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ESOP Vs Sweat Equity Shares

Updated on: Jan 12th, 2022


6 min read

A company can issue its shares to the employees. This provides an incentive for the employees to contribute better to the company and motivate them. It also helps to retain the employees in the company for the long term. The employees are the key factor for the success of the company. Their efforts can be compensated by way of issuing shares to them.

Employees Stock Option Scheme (ESOP) and Sweat Equity Shares are two methods of issuing shares by a company to its employees. By issuing the shares, the company can also increase its capital. Both ESOP and Sweat Equity Shares are issued as per the provisions of the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014. However, the listed companies need to comply with the provisions of the Securities Exchange Board of India Regulations/Guidelines for the issuance of these shares.

Employees Stock Option Plan

Employee Stock Option is defined under Section 2(37) of the Companies Act, 2013. The employees stock option means the option provided to the directors, employees or officers of the company or its holding or subsidiary company, which gives the right or benefit to subscribe or purchase the shares of the company at a predetermined price on a future date. It is issued by a company when it wants to raise its subscribed capital. Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 regulates the procedure of the issue of ESOP.

Sweat Equity Shares

Sweat Equity Share is defined under Section 2(88) of the Companies Act, 2013. The sweat equity shares mean shares issued by a company to its directors or employees for non-cash consideration or at a discount for making rights available in the nature of intellectual property rights or providing know-hows or any providing any value additions in any form. Rule 8 of Companies (Share Capital and Debentures) Rules, 2014 regulates the procedure of issue of sweat equity shares.

ESOP vs Sweat Equity Shares

ParticularsESOPSweat Equity Shares
NatureESOPs are issued in the form of an incentive and as a retention plan to directors and employees. They do not create an obligation, and it is in the form of a right given to employees to exercise their option to purchase the shares.Sweat equity shares are issued to the employees or directors as consideration for providing intellectual property rights or know-how or any value additions to the company. 
AllotmentESOP is granted in the form of an option for the employees to purchase the shares at a predetermined price on a future date. These shares are allotted to the employee or directors only after exercising their option of the ESOP grant.Sweat equity shares are directly allotted to the employees or directors at a discount or for consideration other than cash.
Eligibility1. A permanent employee of the company who is working in India/outside India.2. A Director of the company, which includes a whole-time/part-time director but not an independent director.3. A permanent employee or director of a subsidiary company in India or outside India, or holding company, or an associate company.
But the following employees are not eligible –1. An employee who belongs to the promoter group or is a promoter of the company.2. A director who, either himself or through any body corporate or through his relative, holds more than ten per cent of the company’s outstanding equity shares, whether directly or indirectly.
1. A permanent employee of the company working in India/outside India.2. A Director of the company whether a whole-time or not.3. A permanent employee or director of a subsidiary company in India or outside India or holding company.
ConsiderationThe consideration for ESOP has to be paid in cash.The consideration for sweat equity shares is other than cash or at a discount which may be partly cash and party non-cash. 
Lock-in PeriodThe company decides the lock-in period. The lock-in period is three years as per the Companies (Share Capital and Debentures) Rules.
Pricing GuidelinesThe company decides the exercise price. There are no pricing guidelines defined under the  Companies (Share Capital and Debentures) Rules.A registered valuer determines pricing guidelines.
RestrictionsThe company has no restrictions for issuing or granting ESOPs.The company cannot issue sweat equity shares in excess of 15% of the already existing paid-up equity share capital in a particular year or shares of the issue value of Rs.5 crores, whichever is higher.Also, the sweat equity shares in the company should not be issued more than 25% of the paid-up equity capital of that company at any time.

Disclaimer: The materials provided herein are solely for information purposes. No attorney-client relationship is created when you access or use the site or the materials. The information presented on this site does not constitute legal or professional advice and should not be relied upon for such purposes or used as a substitute for legal advice from an attorney licensed in your state.

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Quick Summary

Companies issue shares to employees through ESOP and Sweat Equity Shares for motivation, retention, and capital increase. ESOP is an option to buy shares in the future while Sweat Equity Shares are given for non-cash consideration. Eligibility criteria and considerations differ for the two schemes, governed by rules and regulations set by the Companies Act, 2013. Pricing, restrictions, lock-in period, and issuance norms vary between ESOP and Sweat Equity Shares.

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