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July 2016

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Ministry of Corporate Affair’s Notification relaxing restrictions in respect of

Sweat Equity Shares and Employee Stock Options for Start-up Companies

  1. Background

1.1   Ministry of Corporate Affairs has issued the Companies (Share Capital and Debentures) 3rd Amendment Rules, 2016 (“Amendment Rules”) vide Notification no. G.S.R. 704(E) dated July 19, 2016 which has amended specific provisions of the Companies (Share Capital and Debentures) Rules, 2014 (“Companies Rules”) with a view relax restrictions on issue of Sweat Equity Shares (“Sweat Equity”) and Employee Stock Options (“ESOP”) particularly for start-up companies.

 

1.2   The Companies Rules as originally notified had come in to force with effect from April 01, 2014 since more than 2 years from now and used to provide for all unlisted companies including start-up companies that:

a.    In respect of Sweat Equity under Rule 8(4) of the Companies Rules: No company shall issue Sweat Equity Shares beyond limit of 15% of existing paid-up equity share capital during any one year, subject to overall limit of 25% paid-up equity share capital at any time.

b.   In respect of ESOPs under Rule 12(1) (c) of the Companies Rules: ESOPs cannot be granted even to an employee/ director who is a promoter, or a person belonging to the promoter group i.e. a promoter’s immediate relative, nor a director who either himself or through his relative or through any body-corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.

 

1.3 Whereas in the meantime, Company Law Committee (“CLC”) was constituted with a view to provide its recommendation to deal with issues arising out of implementation of the recently enacted Companies Act, 2013. This was followed by a nationwide start-up movement which was officially launched by the Central Government on January 16, 2016 primarily with a view to encourage entrepreneurship, innovation and sustainable economic growth. The CLC after considering representations of various professional/statutory bodies and Industry Associations, gave its report in respect of Companies Rules on February 01, 2016 with following recommendations among others:

 

a)      “…start-ups, who may require such instruments may be permitted to issue sweat equity shares beyond twenty-five percent and up to fifty percent of the paid up equity share capital.”; and

 

b)      “…in order to encourage start-ups, this rule may be relaxed to enable issuance of ESOPs to promoters who may be working as employees or employee directors or whole time directors which would help the promoters to gain from increase in future valuation of the company without in anyway impacting finances of the company during its initial years.”.

 

1.4   It seems that the Amendment Rules have been notified in due adoption of recommendations of CLC. By way of this newsletter, we wish to highlight and analyze the important aspects of the Amendment Rules particularly on Sweat Equity and ESOPs that would help understanding the benefits and need for action, if any.

  2. Amendments to the Companies Rules : As it is


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