ESOPs for founders: Well intended relief, garbled by language?

SEBI’s explanation remains ambiguous on share options granted to start-up promoters

– Payal Agarwal, Partner & Sakshi Patil, Executive

Starting a company often means wearing multiple hats. In these early stages, many founders structure their compensation through Employee Stock Option Plans (“ESOPs”) rather than traditional salaries. This arrangement makes perfect sense when resources are tight and every rupee earned needs to be reinvested into growth of the company. ESOPs align founders’ interests with the company’s long term success.

But here’s when things get complicated: the companies grow and prepare to go ‘public’; the founders find themselves classified as “promoters” under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”). With more risks than rewards, they find themselves in a position, where their earlier ESOP grants, reflecting the growth of the company built by them, though perfectly valid during the grant, may now be taken away.

Recognising this unfair situation, at its meeting held on June 18, 2025, SEBI has approved an amendment providing regulatory relief for founders of companies who hold ESOPs and are subsequently classified as promoters at the time of an IPO. The amendment seeks to clarify the position of ESOPs and other share based benefits, granted to promoters and promoter group members prior to categorisation as such, and permit the exercise of such grants even after listing of the company.

While the amendments seek to enable founders in IPO-bound companies to avail of the share based benefits granted to them, the language of the explanation falls short of the intent. In this article, we discuss the need for the amendments in line with the existing scenario, how the amendments seek to meet the need and the gap that remains.

Proposal laid down in Consultation Paper

The proposal approved by SEBI in its recent BM is based on the proposal contained in its consultation paper dated March 20, 2025 to include an explanation under Regulation 9(6) of SBEB Regulations.

As per the Para 3.5.1 of the Consultation paper, SEBI had proposed to include an explanation may be inserted under regulation 9(6) of SBEB Regulations which would state:

Explanation 2: an  employee, identified  as  a “promoter”  or  “promoter  group”  in the draft offer document filed by a company in relation to an initial public offering, who was granted  options, SARs or other benefits  under  any  scheme prior to being identified as a “promoter” or “promoter group”, as the case may be, shall be eligible to continue to hold, exercise or avail any such option, SAR or benefit, in accordance with its terms and granted, prior to one year from the date when the Company (i.e. its’ Board) decides to undertake Initial Public Offering and, in compliance with these Regulations.

The proposed explanation provides a clarification with respect to holding or exercise of share options or other similar benefits granted to an employee, identified as promoter/ promoter group in the DRHP, subject to the following conditions:

1. The grant of options or benefits must have been made prior to the employee being identified as a ‘promoter’ or ‘promoter group’; and
2. The grant must have occurred at least one year prior to the Board’s decision to undertake an IPO.

These conditions have been discussed in detail in the later part of this article. Before that, it is necessary to understand the need for the amendment.

Need for the amendment: prohibition on promoters holding ESOPs

An explanation to Rule 12(1) of the Companies (Share Capital and Debentures) Rules, 2014 excludes a promoter or a person belonging to the promoter group from the definition of ‘employee’, in the context of eligibility for grant of ESOPs.

However, pursuant to Companies (Share Capital and Debentures) Third Amendment Rules, 2016 Dated July 19, 2016, a proviso has been added to the aforesaid explanation that provides an exemption for start-up companies up to ten years from the date of its incorporation or registration. Therefore, in case of a start-up, a promoter or member of promoter group may also be issued ESOPs upto 10 years from the date of its incorporation.

Similar prohibition applies to a listed entity, as per Reg  2(1)(i) of SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, pursuant to  which, an employee does not include a promoter or a person belonging to promoter group. There is no exemption for a start-up company under the said Regulations.

Founder or promoter : a question of identity

The term ‘promoter’ is defined in an almost similar fashion in both Companies Act, 2013 (“ and ICDR Regulations.  As per the definition, there are three limbs to the definition of promoter, being:

1. Promoter by proclamation: that is, the person who is named as promoter in the offer documents or the annual return.
2. Promoter by control: that is, a person having control over affairs, whether as shareholder, director or otherwise, directly or indirectly.
3. Promoter by absentee control: that is, by orchestrating the affairs of the company by giving instructions to the board of directors, which the latter is accustomed to adhere to.

Further, the term ‘promoter group’, is not a defined term under the Companies Act, 2013 and hence, may be open to interpretation.

On the question of whether or not every founder may be considered as promoters, what needs to be understood is that while the founder may be the one who initiates the idea of the start-up, it may so happen that subsequent to new investors coming in, the founder may gradually lose his powers to control the affairs of the company. The board becomes independent, the private equity investors get to have a call in various matters, and the powers get diluted, pursuant to which the founder may not be recognised as a promoter after all.

However, the stock exchanges apply various additional criteria for considering a person as ‘promoter’, some of which may categorise a Founder as promoter, regardless of whether the same is holding ‘control’ in the company or not. 

For instance, as per news reports^[1], the guidance issued by NSE for promoter categorisation in case of an IPO-bound company, requires founders to be categorised as promoters if:

1. They hold a position or have the right to be nominated, as a director or KMP/SMP; and
2. They have a collective shareholding of 10% or more of the equity shares (including options which are vested till the date of listing) of the company, either directly or through any legal entities or persons controlled by such founder or his/her immediate relatives.

Therefore, even when a founder may not be holding ‘control’ in a company, he may be categorised as a promoter by holding options if they are crossing the 10% threshold.

Fate of ESOPs issued to founders, later turned promoters

The SBEB Regulations, as discussed above, do not allow promoters to hold ESOPs or other share based benefits in a listed entity. Although applicable to listed entities, the compliance is required to be ensured at the stage of filing of DRHP, and hence, IPO-bound companies are also covered.

While the Regulations exclude the promoters from the definition of an employee eligible for the receipt of ESOPs, it does not clarify the treatment of options that are already granted to promoters, prior to such classification. This led to a confusion in case of options issued to Founders-turned-Promoters, putting the fate of such granted options in a grey area.

In case a view is taken that such options need to be liquidated, and the benefits thus accruing, has to be foregone, at the time of identification as a promoter, the same would not be justified. It is not on their own wish to become a promoter, and since the options are part of the remuneration of the Founders as employees, granting them an immunity for  such options is needed.

Decoding the conditions for exemption

1.     Grant of options prior to identification as promoter or promoter group

The purpose of the amendments is to primarily cover the ‘founders’ of start-up companies, where it would be typical to give share based options to incentivise the founders and as a remuneration against the services offered by such employees.

As discussed above, there may be situations where a person, though a founder of the company, was not categorised as promoter under CA, 2013. However, pursuant to the categorisation conditions followed by the SEs, during filing of DRHP, may get covered as a ‘promoter’ or ‘promoter group member’.

The explanation refers to grant of share based benefits, prior to being identified as a “promoter” or “promoter group”, and thus, refers to such employees/ founders who were not categorised as promoter/ promoter group prior to grant of options.

However, consider the case of a founder of a start-up who was identified as a promoter since inception, but was granted ESOPs pursuant to the exemption available to start-ups under CA, 2013. If the company later decides to go for listing, it remains unclear whether such ESOPs would remain valid under this proposed explanation. This is because, technically, the first condition requiring that the ESOP grant be made before the individual was identified as a promoter, is not satisfied in such cases.

This condition risks contradicting the very objective of the amendment, which is to safeguard pre-IPO entitlements granted to founders while ensuring regulatory safeguards for promoters are maintained at the time of listing. The start-up related exemption, as available to the promoters under CA, 2013 is with the objective of permitting the founders, whether promoter or otherwise, to be benefitted from the growth of the company and be entitled to share based benefits.

2.     Grant must have occurred at least one year prior to the Board’s decision to undertake an IPO

The condition requires the options or other benefits to have been granted at least 1 year prior to the board’s decision of undertaking an IPO. The clause provides a cooling off period between the grant of options and the company’s IPO decision, so as to prevent situations where companies might quickly issue ESOPs or other share based benefits to promoters just before going public, thus taking benefit in ingenuine cases.

The one year requirement is a reasonable safeguard, as it helps protect the interest of public shareholders and ensure that such grants are made in advance to genuine employees only as a reward for their contribution to the company and not as an opportunistic benefit tied to the IPO.

Conclusion

While SEBI’s proposal to introduce an explanation under Regulation 9(6) of the SBEB Regulations is a well-intended step towards addressing the gaps affecting founders of start-ups, its current framing leaves room for ambiguity.

The final wording of the amendment, once notified, will be pivotal in determining whether this balance between protecting founders’ rights and maintaining necessary safeguards for promoters. It is hoped that SEBI will clearly address this issue in the final version, so that the real purpose of the amendment is not lost in technical wording.

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^[1] https://www.moneycontrol.com/news/business/ipo/executive-startup-founders-holding-more-than-10-stake-may-be-categorised-as-promoters-12508551.html

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