Key Differences between ESOP and Sweat Equity

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.

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.