Sweat Equity Shares Vs ESOP: Overview & Differences Between Them

Some of the big multinational companies (MNCs) reward their employees through a number of ways other than only salary and monetary incentives. One such way of rewarding the employees for their effort and dedication is by allocating shares (stock shares) in their name. This does not go only as a reward but also helps the company in achieving better employee retention since good and hard working employees are key to the success of any company that wants to grow in the long run and excel out in the competition.

When it comes to issuing shares to employees, Sweat Equity Shares and Employees Stock Option Scheme (ESOP) are the ways generally used by the companies. The best part about issuing shares in the name of employees is that it also helps to increase the market capitalisation of the company. Although Sweat Equity Shares and ESOP may look similar in the first instance, there are still a number of differences that need to be highlighted for a better understanding of the two. However, instead of jumping directly into learning the differences between Sweat Equity Shares and ESOP, let us first understand both in brief.

Both Sweat Equity Shares and ESOP are offered as rewards to employees or directors of the company.

Sweat Equity Shares

By definition under the under Section 2(88) of the Companies Act, 2013, these shares are issued to the company’s members of the board of directors or employees as a non-monetary benefit, sometimes at a discount, to make rights available in the form of intellectual property rights in the name of the shareholder. Sweat Equity Shares are generally issued to the ones who have contributed to the formation or growth of the company, hence the name ‘Sweat Equity Shares’.

Employees Stock Option Scheme (ESOP)

Defined under Section 2(37) of the Companies Act, 2013, Unlike Sweat Equity Shares, Employees Stock Option Scheme (ESOP) means the options offered to the officers, directors, and employees, or any subsidiary company to purchase or subscribe to the company’s own share in the future at a predetermined price. These shares are generally issued when a company wants to increase its subscribed capital. While issuing ESOP, the employer (company) or the issuing part reserves the sole discretion to decide who could avail the options.

Sweat Equity Shares and ESOP gives the employees/directors a sense of ownership right in the company.

Differences between Sweat Equity Shares and Employees Stock Option Scheme (ESOP)

As clear from the aforementioned definitions itself, both the Sweat Equity Shares and Employees Stock Option Scheme (ESOP) are issued for the same purpose but have quite a lot of differences that one needs to understand. Let us discuss those aspects which separate the one from the other.

Basis	Sweat Equity Shares	Employees Stock Option Scheme (ESOP)
Type	Sweat Equity Shares are issued to provide intellectual property rights to the directors or employees of the company, who, in general, have contributed to the formation of the company.	Employees Stock Option Scheme or ESOP are issued as a type of incentive/reward to retain the employees and directors of the company. It is more like an option offered to allow the purchase of the share.
Eligibility	●     The shareholder must be a permanent employee of the company ●     Whole/part time director ●     Employee or director of a subsidiary/holding/associate company	●     The shareholder must be a permanent employee of the company   ●     Director of the company (whole/part time) ●     Permanent employee or director of a subsidiary company
Allotment	Sweat Equity Shares are allotted directly to the employees/directors of the company or any of its subsidiary companies.	ESOP is actually a type of scheme in which the employees or directors of the company or its subsidiary companies are given the right/option to purchase the share.
Price	Sweat Equity Shares are often offered at a discount by the company.	The employees or directors who are offered shares under ESOP are allowed to purchase the share in the future at a predetermined price.
Lock-in Period	The lock-in period in Sweat Equity Shares is three years (fixed as per the Company Rules)	The lock-in period in ESOP is decided by the company.
Limitations	Sweat Equity Shares cannot be issued over 15% of the already paid-up equity share capital in a particular year or of the issue value of INR 5 crores, whichever is more.	There is no restriction or limitation on the company to issue ESOP to the employees or directors.
Consideration	In Sweat Equity Shares, the consideration is anything other than cash or at a discount. This may be partly cash and partly non-cash.	In the case of ESOP, the consideration is paid in cash.
Guidelines Related to Pricing	The valuer (registered) decides the pricing guidelines.	There are no guidelines related to the pricing described under the Companies Rules.
Taxation	The tax in Sweat Equity Shares is calculated under the ‘Salary’ head in the hands of the employee, in the year in which they are issued.	After the vesting period (after the exercise of the option), the employer calculates the value of the tax, under ‘income from salary’ head.

Role of Sweat Equity Shares and Employees Stock Option Scheme (ESOP) in a Company

Sweat Equity Shares and ESOP plays an important role in rewarding employees and directors and retaining them for a longer period. Unlike the monetary incentives and rewards that are conventionally offered, these two ways also help the issuer to raise capital and increase its market value. Since employees and directors play a crucial role in determining the success of any company, Sweat Equity Shares and ESOP are great ways to ensure that the employees do not feel alienated from the environment and get a sense of ownership in the company.

So we have learned thoroughly the importance of Sweat Equity Shares and ESOP in a corporate structure and the benefits they bring for the employees and the company simultaneously. However, there are a number of differences that range from the type, price, allotment to limitations and other guidelines that differentiate a lot. Hence, both are used for different purposes, different employees/directors, and in different cases.