ESOP and sweat equity shares are both methods by which a company can issue shares to its employees, acting as an incentive for employees to contribute to the company's growth. While they are often confused, there are many differences between the two. To compare the two, it's important to first understand what each term means. Let's start with the fundamentals.
What are ESOPs?
ESOP is a plan where a company offers its directors, employees, and officers the option to buy shares in the company at a discounted price. The plan specifies the eligible employees, share price, and grant date in advance.
However, the shares are not immediately given; they are held in a trust fund during a predetermined vesting period. Eligible employees must remain with the company during the vesting period to receive the shares. If they do, they can buy the shares at the grant price on the vesting date.
What is sweat equity?
Sweat equity is a type of equity that can be issued to employees of a company. It is a way for companies to show their appreciation for employees who have made exceptional contributions to the growth of the company. In other words, it is a reward for their hard work and service to the company.
Sweat equity shares are issued for non-cash consideration or at a discount. These shares are allotted to specific employees or directors for any of the following reasons:
- Exceptional contribution to the successful conclusion of a project or an assignment
- Exhibition of technical expertise in any given field
- Value addition by the employee to the company through any outstanding contribution or by rights to intellectual property
Sweat equity shares vs ESOP: The key differences
Let's now compare ESOPs and sweat equity shares in important areas. See the differences in the infographic below.
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Particulars
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ESOPs
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Sweat equity shares
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Governing section
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Section 2(37) of the Companies Act, 2013
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Section 2(88) of the Companies Act, 2013
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Meaning
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ESOPs are options that give the employees of a company the right to purchase the company’s shares at a specified price on a future date.
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Sweat equity shares are shares issued to the directors/employees of a company at a discount or for non-cash consideration, for contributing to the company in the form of technical expertise or intellectual property.
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Nature of shares
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ESOPs are issued as an incentive to retain the top talent in the company.
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Sweat equity is issued as a reward for employees who have played a significant role in the company’s growth.
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Eligible recipients
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- Any permanent employee of the company working in India or abroad
- Any director of the company, including full-time and part-time directors (but excluding independent directors)
- Any permanent employee or director of a subsidiary company in India or abroad, or of a holding company or an associate company
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- Any permanent employee of the company working in India or abroad
- Any director of the company
- Any permanent employee or director of a subsidiary company in India or abroad, or of a holding company
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Timing of the issue
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ESOPs can be issued at any time after the company has been incorporated.
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Sweat equity shares can be issued only after the company has been in business for at least 1 year.
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Quantum of the issue
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There are no restrictions on the quantum of ESOP issue.
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In case of one-time issues:
A company can only issue sweat equity shares up to 15% of its existing paid-up share capital or Rs. 5 crores, whichever is higher.
In case of lifetime issues:
A company can issue sweat equity shares up to 25% of its paid-up share capital.
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Consideration for the issue
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The consideration for ESOPs needs to be paid in cash.
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The consideration for sweat equity shares can be paid in cash or as non-cash consideration.
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Pricing of the issue
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The grant price or the exercise price is decided by the company itself.
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The prices of sweat equity shares are decided by a registered valuer.
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Lock-in period
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ESOPs do not have any specific lock-in period.
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Sweat equity shares have a lock-in period of 3 years.
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Taxation at the time of allotment
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ESOPs are considered as perquisites on salary and are taxed accordingly, under the head ‘income from salaries.’
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Sweat equity shares are taxable under the head ‘income from salaries’ in the year of allotment.
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Taxation at the time of sale of shares
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The profits from the sale, if any, are taxed as capital gains.
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The profits from the sale, if any, are taxed as capital gains.
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Want to read up about taxation for ESOPs? Here is a detailed blog.
Summing up
The bottom line is that ESOPs and sweat equity shares share some basic commonalities. They are both issued to employees and may both be offered at discounted prices. However, there are several differences between ESOPs and sweat equity shares. Understanding these distinctions can help you better comprehend the type of shares you receive, if your company issues either ESOPs or sweat equity.
Frequently Asked Questions
1. Why do companies issue ESOPs?
Companies issue ESOPs to attract and retain top talent. Eligible employees can buy shares at a discount but only after a vesting period. ESOPs retain talented employees and motivate them to contribute to the company.
2. What is meant by sweat equity?
Sweat equity refers to shares given to employees for their contribution to the company, including technical expertise, value addition, or intellectual property rights.
