Tag Archives: Sweat Equity

Amendments to Companies Act and some relief to Permitted Startups

With the ability to modify the guidelines quick and fast, Companies Act has become dynamic. On 19 July 2016, the Ministry of Corporate Affairs notified the Companies (Share Capital and Debentures) Third Amendment Rules 2016 (Amendment) to amend certain provisions of the Companies (Share Capital and Debentures) Rules 2014 (Rules). These Rules contain the procedures for issuance of shares and debentures and disclosures to be made.
Notes of the Amendments made:

1. Relaxation of preferential allotment process:
Earlier to these amendments, any securities issued through the ‘private placement’ process had to be fully paid up at the time of allotment. This infact was an anomaly, because, if the company chose a ‘right issue’ process, then it was possible to issue partly paid shares. The amendment now seeks to set this anomaly right and made it possible to issue partly-paid shares even through private placement process.

2. Determination of conversion price:
Earlier to these amendments, a company issuing convertible securities had to determine the conversion price at the time of issuance. This is true for any foreign direct investment as well. Now, companies may either determine the conversion price (a) upfront at the time of offering the convertible securities, or (b) not later than 30 days prior to the date the holder of convertible securities becomes entitled to convert such convertible securities, based on a valuation report of a registered valuer issued not later than 60 days prior to such date. The change in the foreign direct investment guidelines is still the same and it has to be notified to RBI at the time of issuance.

3. Issue of secured debentures:
Earlier to these amendments, a company could provide only its own assets and properties as a security for issuance of secured debentures. Now, the companies can issue secured debentures by creating a charge on the assets and properties of its subsidiaries, holding company or associate companies. The amendment expressly permits companies intending to redeem their debentures prematurely to transfer such amounts in excess of the limits specified under the Rules as may be necessary to the Debenture Redemption Reserve.

4. Issue of equity shares with differential rights:
Earlier, companies could not issue equity shares with differential rights if they defaulted in (a) the payment of dividends on preference shares, (b) the repayment of a term loan (or interest thereon) from specified institutions, (c) the payment of statutory dues relating to employees, or (d) crediting prescribed amounts in the Investor Education and Protection Fund. Now, such defaulting companies to issue equity shares with differential rights after 5 years from the end of the financial year in which they make good the default. It would have been nice, that a company could issue such shares immediately upon compliance.

5. Sweat equity shares by Permitted Start-ups:
Start-ups (as defined in notification number GSR 180(E) dated 17 February 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India – “Permitted Startups”) are now permitted to issue sweat equity shares up to 50% of their paid-up capital for the first 5 years from the date of their incorporation. For other companies, this limit continues to be 25%.

6. Stock options to promoters and shareholder-directors of the Permitted Start-ups:
Permitted Start-ups can issue stock options to their promoters and to directors who hold more than 10% of the start-up’s equity shares for the first 5 years from the date of their incorporation. The restriction on issuing stock options to promoters and such directors continues for all other companies, who are not Permitted Startups.

7. Form SH-7 by companies not having share capital:
The Amendment requires that Form SH-7, for intimating any alteration of a company’s authorised share capital, be filed by companies that do not have share capital in case of an increase in the number of members.

Author: Venkatesh Vempati, works as an Associate with the Compliance Team

Issue of sweat equity shares for a private company – Companies Act, 2013.

Issue of sweat equity shares for a private company used to be regulated by Section 79A and Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003 under Companies Act, 1956. Now the same is regulated by Section 54 and Chapter 4 under Companies Act, 2013.
“Sweat equity shares” means such equity shares, which 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 in the nature of intellectual property rights or value additions, by whatever name called.


Essentials of Sweat Equity:

Eligibility for Sweat-
a) Permanent employee of the Company who has been working in India or outside India, for at least last 1 year
b) Director of Company-Whole time director or not
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.
Value Addition– Has been defined. It means actual or anticipated economic benefits derived or to be derived by Company from an expert or a professional for providing know-how or making available rights in the nature of intellectual property rights.
Authorisation by shareholders– Yes, prior shareholders approval through special resolution is required.
Time limit for issuing Sweat: Allotment of sweat equity shares shall be made within 12 months from the date of passing special resolution.
Time Gap– There should be at least 1 year between the commenced of business and issue of such shares.
Valuation– Valuation of sweat shares and intellectual property rights(IPR)/know how/ value additions shall be done by Registered Valuer.
Notice of General Meeting– Critical elements of Valuation Report shall be sent along with the Notice. Particulars like class of shares, price, consideration, principal terms of conditions, employees to whom sweat is proposed is required to be mentioned in explanatory statement.
Limit on sweat equity: In a year, sweat shares shall not exceed 15% of existing paid up equity share capital or shares having issue value of Rs. 5,00,00,000, whichever is higher. However, it should not exceed 25% of paid up equity capital of Company at any time.
Mandatory lock-in period- 3 years from the date of allotment. The fact that the share certificates are under lock-in and the period of expiry of lock in shall be mentioned in prominent manner on share certificate.
Manner of treatment of sweat issued for other than cash in Books of accounts-
a) If non-cash consideration takes the form of a depreciable or amortizable asset- Should be carried to the balance sheet according to accounting standards; or
b) In other cases- Shall be expensed as provided in the accounting standards.
Accounting value of sweat equity
a) If sweat equity shares are not issued for acquisition of an asset- Value shall be treated as a form of compensation to the employee or the director in the financial statements of the Company.
b) If sweat equity shares are issued for 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
Rights/limitations/restrictions applicable on sweat equity shares- Shall rank pari passu with other equity shareholders.
Disclosure in Directors Report- Particulars like class of director or employee, class of shares, number of sweat equity shares, percentage of sweat equity shares in total post issued and paid up share capital, diluted Earnings Per Share, consideration received.
Register of Sweat Equity Shares– Details of sweat shares shall be mentioned in this Register. Shall be maintained at Registered Office or such other place as the Board may decide. Entries shall be authenticated by CS of the Company or by any other person authorized by Board.

Author : Geetika Chandel – a Company Secretary; manages Compliances at NovoJuris. She loves making graffitis.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

All about ESOPs – Part I of the series

An Employee Stock Option Plan (ESOP) is an option given to the employees to buy the shares of the Company. Until the option is exercised and converts into a share, an option holder does not get any shareholder rights of voting, dividends and the like. An Option is valuable because it gives the right to purchase the shares at typically a pre-determined price, so that an employee gets to benefit from an upside to the value.
The transparency, quality and consistency of the ESOP including messaging by the company’s leadership determines the employees’ enthusiasm, indifference or cynicism.

This blog post is the first of a series of 5.

  •  This one is a Basic Primer and covers: Terms used, what makes it attractive and  a little bit about taxation and valuation.
  •  How to Implement, nuances of implementing
  •  Foreign companies reaching out to employees in India and vice versa
  •  And round off with the implications of ESOP, timings when there is an external investment due in the company.

Basic glossary:

  •  Grant: Is the act of commitment by the employer through informing the employee of the eligibility for the Options under ESOP.
  •  Vesting: Has two parts- Vesting percentage is the portion of the total options Granted which can be exercised on completion of the Vesting Period.
  •  Exercise: Is the act of paying the Exercise Price to convert the Options into Shares
  •  Exercise Period: Any time after the Vesting Period within which the employee has to Exercise.
  •  Lapse of Options: After a certain period, typically termination, expiry of Exercise Period the Options lapse and cannot be converted to Shares.

An ESOP can be used for multiple purposes – as a talent retention tool, as an incentive, as a remuneration mechanism. Accordingly the parameters of the Plan would be tailored. If retention, then probably the vesting period would be longer. If incentive, then probably the Exercise Price would be kept low, may be face value of shares, so that the employee enjoys a high upside. If remuneration tool, then the eligibility criteria would possibly be all employees. But typically, it is a combination of all of these factors and hence a good balance is required to be detailed in the Plan.

An Option is different from Sweat Equity. Sweat Equity means Shares (not Options) granted “in lieu of” services, technology transfer etc. Sweat Equity because it is a Share and will have shareholder rights. Also, tax treatment and accounting treatment is different compared to Options.

What makes Options attractive is that the Exercise Price to be paid by the employee is usually lesser than market price. But taxation kind of spoils the party.

Here’s a little about ESOP taxation for private and unlisted companies. (Please consult an expert before implementing. Tax rates, tax incidence keep changing):

a. Until 2009 ESOPs attracted Fringe Benefit Tax. With FBT now removed, ESOPs are taxed as a perquisite provided by the employer to the employee.

b. The tax incidence is when an employee Exercises the Grant by paying the Exercise Price.

c. The perquisite value for tax is calculated as Fair Market Value (FMV) of the Shares on the date of Exercise (less) Exercise Price. Calculation of FMV is detailed in Direct Tax Notification No. 23 dated 8 April 2010. Care to be taken if there is any prior VC funding etc. because that price might be considered as FMV.

d. When an employee ‘sells’ the Shares, then he further pays capital gains tax on the sale price (less) price arrived at point c above.

(This might be a little over-whelming, but that is why the experts!)

This then raises a question as to when is the ideal time to Exercise. Any time after Vesting, the employee has a choice based on his personal financial strategy, his visibility of the movement, of the Share price can Exercise, also keeping in mind the tax pay-out.
Coming up next is the process of implementing and nuances around it.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.