more profitable in the long run. If the fundamentals of the company are strong then for sure sweat equity shares can generate more value in the future as compared to cash. Because of inflation, the value of the cash will decrease but not the value of shares.

Q5) Is there any lock-in period for sweat equity shares?

Answer: Yes! The Sweat Equity Shares have a lock-in period of 3 years from the date of allotment. Before that time frame, the shares cannot be redeemed or sold in the US.

Q6) What does value addition mean?

Answer: Value addition is the creation of actual or predicted benefits for the company generated by its employees, or directors. It can be in any form like providing know-how or intellectual property rights.

Q7) Are sweat equity shares taxable?

Answer: Yes! Whenever shares are assigned to employees, they become part of the employee’s taxable income for that particular year. For detailed information on taxation and sweat equity click here.

Q8) Why do companies issue shares instead of paying cash? Is it a more profitable option?

Answer: Maintaining cash flow in the early stages of a company is very important, and sweat equity shares are one way to do this. The benefits of sweat equity shares also extend to helping retain highly motivated employees in the company.

Q9) How is the value of sweat equity shares decided?

Answer: A registered valuer is consulted to determine the value of the intellectual rights/know-how of the employee or director. Accordingly, the valuer decides the value of the sweat equity shares and also justifies his/her valuation.

Q10) What are the differences between ESOP and sweat equity shares?

Answer: 

  • Unlike sweat equity, ESOP is a form of employee stock purchase plan that allows directors and employees to purchase company stock at a predetermined price at a future date.
  • The lock-in period of ESOPs is decided by the company whereas sweat equity has a fixed 3 years of the lock-in period.
  • When it comes to ESOP, employees buy company shares at a predetermined price but sweat equity shares are issued in place of cash or at a discount.
  • The company decides the price of the ESOP shares. There is no guideline regarding it in the company’s law. On the other hand, the value of sweat equity shares is determined by a registered value.
  • The company has no restrictions on granting ESOPs. On the other hand, for granting sweat equity shares there are many restrictions.

After discussing sweat equity shares in detail, it is clear that it benefits both the company and the employees. By owning shares of the company, the employees will have a sense of ownership of the company which will motivate them to work even harder.

So, these shares work for both:

  • It maintains proper cash flow in the company.
  • Provide appropriate incentives to the employees.
  • An effective way for companies to retain their valuable employees.
  • Owners of sweat equity shares can expect a good return in the future.

Click here for a detailed blog on how Sweat Equity works.

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