Section 40(1) of the Companies Act, 2008 has always required that a company must not issue shares unless the board determines that the consideration received is adequate. Before the introduction of the 2008 Act, this was traditionally understood to mean consideration that was both measurable and current at the time of issuance, such as cash or an asset-for-share transaction (also sometimes called a "share swap").

By contrast, the concept of "sweat equity" involves issuing shares in exchange for future contributions of effort or expertise (such as future services or deliverables), rather than immediately realisable value. These arrangements are frequently used in startup and growth-stage ventures seeking to reward key individuals without immediate cash outlay.

This introduces the risk that the company may never in fact receive value, or whether that is "adequate".

Position before the recent amendment – the problem with the old "trust" arrangement

Under the pre-amendment legal framework, section 40(5) permitted issuance of shares up-front but the value was to be delivered at a later stage provided that the issued shares be held "in trust" pending realisation of the future consideration in full.

However, our legislation did not define or regulate these so-called "trust" arrangements clearly, including specifically who bears fiduciary responsibility or dealing with integrity of the share issue and recordal in the securities registers. This presented uncertainty and possible enforceability and compliance risks as well as potential exposure for breaches of directors' duties.

While certain complex workarounds (e.g. options, phantom shares, or deferred issue structures) could avoid having to rely on the unclear trust mechanism, this could defeat the possible intended goals of the contracting parties who may want to achieve immediate vesting, including potential tax advantages if properly structured as restricted equity instruments in a section 8C context.

The new sweat equity regime

The 2024 amendments to section 40(5) to (7), effective from 27 December 2024, have removed the problematic reference to trusts and replaced this with a more robust stakeholder arrangement. Shares issued for deferred consideration (whether by way of future services or otherwise) must now be transferred to an independent stakeholder, typically an attorney, notary public, or escrow agent with no interest in the company or subscribing party.

Importantly, these shares must be governed by a written stakeholder agreement which:

• sets out the terms under which the shares will be released or forfeited;
• defines the timeline and nature of the consideration to be delivered;
• addresses consequences of default or dispute; and
• includes mechanisms for independent verification of performance or value delivery.

This framework establishes interlocking fiduciary and contractual duties between the company, stakeholder, and intended shareholder, significantly improving commercial certainty and risk compliance.

Some practical considerations

To properly give effect to a valid sweat equity arrangement will require a clear agreement which fulfils the above indicated criteria. Some items to carefully consider when drafting such an agreement include:

1. Choice of stakeholder: The selected stakeholder must be demonstrably independent and capable of administering the arrangement neutrally. Using the attorneys may come to mind at first, but care should be taken here as attorneys involved in the drafting process would often be acting for a particular party concerned. It may be appropriate to involve expert fiduciary service providers, such as an escrow agent.
2. Consideration and adequate value : The agreement should clearly reflect the valuation basis for the shares, the metrics of performance or services to be delivered, and verification mechanisms. It may also require tailored provisions to address tax, forfeiture, or clawback events.
3. Timing of vesting: Although the shares may be recorded as issued in the company’s securities register, the stakeholder arrangement suspends transfer of beneficial ownership. Companies should ensure that internal records, corporate actions, and shareholder communications reflect this distinction until all obligations have been discharged. A suitable tax expert should be involved, especially in incentive contexts which may need to traverse section 8C implications.
4. Alignment with constitutional documents: The company's MOI or any related shareholders’ agreement should be checked for consistency with this structuring. MOIs may need to be amended to cater for shares issued subject to stakeholder arrangements.

In conclusion

The amendments to section 40 represent a meaningful shift in how South African company law accommodates sweat equity. While the reforms replace the uncertain "trust" device with a structured stakeholder regime, they also introduce new complexity, particularly regarding the timing of vesting and tax recognition of value.

The previous ability to achieve immediate vesting (and potentially favourable tax outcomes under section 8C) may no longer be as easily accessible, depending on how the stakeholder arrangement is implemented.

For founders, boards and legal practitioners, it appears clear that sweat equity can now be formalised with greater legal confidence but only if carefully structured through a compliant stakeholder agreement, aligned with both the company’s constitutional documents and the intended tax treatment.