During the ongoing pandemic, startups have been looking to conserve cash, while ensuring that their employees are motivated and adequately compensated. Startups have been offering ESOPs, sweat equity, phantom stocks as well as other equity linked incentives to their employees.

To provide flexibility to startups, the Ministry of Corporate Affairs (“MCA”) has amended the Companies (Share Capital and Debentures) Rules 2014 (“Rules”) with regard to issue of sweat equity shares.

What is Sweat Equity?

Sweat equity shares are shares issued by the company to their employees or directors for the hard work and sweat they put in for the company. Sweat equity shares are defined in Section 2(88) of the Companies Act, 2013 (“Act”) and are governed by Section 54 of the Act and Rule 8 of the Rules.

Sweat Equity can only be issued to employees or directors of a company for providing their know-how or making available rights in the nature of intellectual property rights or value additions. Startups can issue sweat equity as soon as they are incorporated. We have discussed the process of issuing sweat equity, pricing etc. here.

What is the new relaxation?

The Department for Promotion of Industry and Internal Trade had earlier issued a notification on 19 February 2020 in which the definition of “Startup” had been revised. Accordingly, the MCA has made amendment in Rule 8 with regard to this notification. The MCA has amended the clause so that the definition of “Startup” shall now be recognized as defined in the notification issued on 19 February 2019 instead of the earlier notification dated 17 February 2016.

Also, the MCA has increased the time limit till when a startup can issue sweat equity shares from five years to ten years from the date of its incorporation. Accordingly, a startup can issue sweat equity shares for ten years from the date of its incorporation.

TL Views

This relaxation will go a long way in helping the startup ecosystem since many startups are looking at issuing sweat equity to their employees as a mechanism to incentivize employees while conserving cash.  

This post has been contributed by Ms. Vaneesa Agrawal and Ms. Vasuvita Singh.

[DISCLAIMER:  This article is for academic purpose and is solely to provide readers with general information regarding developments in Indian law. The information contained herein does not constitute legal or a professional advice.]