[Arushita Singh is a fourth year student at National Law Institute University, Bhopal]
In its recent consultation paper, the Securities and Exchange Board of India (SEBI) has proposed a slew of amendments aimed at refining the regulatory landscape for public issues and offering clarity on procedural requirements. Among these proposals, a clarificatory amendment aims to resolve ambiguities surrounding employee stock options (ESOPs) granted to founders prior to an initial public offering (IPO), clarifying that such options would remain exercisable even after these individuals are reclassified as promoters in the draft red herring prospectus (DRHP).
At first glance, this move has been met with optimism. By allowing founders to continue benefiting from ESOPs post-listing, SEBI aims to encourage startup founders to pursue IPOs without the fear of losing shareholding incentives. According to the proponents, given the capital-intensive nature of scaling technology-intensive companies, aligning founder interests with long-term shareholder value creation may drive more IPO activity in India’s startup ecosystem.
However, from a corporate governance standpoint, this proposed amendment invites the key question: is this change necessary, or does it risk becoming redundant given the existing suite of stock-linked compensation mechanisms and incentive structures already available within the legal framework? Promoters of technology-driven companies are already empowered to retain control through superior voting rights (SVR) shares under the dual class shares (DCS) mechanism, which enables overarching control without any undue financial incentives. Furthermore, sweat equity shares are purpose-built instruments designed precisely to reward promoters and key managerial personnel for their contributions to value creation.
Against this backdrop, this post analyses the potential risks associated with SEBI’s proposed clarificatory amendment on ESOPs. It evaluates whether the availability of existing alternatives renders the move superfluous. In doing so, it probes whether this shift could inadvertently blur boundaries and create scope for promoters to secure unwarranted advantages, potentially at the expense of public shareholder interests.
SEBI’s Proposed Amendment: What’s Changing?
Under rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 (“Share Capital Rules”), unlisted companies are generally barred from issuing ESOPs to promoters and their group members. However, startups recognized by the Department for the Promotion of Industry and Internal Trade enjoy an exemption from this restriction for up to 10 years.
For technology-driven startups, ESOPs serve as a crucial mechanism to compensate founders for equity dilution across successive funding rounds. These grants are legally sound when issued, as the recipients were not yet classified as promoters. However, a regulatory shift occurs when such companies transition towards an IPO, triggering SEBI’s framework for promoter identification. A founder is designated as a promoter if they: (a) hold a board or key managerial position, and (b) possess at least 10% equity, directly or indirectly.
Once classified as promoters, founders are prohibited from receiving fresh ESOP grants under SEBI’s (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SBEB Regulations”). However, these regulations remain silent on the exercisability of ESOPs granted before the IPO, creating uncertainty regarding their validity post-listing.
To resolve this ambiguity, SEBI proposes a clarification: founders classified as promoters at the IPO stage may exercise pre-IPO ESOPs, provided they were granted at least one year before the board’s IPO decision. For proponents, this reform not only strengthens regulatory clarity but also fosters a more startup-friendly IPO ecosystem by preserving ESOP-driven incentives for founders. Moreover, it acknowledges the role of ESOPs in mitigating shareholding dilution, a key concern for high-growth startups navigating public markets.
Understanding the Rationale Behind SEBI’s Move
The rationale of SEBI revolves around promoting and preserving long-term commitment through incentivising the founders of the company. One of the defining characteristics of new-age technology companies is the significant dilution of founder shareholding across multiple funding rounds. Unlike traditional businesses where promoters maintain controlling stakes, startup founders often see their ownership reduced to single-digit percentages by the time they reach an IPO. Retention of ESOPs post-IPO could provide an incentive for promoters who may no longer be classified as employees but remain integral to a company’s vision.
On a broader level, the objective behind this move is ostensibly aimed at boosting the IPO ecosystem for startups. One of the major deterrents for startup founders considering an IPO is the risk of losing control over strategic decision-making. Public markets, with their stringent corporate governance norms, often limit the ability of founders to operate with the same autonomy they enjoyed in private markets. The Indian startup ecosystem has witnessed cases where founders hesitated to go public due to concerns about losing influence.
Is SEBI’s Move Necessary Given the Availability of Other Alternative Incentives?
Section 54 of the Companies Act, 2013 explicitly permits companies to issue sweat equity shares to promoters, acknowledging their role in value creation. This distinction is reinforced by SEBI SBEB Regulations and rule 12 of the Share Capital Rules, which categorically exclude promoters from eligibility for ESOP. The availability of sweat equity shares as a structured and legally recognized compensation mechanism makes the extension of ESOPSs to promoters post-IPO both unnecessary and misaligned with corporate governance principles. Unlike ESOPs, designed specifically to retain and incentivize employees, sweat equity shares serve as a purpose-built instrument for rewarding promoters and key managerial personnel for their strategic vision, expertise, and long-term contributions to the company’s growth.
Moreover, the extant legal framework already accommodates DCS structures for new-age technology companies and enables founders to retain enhanced voting rights while holding a lower percentage of economic ownership. This mechanism allows promoters to exercise strategic control over the company without accumulating disproportionate financial benefits. Unlike ESOPs, which grant additional equity at a discount, DCS ensures that control remains intact without further dilution of shareholder value. ESOPs serve as performance-based compensation for employees who contribute to the company but lack equity exposure. However, promoters, who already shape corporate strategy and enjoy capital appreciation, do not require extra financial incentives through stock options.
The Case of Potential Double Dipping, Unfair Advantage, and Governance Distortions
Promoters already hold significant economic and strategic stakes in the company. Their influence extends beyond financial participation to board control, strategic decision-making, and, in some cases, access to superior voting rights through DCS structures. They are further incentivised with other stock-linked compensation, such as sweat equity shares. If promoters are permitted to be entitled to both financial incentives (such as ESOPs) and strategic control, this may potentially create a conflict of interest.
A striking example is the case of Paytm, where the founder who, despite holding superior voting shares, was granted additional stock options as a post-IPO incentive. While this was meant to retain his commitment to the company, some investor groups raised concerns about whether this represented a “double benefit”—a financial windfall without corresponding downside risks. In the US, WeWork’s Adam Neumann had extensive stock-based incentives despite wielding disproportionate control through dual-class shares. This governance imbalance led to a corporate governance crisis, eventually forcing SoftBank to restructure WeWork’s ownership model. Another controversy involving Religare Enterprises Limited demonstrates the potential conflict of interest concerns that arose from the grant of ESOPs to their chairperson who already had significant control over the company’s strategy. Similarly, in the case of Gokaldas Exports, the allotment of ESOPs to top executives drew objections from proxy advisory firm Institutional Investor Advisory Services (IiAS), which urged shareholders to vote against the proposal. IiAS emphasized that ESOPs should serve as broad-based employee incentives rather than tools to disproportionately enrich senior leadership already enjoying substantial compensation.
ESOPs inherently lead to equity dilution, reducing the proportionate holding of existing shareholders. While this is a well-accepted trade-off in employee compensation, the impact is far more contentious when controlling promoters receive ESOPs post-IPO. If similar grants were extended to promoters, public shareholders would bear an even greater dilution cost, without any added governance checks.
Conclusion
A company’s pre-IPO and post-IPO realities are distinct. Post-IPO fundamentally transforms a company’s ownership and governance structure. A previously private entity controlled by a concentrated group of founders and early investors transitions into a publicly traded corporation, where accountability shifts towards a broader base of shareholders, including institutional and retail investors. This structural evolution challenges the premise that founders, who were granted ESOPs as employees before the IPO, should necessarily retain and exercise these options after being reclassified as promoters. With public listing, ownership disperses into the hands of retail and institutional investors who, though removed from day-to-day control, place their trust in robust governance frameworks. This transition elevates the fiduciary obligations of founders-turned-promoters, who must now operate under the watchful eye of the market. Granting post-IPO ESOPs to promoters blur the lines, as they would simultaneously benefit from control mechanisms and financial incentives initially designed for employees, potentially creating a misalignment with public shareholders’ interests.
If, however, it is permitted for promoters to retain ESOPs post-IPO, such retention must come tethered to regulatory oversight. Performance-based vesting and exercise of control over ESOPs should be a fundamental requirement, ensuring that ESOPs for promoters are contingent upon demonstrable value creation. Additionally, the nomination and remuneration committee, remaining impervious to promoter influence, should oversee the eligibility and quantum of ESOP grants and ensure accountability is not just claimed but credibly enforced. Such guardrails are essential to mitigate conflicts of interest, uphold corporate governance standards, and safeguard the integrity of public capital markets.
It is well known that promoters frequently face scrutiny for leveraging their influence to entrench control or extract disproportionate financial benefits, sometimes at the expense of public shareholders. History is replete with cautionary tales of excessive promoter dominance—cases where the very mechanisms intended to incentivize leadership were deftly repurposed into levers of self-enrichment and strategic entrenchment. Against this backdrop, any policy that even nudges the balance further in favour of promoters warrants not just scrutiny, but surgical precision and a healthy dose of scepticism.
– Arushita Singh
