Share Based Employee Benefits and Sweat Equity: formula sheet

Key formulas

Sequence of an ESOP

Grant → Vesting → Exercise → Allotment

Use this order in every answer. Options cannot be exercised before they vest.

ESOP in one line

Option = right to buy at exercise price, not an obligation

If the market price is below the exercise price, the employee can let the option lapse.

Employee's gain on exercise

Gain per share = Market price − Exercise price

Positive only when market price exceeds exercise price. SAR pays this kind of difference over a base price.

Who regulates what

Listed or proposed-to-be-listed companies: SEBI regulations (section 24). Other companies: Central Government.

Section 24 covers issue and transfer of securities. Matters such as prospectus and redemption of preference shares stay with the Central Government, Tribunal or Registrar.

Dematerialisation for public offers

Section 29(1): every company making a public offer issues securities only in dematerialised form

Prescribed classes of unlisted companies must also hold and transfer securities only in demat form under section 29(1A).

Approval

ESOP scheme = special resolution of shareholders (75% of votes cast in favour)

A special resolution needs votes in favour to be at least three times the votes against. Listed companies pass a separate resolution for each scheme.

Administration

Scheme administered by the compensation committee

In a listed company, the nomination and remuneration committee acts as the compensation committee. The scheme is framed and run by this committee.

Minimum vesting period

Grant to vesting ≥ 1 year

The one-year minimum does not apply if the employee dies or becomes permanently incapacitated. Vesting can be staggered, for example in instalments.

Exercise period

Exercise happens after vesting, within the period fixed by the company in the scheme

Vested options not exercised in time lapse. The scheme also states the exercise period after the employee leaves.

Eligible employee

Permanent employee, or director (not independent director), of the company, its subsidiary or holding company, or its associate company

A promoter or promoter group member is not eligible. A director who, directly or through relatives or a body corporate, holds more than 10% of the outstanding equity shares is also not eligible.

Exercise price

Exercise price is set by the company, in line with the applicable accounting policies

The price may be below, at or above market price. If below market, the discount is treated as employee compensation cost under the accounting rules.

Lock-in

ESOP: no minimum lock-in on shares allotted on exercise; ESPS: minimum lock-in of 1 year

The scheme may impose its own lock-in. This is the standard point of difference with ESPS.

Rights of option holder

Option holder has no dividend or voting rights until shares are allotted; options are not transferable

Options cannot be pledged, hypothecated or mortgaged.

ESPS in one line

ESPS = employees buy shares at the offer price → allotted → minimum one-year lock-in from allotment

Employee pays and becomes a shareholder. No option stage, unlike ESOP. The lock-in does not apply to shares allotted under ESPS in a public issue.

SAR payout

SAR payout = (Market price on exercise − Base price) × Number of SARs

Payable in cash or in shares of equal value, as the scheme provides. Payout is nil if market price is not above base price.

Shares issued on share-settled SAR

Shares issued = SAR payout ÷ Market price on settlement date

Use this only when the scheme settles in shares. Round as the scheme states.

Discount on ESPS

Discount per share = Market price − Offer price

Applies only if the shares are offered below the market price. It is then the benefit to the employee and is treated as employee compensation cost in accounting.

Financial assistance bar (Companies Act, section 67(2))

No public company may give financial assistance, directly or indirectly, for purchase or subscription of shares in the company or in its holding company

Exceptions in section 67(3): (a) a banking company lending in the ordinary course of its business; (b) money provided under a scheme approved by the company through special resolution, in the prescribed manner, for purchase of or subscription for fully paid-up shares in the company or its holding company, where the shares are held by trustees for the benefit of employees or by the employees; (c) loans to employees (other than directors or key managerial personnel) up to six months' salary or wages to buy or subscribe for fully paid-up shares in the company or its holding company, to be held by them by way of beneficial ownership.

Penalty for breach of section 67

Company: fine ₹1,00,000 to ₹25,00,000. Officer in default: imprisonment up to 3 years and fine ₹1,00,000 to ₹25,00,000

Section 67(5). State both limbs.

Authority for issue (section 54(1)(a))

Sweat equity issue = authorised by special resolution

A board resolution alone is not enough.

Contents of the resolution (section 54(1)(b))

Number of shares + current market price + consideration, if any + class or classes of directors or employees

Learn all four items. Examiners often ask for them.

Route of issue (section 54(1)(d))

Listed company: SEBI regulations. Unlisted company: prescribed rules

The section itself does not give the detailed procedure.

Rank of shares (section 54(2))

Sweat equity shares rank pari passu with other equity shares

Same rights, limitations and restrictions as equity shares.

Annual limit (under the Rules)

Issue in a year ≤ higher of 15% of existing paid-up equity share capital or ₹5 crore of face value

This comes from the Rules, not section 54. Special relaxations exist for startups, so read the question's facts.

Overall limit (under the Rules)

Total sweat equity shares issued at any time ≤ 25% of paid-up equity share capital

Check the existing sweat equity shares before computing fresh room.

Lock-in (under the Rules)

Sweat equity shares are locked in for 3 years from the date of allotment

Mention as a rule, with no section number. Study it with valuation and disclosures.

Conditions for issue (Section 54(1))

Class already issued + special resolution + resolution states number, current market price, consideration, class of directors/employees + SEBI regulations (listed) or rules (unlisted)

Clause (c) was omitted with effect from 7-5-2018, so do not quote the old one-year condition as part of the section.

Rights of holders (Section 54(2))

Sweat equity shares rank pari passu with other equity shares

Same rights, limitations and restrictions as equity shares.

Valuer appointment (Section 247(1))

Appointed by audit committee; if none, by the Board

The valuer must be registered and a member of a recognised organisation.

Valuer duties (Section 247(2))

Impartial, true and fair valuation + due diligence + prescribed rules + no interest in the asset (3 years before appointment or 3 years after valuation)

Valuer penalty: fine ₹25,000 to ₹1,00,000. If intent to defraud: imprisonment up to 1 year and fine ₹1,00,000 to ₹5,00,000. On conviction, the valuer must refund remuneration and pay damages.

Lock-in

3 years from allotment (Companies Rules for unlisted companies; SEBI SBEB & SE Regulations, 2021 for listed companies)

Lock-in means non-transferable. Check the current ICSI material for any change.

Accounting amount

Cost to company = (Fair value per share − Price paid per share) × Number of shares

Debit employee benefit expense, or an intangible asset if it meets recognition criteria. Credit share capital at face value and securities premium for the rest.

Initial value and withheld price (s. 378E(1))

Member first receives: value fixed by Board for produce supplied. Balance = withheld price, paid later.

Subject to the articles. Paid in cash, in kind or by equity shares, in proportion to produce supplied in the financial year, to the extent and on the conditions the Board decides.

Limited return (s. 378E(2))

Return on share capital contributed = limited return only

Limited return is the maximum dividend specified by the articles (s. 378A(d)). Bonus shares may be allotted as per section 378ZJ.

Patronage bonus (s. 378E(3))

Surplus after limited return and reserves under s. 378ZI → patronage bonus in proportion to participation in business

Paid in cash or equity shares or both, as the members decide at the general meeting. Approval of the bonus itself is by resolution at the AGM (s. 378S(b)).

Meaning of patronage bonus (s. 378A(i))

Payment from surplus income to Members in proportion to their respective patronage

Patronage means use of the company's services by participation in its business activities (s. 378A(h)).

Who decides what (s. 378S)

Approval of patronage bonus, bonus shares and declaration of limited return: by resolution at the annual general meeting

The Board can exercise these powers only through such resolutions.

Quick revision

• Share based employee benefits reward employees with shares or with payments linked to share value.
• ESOP gives a right to buy shares later at a set price. The employee is not a shareholder until the option is exercised.
• ESPS means the employee buys shares directly under a scheme.
• SAR pays the employee the rise in share value, usually in cash, so shares may never be issued.
• Section 54: sweat equity can only be issued of a class of shares already issued.
• Section 54(1)(a): the sweat equity issue needs a special resolution.
• The resolution must specify the number of shares, the current market price, the consideration (if any) and the class of directors or employees.
• Listed companies issue sweat equity under SEBI regulations. Unlisted companies follow the prescribed rules.
• Sweat equity shares carry the same rights and restrictions as equity shares and rank pari passu with them (Section 54(2)).
• Section 68(5)(c) allows buy-back of securities issued to employees under a stock option or sweat equity scheme.
• Section 67(3)(c) allows a company to lend an employee, other than a director or KMP, up to six months' salary or wages to buy fully paid-up shares.
• Section 378E: a Producer Company member gets initial value for produce, a limited return on share capital, and patronage bonus from the surplus.

Common mistakes

• Treating an ESOP option as an obligation to buy Fix: Write that the employee has a right, not an obligation, and may let the option lapse.
• Confusing vesting with exercise Fix: Vesting gives the right to exercise. Exercise is the actual purchase. Keep the order grant, vesting, exercise, allotment.
• Treating the option holder as a shareholder from the date of grant. Fix: Write that shares come into existence only on exercise and allotment. Until then there is no right to dividend or vote.
• Saying vesting and exercise mean the same thing. Fix: Vesting means the employee earns the right to exercise. Exercise means the employee actually pays and applies for shares. Vesting always comes first.
• Treating ESPS as an option scheme. Fix: Remember that in ESPS the employee buys the shares at the offer stage. There is no option period or exercise decision.
• Saying SAR always results in shares being issued. Fix: SAR pays the gain. Settlement may be in cash or shares as the scheme says. Write both.
• Saying a board resolution is enough to issue sweat equity shares. Fix: Write that section 54(1)(a) requires a special resolution passed by the company.
• Leaving out items of the resolution, especially the current market price and the class of recipients. Fix: Learn the four items together: number, current market price, consideration, class or classes of directors or employees.
• Writing the wrong lock-in period for sweat equity shares. Fix: Write three years from allotment. Cite the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 for listed companies and the Companies Rules for unlisted companies. Do not write one year or five years.
• Letting the Board or the promoter fix the value of know-how. Fix: Say that a registered valuer values the contribution. Section 247 requires appointment by the audit committee or, if none, by the Board.

Exam tips

• Begin with a crisp definition of each scheme. Examiners award marks for correct meaning first.
• Always show the grant, vesting, exercise sequence when options appear.
• State the listed versus unlisted position and cite section 24 for who regulates.
• Where figures appear, show gain as market price minus exercise price and multiply by the number of options.
• End with a one-line conclusion, as ICSI answers require provision, analysis and conclusion.
• Write the stages as a short timeline (approval, grant, vesting, exercise, allotment). This helps you score marks for sequence in long answers.
• In case studies, check eligibility of each named person one by one. Examiners usually plant an independent director or a promoter group member.
• Quote section 62(1)(b) of the Companies Act, 2013 and the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 together. Give section or regulation numbers only where you are sure of them.