“A small piece of a big pie is better than a large piece of a small pie.” Those who embrace this adage willfully are the most successful entrepreneurs and investors in the world. If your heroes are the likes of Zuckerberg, Bezos, Gates, or Musk, you would do well to emulate the adaptation of sweat equity they undertook in order to burgeon their respective empires.
Starting a venture can mean bidding goodbye to years of savings, taking on burdensome loans, and other such actions that translate into leaps of faith. Often overlooked, however, is the personal, intangible investment that new business owners inject their ventures with. The blood, sweat, and tears in the equation. Thankfully, the corporate world has ordained these with a pathway to recognition – sweat equity. It is the product of the quantification of the aforementioned blood, sweat, and tears.
Understanding Sweat Equity
To gain further clarity, let us take the development of a fashion brand as an example. In this instance, we have a business graduate, and an astute fashion designer who are ideating a new business that aims to create a sustainable fashion brand, that combats fast fashion. While the business graduate is possessive of capital of $100,000 that he intends to divest in the business, the fashion designer admittedly has no capital investment funds to contribute to their budding business. The fact of the matter is that, without either one of these disparately skilled entities, the business will hit a wall.
What would be ideal in this setting is if a sweat equity agreement were to be set up, whereby the work and expertise of the fashion designer would be regarded as investment, albeit an intangible one.
Sweat Equity Shares
Sweat equity shares have proven to be a boon to the corporate world by way of promoting healthy competition and serving as a reward for the employees of the company while at the same time furthering the development of the company. Sweat equity shares These shares are offered by the company to the employees or directors, for the exercise of their expertise and knowledge, or on account of rendering value-additives, like intellectual property rights.
Such shares are issued as a reward to the employees, either by cutting them a discount on such shares, or by granting these shares in exchange for consideration. For instance, if ‘X' contributes towards the betterment of the company by developing a program for optimization of operations, then a share issued by the company in the name of ‘X', as a reward for their time, effort and contribution shall be termed as a sweat equity share.
The company issues sweat equity shares to its personnel instead of having to remunerate external professionals for their technical know-how, if the same work manages to be accomplished by company employees. Notably, sweat equity shares can be of great benefit for start-up companies that might otherwise be rendered paralyzed if they had to bear the financial burden for the whole company from the get-go. A start-up requires a great number of funds for various functions and activities of the company. As for the sweat equity share system in well-established companies, large investment funds can be delved into, in order to issue sweat equity shares; their presumably heavy returns can then greet the employees. A special procedure is required to be carried out for the company to be able to issue such shares; the same can be done by the passing of a resolution the company's general meeting. The majority of votes by the shareholders of the company will have to be in favor of such a resolution in order for it to be deemed to have passed.
Often, companies resort to a scheme wherefore certain company targets can be established; upon the completion of a pre-established task, employees shall receive an aggregate of shares in the company.
- Sweat equity shares are issued by the company to the working personnel or directors of the company at a discounted rate or in exchange for consideration other than cash.
- The employees in exchange for their contribution to the welfare of the company receive partial or full ownership in the sweat equity shares.
- These shares serve as a reward besides the basic remuneration received by employees of the company.
- This acts as an incentive and motivation for the employees of the company while at the same time benefitting the company.
- The company is also able to achieve the purpose of retaining its employees by such rewards.
- The terms and details of the shares issued shall be proposed and discussed via a general meeting in the company.
- The employees have the additional motivation, and at the same time, the company benefits, hence, proving to be a two in one situation where two benefits are achieved via sweat equity shares.
- Initial start-up companies benefit from such an arrangement to a great extent due to the lack of financial sources as compared to well-established businesses and promote a healthy competitive market.
- Such shares can be issued to the employees, directors or promoters of the company.
- Sweat equity serves as a non-monetary benefit and comes in the shape of effort, labor and time contributed towards the development and welfare of the company.
While the Commercial Companies Law (CCL) of the UAE conceptually recognizes contributions in kind (i.e. sweat equity), most of its references to share capital deal in cash payments. Article 17 of the CCL, on the nature of the share provided by a partner, expressly states that the partner may not contribute in work rendered that is a constituent of company capital, unless he is a joint partner.
All contributions in kind to the company shall be evaluated at the expense of the relevant contributors, by one or more approved financial consultants; should the evaluation be deemed a failure, the assessment shall be rendered void. The competent authority may discuss and object to the evaluation report and appoint another assessor, as required, at the cost of the partners providing such shares.
If the contributions in kind are found to have been evaluated above their true value, the partner providing such contributions shall pay the difference in cash to the company. Notably, however, it is expressly stated in the CCL that a contribution in kind in a limited liability company cannot take the form of a work contribution.
While employees cannot be rewarded “sweat equity” per se in the UAE, they do have access to a company's share capital via a coveted path - ESOP (employee share option schemes).
ESOPs in the UAE
Employee share option schemes (ESOPs), and other long term incentive plans are united with the entity of “sweat equity”, in that they all share the fundamental purpose of retaining, and incentivizing valued employees. By tethering part of an employee's remuneration to the company's financial performance under an ESOP, employees have a direct, tangible incentive to align themselves and their functioning to guarantee the company's success; this is for the simple reason that higher company performance will increase the value of their individual rewards. ESOPs have proven to be remarkable tool for employers to help retain valuable, fee-earning staff members. This is because the ESOP has been engineered such that its rewards are typically staggered over time; the longer an employee remains employed by the company, the greater the magnitude of their rewards.
The CCL specifically provides that UAE companies may, by way of a special resolution approved by their general assembly, increase their share capital to be able to effectuate an ESOP for UAE-based employees. It must be noted that participation in the ESOP is reserved for the company's employees; the CCL does not allow for directors of the company to participate in the scheme.
In the nineteenth century, the idea that workers who invested their skills and labor might also partake of the capital growth of a company was virtually unheard of. Things have evolved vastly since. Today, a growing number of companies recognize that, in a highly competitive market, with costs under constant pressure, the key to sustainable competitive advantage lies in getting the best out of its people. While sweat equity is certainly an area of some complexity, with potential traps for the unwary, a well-structured employee share incentive arrangement bears a great deal of profitable potential.
Originally published by STA Law Firm, June 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.