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Difference between ESOPs and Sweat equity shares

Prabhat Nigam

| Updated: Apr 14, 2022 | Category: Annual Compliance

Difference between ESOPs and Sweat equity shares

Introduction

Employee Stock Option Plans or commonly called as ESOPs are basically stock options which the company gives to its very senior or key employees. However, early stage start-ups give stock options to those employees who had worked with them from early days in order to reward their loyalty. For example, a tech giant has given ESOPs to its chefs also. Similarly, Sweat equity shares is another mechanism for rewarding its high performance employees where the company issues shares to its employees in return for the value of services provided by them to the company. ESOPs and Sweat equity shares are given to the employees of the company for retaining the key employees and also high performing employees respectively.      

How are ESOPs and sweat equity shares regulated?

Following is the regulatory framework for regulating ESOPs and sweat equity shares in India:

  • The Companies Act, 2013
  • In case of unlisted companies and private companies: Companies (Share capital and Debentures) Rules, 2014
  • In case of listed companies: SEBI (Share based employee benefits) Regulations, 2014  

How are ESOPs and sweat equity shares granted?

Both the ESOPs and sweat equity shares are granted by implementing the following:

  • A stock option plan needs to be created which lists down the terms of stock option plans and how they will be granted under this scheme.
  • A grant letter will also be issued to the employee to whom it is granted.

What are sweat equity shares?

The Companies Act, 2013 provides the definition of sweat equity[1] shares under sub-section 88 of section 2. The provision states that:

Sweat equity shares are the stock options which the company issues to its directors or employees at a discount or for consideration other than cash in return for providing their know-how or making available rights in the nature of intellectual property rights or value additions by whatever name called.

What are ESOPs?

Employee Stock Option Plans or ESOPs is an option given to the senior employees like directors, officers and also to employees where they are given a right to exercise the option to purchase the shares of the company at a later date. The ESOPs are given as an incentive and also works as retention plan to retain the important talent within the company for longer periods.  

What are the major difference between ESOPs and sweat equity shares?

The difference between ESOPs and sweat equity shares can be laid down under the following heads:

  1. Allotment of stock options

Under ESOPs, the stock options are granted to the employees in the form of an option to purchase the shares at a predetermined price on a future date. These shares are allotted to the employees only after such employees or directors exercise their option of the ESOP grant whereas sweat equity shares are directly allotted to the employees or directors at a discount or for consideration other than cash. In sweat equity shares allotment, there is no concept of exercising option. The shares are directly allotted to the employees.

  • Eligibility of the employees to receive stock options

In case where ESOPs are granted to an employee the employee should be one who has either been working for the company in India or outside India. In case of directors which include whole-time directors or part time directors but they do not include an independent director. Further, a permanent employee or a director of the subsidiary company incorporated in India or outside India, or a holding company or an associate company. However, the following employees are not eligible for receiving ESOPs. An employee who belongs to a promoter group of the company or a director who himself holds or through his relative or through any body corporate, holds more than 10% of the company’s outstanding equity shares directly or indirectly.

On the other hand in case of sweat equity shares the eligible person to receive stock option includes a permanent employee of the company working in India/ outside India; director of a company whether whole time or not; a permanent employee of a subsidiary company inside India or outside India or of a holding company.  

  • Consideration for receiving stock options

In case of ESOPs, the stocks can be purchased only in cash. Therefore, the consideration for exercising ESOPs is cash from the employee whereas in case of sweat equity shares, the consideration is other than cash or at a discount which can partly be cash and partly non-cash.

  • Decision on Lock-in period

The decision regarding the lock-in period is decided by the company only on which there is no statutory limit. The company is free to decide any period, however long it may be. The best practice that is followed among the companies is of 4 years where the stock options are released every year up to certain percentage. For example 25% every year.

In case of sweat equity shares the lock-in period has been as 3 years according to Companies (Share Capital and Debenture) Rules.

  • Pricing guidelines of the stock options

In case of ESOPs, the company gets to decide the exercise price since no guidelines have been given under the Companies (Share Capital and Debentures) Rules whereas in case of sweat equity shares, a registered valuer gets to decide the pricing guidelines.

  • Restrictions imposed on issuing of ESOPs

There are no restrictions imposed on the company for issuing or granting of ESOPs. However, in case of sweat equity, the limit has been set at a maximum of 15% of the already paid-up share capital in a particular year or shares of the issue value of Rupees 5 crores whichever is higher among the between the two. Further, the sweat equity shares in a company should not be issued more than 25% of the paid-up equity capital of that company at any point of time.   

Conclusion

Having gone through the number of difference between ESOPs and sweat equity shares, it can be seen that for availing ESOPs the employee needs to exercise the option of buying the stocks as per the ESOP scheme. There is no inherent right vested in the employee. It is only an option that can be availed by the employee in the future. On the other hand, sweat equity shares can be directly availed as a fruit for their contribution to the company. 

Read Our Article:Employee Stock Option Plans (ESOPs)- An Overview

Prabhat Nigam

Prabhat has done his BA LLB (Hons) and has been writing research papers since his law school days. His interest in content writing made him pursue a career in legal research and content writing. His core areas of interest are indirect taxes, finance and real estate.

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