Sweat Equity: Enabling Innovation or Inviting Uncertainty?

Sweat equity refers to non-monetary contributions made to a company in the form of physical labor, intellectual effort, technical expertise, strategic inputs, and time. In the startup ecosystem, particularly during the early and high-risk stages of a business, founders and key employees often forgo salaries and instead invest their skills and commitment in anticipation of future rewards.

Globally, sweat equity is widely accepted as a legitimate form of contribution, especially in innovation-driven economies such as the United States and India, where venture ecosystems acknowledge that value creation extends far beyond financial capital.

Nepal has now taken a step in this direction. An amendment to the Companies Act, 2006,  allows
companies to issue shares  in exchange for non-cash contributions such as services,  intellectual property, technical expertise, goodwill, and technical know-how. The reform  aims to bridge the gap between financial limitations and the growing demand for intellectual and human capital. However, while the intention behind the amendment is progressive, its implementation raises serious  legal, regulatory, and practical  concerns. The fundamental question is whether sweat equity has been introduced without adequate preparation. Sweat equity can drive innovation and reward commitment—but without clear rules, it can create legal confusion and corporate conflict.

Sweat Equity in the Nepali Legal Context

Although the amended Companies Act formalizes different types of non-cash consideration for 
subscription or purchase of shares in the Company, it does  not define sweat equity explicitly. 
In practice, sweat equity refers to shares or ownership interests granted to individuals in return 
for non-cash contributions such as labor, technical expertise, intellectual property, or strategic 
guidance that directly helps a business grow. Unlike traditional shareholders who contribute capital, sweat equity holders invest effort and skill, often  when  the company is most vulnerable.

The amendments, introduced via "An Act to Amend Certain Nepal Laws to Improve the Economic and Business Environment and Increase Investment" on March 31, 2025,  added subsections 18(3A) to 18(3E) to the Companies Act. These allow issuance of shares for non-cash contributions like intellectual property, technical know-how, services, assets, and other intangibles after incorporation. Such shares can be issued  to promoters, employees, or others, with limits of 20% of paid-up capital for ordinary companies and 40% for startups. However, there are no guidelines  on vesting  schedules, tax treatment, timelines,  forms, or regulatory filings. This lack of clarity increases administrative risk and discourages adoption. 

Valuation: The Biggest Obstacle

One of the most contentious aspects of sweat equity is valuation.  The amended law requires all 
non-cash contributions to be valued in monetary terms, similar to equity investments, by a 
certified  engineer or a professional auditor. While this requirement seeks  to ensure fairness and 
transparency, it presents a serious challenge when applied to intangible assets, particularly  technical know-how sharing.

Valuing intellectual property, services rendered, or strategic inputs can, to some extent, be rationalized through established methodologies of revenue calculation. However, technical expertise and know-how are inherently subjective. Their value often depends on future performance, market conditions, and the company’s success in applying such expertise. In the absence of a statutory valuation body such as the proposed Nepal Valuers’ Council or a dedicated regulatory authority in Nepal to review and verify valuation  reports, there is a high risk of inaccurate or inflated valuations.

Such valuation  can unfairly dilute existing shareholders. The risk is higher in well-performing  companies, where issuing sweat equity at par value may be unjust to existing shareholders.  Conversely, issuing sweat equity at a premium raises further legal and accounting questions. None of these issues have been tested in Nepali courts.

Accountability is also unclear. If valuation  is later found  to be fraudulent and misleading, will those certified engineers or professional auditors be held liable? The law remains  silent on this crucial issue, creating uncertainty and potential exposure to abuse.

What kind of shares are they? Nepali law recognizes only ordinary and preference shares. With the 
introduction of sweat equity, a fundamental question arises regarding the nature and rights attached to such shares. Are sweat equity holders to be treated as pari passu with ordinary shareholders, preference shareholders, or a separate class altogether?

This ambiguity becomes particularly problematic in cases of liquidation or insolvency. Where do sweat equity holders  rank when  a company winds up or files for insolvency? While shareholder agreements may contractually define certain rights and obligations, it remains  uncertain whether contractual arrangements can override statutory provisions, especially under insolvency laws.

The Insolvency  Act, therefore, must be revisited and aligned with the Companies Act to clearly 
address the status and treatment of sweat equity holders.  Without such harmonization, disputes are 
inevitable, and judicial interpretation alone may not provide consistent or predictable outcomes.

Can Institutions Hold Sweat Equity?

The amended law is silent on whether sweat equity can be issued to legal entities such as company 
or firm or partnership firms. Traditionally, technical expertise and know-how are associated with 
individuals rather than institutions. However, in practice, institutions often possess proprietary
technology, specialized  processes, and accumulated expertise. The law must clarify whether 
companies, firms or partnerships can receive  sweat equity, and under  what conditions.

Absence  of a Lock-In Period Sweat equity is meant to empower startups and companies to build 
strong, committed teams without relying solely on financial capital. However, the law does  not impose  any lock-in period  on sweat equity shares.

This omission creates a significant loophole.  Without a lock-in requirement, sweat equity holders  may sell their shares immediately for financial gain and exit the company,  defeating the very purpose of long-term value creation and commitment.

To safeguard the intent of sweat equity, a mandatory lock-in period should be introduced. A lock-in 
period of two to three years for ordinary companies and three to five years for startups would be reasonable. Regulatory authorities must address this gap seriously to prevent misuse.

Conflict with Technology Transfer Policy

The Foreign Investment and Technology Transfer  Act (FITTA), 2019 governs foreign investment and technology transfer through clear and streamlined procedures. Under FITTA, foreign investors may transfer technology and know-how to local industries in return for royalty payments, which are currently capped at 5% of gross sales revenue and subject to repatriation limits.

The introduction of sweat equity, however, may unintentionally undermine this regime. If 
individuals or entities can receive  equity in exchange for technology or know-how and repatriate unlimited earnings through dividends  or capital gains, the incentive to use formal technology transfer arrangements diminishes. Why would a foreign investor accept capped royalty structure when sweat equity offers greater financial flexibility?

This policy inconsistency risks weakening FITTA and undermining structured technology transfer 
agreements. Without harmonization between these legal frameworks, Nepal’s broader investment 
objectives could be compromised.

Foreign Investment Complications

The integration of sweat equity with foreign investment introduces additional complexities, 
particularly under  FITTA. A key challenge  is whether the minimum foreign investment threshold 
applies to technical know-how sharing via sweat equity. FITTA requires a minimum investment of Rs 20 million per foreign investor for most sectors with exceptions for information technology industry investing through automatic route approval process.

If the valued know-how falls below the minimum cap, it may not qualify as foreign direct  investment. This creates a barrier  for startups seeking global expertise, as small-scale know-how transfers might not meet the threshold. Furthermore, the amendments to the Companies Act 
do not explicitly address FITTA interactions, leading to potential conflicts.

Inflow of foreign investment via sweat equity and its recording as foreign investment inflow poses  
another hurdle. Under FITTA, FDI includes equity investments, but non-cash contributions like 
know-how must be valued and recorded as inflows. Ambiguities in valuation  and lack of specific guidelines  for sweat equity could lead to inconsistent recording. Subsequent repatriation of dividends or gains from sweat equity shares may face scrutiny,  as they bypass  royalty caps, further weakening FITTA's structured approach for technology transfer.

Conclusion

The introduction of sweat equity into Nepal’s corporate legal framework is undoubtedly a progressive and welcome reform.  It reflects an understanding that modern businesses are built not only on financial capital but also on human intellect, innovation, and dedication. However, lawmaking does  not end with intent; it must be supported by clarity, consistency, and institutional preparedness.

In its current form, the sweat equity regime suffers  from vague definitions, valuation challenges, lack of regulatory oversight, unclear  shareholder rights, absence of lock-in provisions,  and conflicts with existing laws. Without corresponding amendments to related legislation  particularly insolvency law, valuation  standards, and foreign investment regulations, the objectives of sweat equity may remain unfulfilled.

Sweat can either become a powerful tool for entrepreneurship and innovation or a source of legal 
uncertainty and corporate disputes. To ensure the former,  lawmakers and regulators must align  laws, issue clear guidelines,  and strengthen institutional mechanisms. Otherwise, sweat equity risks becoming a promise  introduced without adequate preparation.

(This opinion article was originally publihsed in February 2026 issue of New Business Age magazine.)