Companies have been using different ways to raise capital and meet organizational goals. Raising capital by issuing shares to the employees/directors is getting quite popular in the modern day corporate world. Two of the most prevalent ways of issuing company shares are Sweat Equity Shares and Rights Issue. What are they and how do they work for the companies and shareholders, we will discuss the same in this article.
Both Sweat Equity Shares and Rights Issue serve the same ultimate purpose for any company, which is raising capital. However, if evaluated closely, we can decipher that the two are used for fairly different purposes and in different scenarios. We will start with understanding what Sweat Equity Shares and Rights Issue is in brief and then learn some fundamental differences between them.
Sweat Equity Shares
A company issues sweat equity shares as a reward to its employees or directors for their extraordinary effort or contribution in the completion of a project, winning a deal for the company, or any such valuable contribution. These also give the shareholders a right and ownership in the company. On the other side, issuing sweat equity shares provide companies an opportunity to retain employees and decrease the attrition rate. A company also raises capital funds that can be used for a variety of purposes such as expanding business, clearing off debt, operational costs, etc.
Sweat equity shares help companies to retain valuable employees.
Sweat equity shares are issued as per the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014. Section 2(88) of the Companies Act, 2013 defines sweat equity shares as shares issued by a company to its employees or directors for contributing their know-how or making available the rights in the nature of intellectual property rights or for adding any value. Moreover, sweat equity shares are not offered to all the employees, directors and shareholders but only to specific employees or directors. Here, the company is at the sole discretion of the top whom the shares are to be issued.
Right Issue
A rights issue is a direct offer by the company to its existing shareholders to buy the shares. The shares are issued in proportion to the existing shareholder pattern. The company’s primary aim from rights issues is to raise capital but at the same time, keep the voting rights of the existing shareholders proportionately balanced. The raised funds can be employed for a variety of purposes like the expansion of the business, acquisition of assets, clearing off debts, etc. Right issue is actually a pre-emptive offer to the existing shareholders to buy new shares at a discounted price (in comparison to the market price).
The provisions for rights issue can be found in Section 62 of Companies Act, 2013 that defines the layout for further issue of capital and states the pre-emptive right of the company’s existing shareholders to subscribe for new shares. The provisions under this act are legally binding on all public and private companies as well as unlisted companies.
Companies can raise funds from issuing both sweat equity shares and rights issues.
Sweat Equity Shares Vs Rights Issue: Differences Explained
We have learned the meaning of sweat equity shares and rights issues and also understood the basic underlying similarities between the two. Now let us have a look at the points that differentiate these two ways of issuing shares.
| Basis | Sweat Equity Shares | Rights Issue |
| Meaning | Shares issued to certain employees or directors of the company for their exceptional work or value addition in some field. | Shares issued to the existing shareholders to raise capital and keep the existing shareholding pattern in a balanced proportion. |
| Governing Section | Sweat Equity Shares are defined under Section 2(88) of the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014. | The underlying principle of Rights Issue is laid under Section 62 of Companies Act, 2013. |
| Eligibility | Shares can be issued only to the employees or directors of the company or any of its subsidiary companies. The company sets a deadline for the eligible individuals to buy the newly issued shares. | Shares can be issued only to the existing shareholders of the company. The number of shares offered depends on the existing shareholding pattern of the company. The proportion or percentage of shares held by each of the shareholders remains the same after the rights issue. |
| Value | The valuation is compulsory and the value or price of the share is decided by a separate department of the company and depends on the intellectual property rights, value additions, or know-how for which the shares are issued. | The valuation is compulsory and the shares are generally offered at a price less than the prevailing market price. |
| Purpose | Sweat Equity Shares are issued to reward certain employees of the company. It helps companies to retain their valuable employees and raise capital by issuing shares simultaneously. The capital raised from the issue of shares can be used to meet organizational goals, clear dues, etc. | Rights Issue is done to raise funds for a range of reasons like expansion, paying debts, etc. This method of issuing shares is preferred when the company does not want to change the existing sharing proportion of the company by issuing shares. |
| Lock-In Period | The issued sweat equity shares come with a lock-in period of 3 years. | There is no lock-in period for shares allotted under the rights issue. |
| Conditions | There are two main conditions in the issuing of sweat equity shares: The company shall not issue shares more than 15% of the existing paid-up equity share capital in a year or shares with issue valuation of Rs 5 crores, whichever is higher.The company shall not issue more than 25% of the paid-up equity capital of the Company at any time. | The share can be issued only to the existing shareholders of the company. |
As we can see, there are a number of distinguishing elements and differences between sweat equity shares and rights issues. It is important for a working professional or a shareholder to have a comprehensive understanding of these two ways of issuing company shares. As for companies, both ways of issuing shares have worked well throughout the corporate structure. They have made many shareholders rich overnight when the company gets listed and becomes a public company. The aforementioned differences will help you to gain a fair idea of the fundamentals of sweat equity shares and rights issues.