In a consultation paper released in March 2025, SEBI proposed amending rules related to employee stock option plans (ESOPs) held by the Founders of the company, even after their classification as Promoters following the company’s listing. SEBI, in its recent Board meeting, after factoring the public feedback and followed by deliberation by the Primary Markets Advisory Committee accepted this proposal. A short background and the change proposed are discussed below.
Background
In many new-age tech companies, the Founder’s shareholding is highly diluted with each round of fundraising. Often, ESOPs are issued to Founders (especially in the formative years) to motivate and incentivize them in the company’s growth, as well as to mitigate cash flow strains.
Under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, there is an express bar on ‘Promoters’ and ‘members of the Promoter group’ receiving ESOPs. Further, the definition of ‘Employee’ in the said Regulations specifically excludes ‘Promoters’ and ‘members of the Promoter group’. Similarly, under the Indian Companies Act, a ‘Promoter’ and ‘member of Promoter group’ are not included within the ambit of the term ‘Employee’.
The existing regulatory framework, as prescribed under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, requires a person to be disclosed as a Promoter if the person holds more than 10% stake in the company or has direct or indirect control over the affairs of the IPO-bound company, whether as a shareholder, director, or otherwise. This leads to Founders being classified as Promoters at the time of filing of the Draft Red Herring Prospectus (DRHP), due to their holding, including through their vested ESOPs.
There was an ambiguity in the law, as the existing provisions did not explicitly state whether an employee holding ESOPs who is subsequently categorized as a Promoter could exercise their granted ESOPs (both vested and unvested).
SEBI Proposal
SEBI, in its 210th Board meeting, has proposed that a person who ceases to be an employee, after having been identified as a Promoter will be allowed to continue to hold their ESOPs, provided those ESOPs were issued at least one year before the company listing its shares under an initial public offer (IPO).
BMR Legal View
The proposed amendment shall facilitate the alignment of the founder’s interests with long-term shareholder value creation, and in turn provide the necessary fillip to IPO activity in India’s burgeoning startup ecosystem. Retention of ESOPs post-IPO could provide an incentive for promoters who may no longer be classified as employees but are integral to a company’s vision. It shall also help companies planning IPOs, including those undertaking reverse flipping (i.e. shifting incorporation from foreign jurisdictions to India), to structure founder incentives and balance the same with public shareholder interests. Care has also been taken to curb potential misuse through inclusion of the rule of a one-year “cooling-off” period and providing that ESOPs granted within a year of DRHP filing remain ineligible.
A trenchant analysis of ESOPs suggest they are a tool to incentivise employees rather than tools which disproportionately enrich senior leadership enjoying substantial compensation. Proxy firms in the recent past have challenged issue of ESOPs to promoters like in the case of Paytm1, Religare2, Gokaldas Exports3.
From a corporate governance standpoint, if the intent of the company is largely to incentivise the Founder/ Promoter to retain his skin in the game, one can explore other mechanics such as issue of Sweat Equity shares or issue of shares carrying superior voting rights or golden share. A nuanced treading of the employee incentive plans is the need of the hour.
With assistance from Jai Babaria, Associate at BMR Legal.
1 https://www.ndtv.com/india-news/sebi-vijay-shekhar-sharma-esops-paytm-owner-ceo-brother-settle-stock-options-case-pay-rs-2-8-crore-8364027
2 https://economictimes.indiatimes.com/industry/banking/finance/ed-to-widen-probe-into-esops-to-rashmi-saluja-religare-officials/articleshow/113676465.cms?from=mdr
3 https://economictimes.indiatimes.com/industry/cons-products/garments-/-textiles/shareholders-reject-key-esop-resolutions-at-gokaldas-exports/articleshow/117464899.cms?from=mdr