Founders of Pre-IPO Startups Push for ESOP Flexibility from SEBI

As Indian startups prepare to go public, a pressing concern has emerged: the inability of founders, often classified as promoters, to receive employee stock options (ESOPS). While these options serve as a critical tool for incentivising key talent, current SEBI regulations prevent companies from issuing ESOPS to promoters, even if their shareholding has substantially diminished after multiple funding rounds.

Successive capital infusions at different growth stages often reduce founder ownership to single digits. Despite this dilution, these individuals remain vital to the strategic direction and success of the company. Hence, ESOPS become an essential lever to retain and motivate founders during and after the IPO process.

Read More: India's $100 Billion Startup IPO Boom: Flipkart, PhonePe & Oyo Eye Listings by 2027. 

SEBI's Current Framework and the Need for Reform

Under existing SEBI rules, promoters and directors holding more than 10% of a company’s share capital are barred from receiving ESOPS. This framework, rooted in the Companies Act as well, was designed to avoid misuse and ensure governance transparency. However, in the startup ecosystem, where capital dilution is the norm, such restrictions may appear misaligned with modern entrepreneurial realities.

Founders in high-growth startups often find their stakes eroded over time. In such cases, equity-based compensation like ESOPS could help align incentives, especially when the cash component of compensation is modest.

Proposed Relaxations: A Step Towards Flexibility

According to reports, in response to industry feedback, SEBI has recently proposed a relaxation that could offer some leeway. According to the new proposal, founders categorised as promoters or part of the promoter group may be eligible to hold or exercise Esop benefits—provided these are granted at least 1 year prior to the company’s decision to go public.

This proposal, however, only applies to ESOPS granted pre-IPO and does not extend to fresh issuances post-listing. Even with this potential concession, the policy remains under consideration, with the final regulatory stance yet to be confirmed.

Founders as Promoters: Regulatory Classification and its Impact

Most startup founders are deemed promoters ahead of an IPO filing due to their control and decision-making authority. This classification carries significant legal implications, including stricter compliance obligations and the aforementioned Esop restrictions.

While such categorisation aligns with governance expectations, it may unintentionally limit the startup’s flexibility in rewarding its leadership team. The current appeals to SEBI reflect an attempt to bridge this gap, recognising that traditional definitions of promoters may not always fit the startup context.

Conclusion

The ongoing dialogue between Indian startups and SEBI underscores a broader challenge—striking a balance between investor protection and fostering innovation. With founders playing a pivotal role in navigating companies through the IPO journey, stakeholders are hopeful for a policy shift that acknowledges the evolving realities of ownership structures in startup ecosystems.

While no formal recommendation or decision has been announced, the conversations signal a maturing regulatory environment that is beginning to adapt to the complexities of the new-age economy.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. This does not constitute a personal recommendation/investment advice. It does not aim to influence any individual or entity to make investment decisions. Recipients should conduct their own research and assessments to form an independent opinion about investment decisions. 

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