Entrepreneurs of start-up companies often forego their salaries and sweat out to make the company work. There is often a doubt of whether a company can issue shares without consideration – or cash consideration. It is well established that a promoter or shareholders may bring in cash or other forms of asset to start or keep the business running. Some key questions remain:
- Can a company issue shares to its shareholders against no tangible consideration (cash / assets)?
- But how does one quantify the efforts of the promoters / shareholders / entrepreneurs?
- If such shares can be issued, what should be the accounting for issue of shares?
- What is the position under The Companies Act, 2013?
- What are the tax implications?
Section 54 of The Companies Act, 2013 allows Issue of Sweat Equity Shares.
The issue can be done only after at least one year of commencement of business and should be authorised by a Special Resolution specifying the number of shares, the current market price, consideration if any, and the class or classes of directors or employees to whom such equity shares are to be issued. For listed companies, SEBI regulations need to be followed. For unlisted companies, Companies (Share Capital and Debentures) Rules, 2014: Rule 8. Issue of sweat equity shares need to be followed.
As per Rule 8 of Companies (Share Capital and Debentures) Rules, 2014, issue of sweat equity shares to its directors or employees (permanent employees – must have worked for at least one year) at a discount or for consideration other than cash, for their providing know-how or making available rights in the nature of intellectual property rights or value additions, may be done if the issue is authorized by a special resolution passed by the company in general meeting.
The expression ‘Value additions’ means actual or anticipated economic benefits derived or to be derived by the company from an expert or a professional for providing know-how or making available rights in the nature of intellectual property rights, by such person to whom sweat equity is being issued for which the consideration is not paid or included in the normal remuneration payable under the contract of employment, in the case of an employee. The issue must be completed within 12 months from the date of resolution.
Rules further provide that:
– The company shall not issue sweat equity for more than 15 percent of the existing paid-up equity share capital in a year or shares of the issue value of INR 5 crores, whichever is higher: Provided that the issuance of sweat equity shares in the Company shall not exceed 25 percent, of the paid-up equity capital of the Company at any time. However, a startup company, may issue sweat equity shares not exceeding 50 percent of its paid-up capital up to 10 years from the date of its incorporation or registration.
– The sweat equity shares issued to directors or employees shall be locked in/non-transferable for a period of 3 years from the date of allotment.
– The sweat equity shares to be issued shall be valued at a price determined by a registered valuer as the fair price giving justification for such valuation.
– The valuation of intellectual property rights or of know-how or value additions for which sweat equity shares are to be issued shall be carried out by a registered valuer, who shall provide a proper report addressed to the Board of directors with justification for such valuation.
Accounting
If the shares are issued pursuant to the acquisition of an asset, the value of the asset, as determined by the valuation report, shall be carried in the balance sheet as per the Accounting Standards and such amount of the accounting value of the sweat equity shares that are in excess of the value of the asset acquired, as per the valuation report, shall be treated as a form of compensation to the employee or the director in the financial statements of the company. The Accounting value shall be the fair value of the sweat equity shares as determined by a registered valuer.
Where there is consideration:
Dr Asset A/c (or Cash A/c)
Cr Share Capital A/c
Where there is no consideration, the amount should be expensed in the Profit & Loss Statement. This should ideally be in the form of compensation to such directors or employees and accordingly, the accounting entry should be
Dr Employee Benefit Expenses A/c
Cr Share Capital A/c
Where the value of assets acquired is less than the value of shares issued:
Dr Asset A/c
Dr Employee Benefit Expenses A/c
Cr Share Capital A/c
As you’d see, the impact would be that the Reserves or Profits would be reduced by the amount of increase in Share Capital. The amount of sweat equity shares issued shall be treated as part of managerial remuneration for the purposes of sections 197 and 198 of the Act, as applicable.
Valuation Impact
For valuers, this means that they may have to value the services from the professionals and assign such value towards the valuation of shares to be issued. They also have to value the company’s shares and identify whether the value of the services corresponds to the value of the shares being issued.
Tax impact
The Shares acquired by the employees or directors or entrepreneurs is treated as Perquisites under Income Tax. Rule 3 of the Income-tax Rules, 1961 prescribes the rules for the valuation of perquisites. According to Rule 3(8), the fair market value of an equity share in a company, on the date on which the option is exercised by the employee, is calculated as follows:
In case of listed companies, the fair market value shall be the average of the opening price and closing price of the share on that date on the said stock exchange (in case of multiple exchanges, take the prices from the exchange that records highest volume of trading).
In case of unlisted companies, the fair market value shall be such value of the share in the company as determined by a merchant banker on the specified date.
.
At Omnifin, we have helped various start-ups assess their share values. Want to know more about how you can value the shares of your company? Reach out to us on +91 88 2000 1234 or email us at contact@omnifinsolutions.com .