The Ministry of Corporate Affairs (MCA) has amended the Companies (Share Capital and Debentures) Rules, 2014, to allow startups to issue sweat equity shares not exceeding 50 per cent of its paid-up capital up for a decade after the registration of the firm. The earlier limit of 5 years was changed to bring MCA provision in line with the Department for Promotion of Industry and Internal Trade's (DPIIT) order.
Industry experts expect the move to help startups in terms of enhancing their ability to incentivise personnel and retain talent.
This will also act as an alternative medium of compensation for employees and avoid pay cuts. "The more it is done to help companies and employees to benefit from the sweat equities, the higher is the retention of talent and the entire eco-system will benefit considerably," said Naganand Doraswamy, managing partner of venture fund Ideaspring Capital and a startup mentor.
Usually, startups issue sweat equity to their employees or directors against any form of intellectual property or technical knowhow without any vesting period. Employee stock options allotment, on the other hand, is linked to employees' performance and based on completion of the vesting period.
Doraswamy also downplayed the concerns on the rule acting as a deterrent in future fund-raising plans. "Ensure employees benefit when the company does well and the venture capitalists (VCs) can automatically make money when the company does well."
"The employees will also have a sense of ownership and can reap the benefits as the valuation of the companies increases. Most of the start-ups usually take over 3-5 years to raise bigger rounds. And, many a time, the top talent is known to quit after encashing the equities (in the early stages)," said Apoorva Ranjan Sharma, co-founder of startup incubator Venture Catalysts and VC accelerator 9Unicorns.
Legal experts, who work closely with startups, too, welcomed the change. "It is a positive step, with reduced cash flow in the ongoing pandemic scenario. This amendment will help the startups, which are in operation for more than five years to issue sweat equity to their employees," said N Raja Sujith, partner- head (South India), Majmudar & Partners.
Going forward, the amendment will also help startups attract fresh talent from the market. VCs and PEs also favour startups with such equity schemes as the employees have "skin in the game" and they perform better to increase the valuation of the company, said Shalini Jain, partner of People Advisory Services, EY India.
MCA also dropped a provision that required listed companies with privately placed debentures to mandatorily set aside the reserves for every year.