Promoter Enrichment or Founder Incentive? A Corporate Governance Perspective on ESOPs in IPO-bound Companies

I. Introduction

As per the Initial Public Offer (“IPO”) trends report by EY, during the first quarter of 2025 the Indian capital market saw 62 IPOs raising $2.8 billion and securing 22% of global IPO activity at the same time. As many as 12 emerging technology companies are planning to raise around $2.2 billion through IPO this year; this excludes Offer for Sale (“OFS”), meaning thereby that the actual figure would be far more than this. In this backdrop, in June 2025, to further the number of startup IPOs in the market and ease compliance for public companies desirous of listing after undertaking a reverse flip, the Securities and Exchange Board of India (“SEBI”), in its Board Meeting, has allowed the founders of IPO-bound companies to exercise their share-based benefits including Employee Stock Options (“ESOPs”) even after being reclassified as promoter at the time of IPO, provided such benefits have been granted a year before the date of filing the Draft Red Herring Prospectus (“DRHP”). This one-year cooling-off period aims to restrict promoters’ enrichment through ESOP grants immediately before an IPO to themselves, and to restrict them from increasing their shareholding in the company disproportionately. Earlier, founders on being recognized as promoters in the DRHP were required to liquidate or forgo their share-based benefits including ESOPs granted to them at the time of IPO. Moreover, the existing framework does not allow companies to give share-based benefits to promoters and promoter groups, except startups recognized by the Department for Promotion of Industry and Internal Trade (“DPIIT”). The move augurs well for the capital market as it would allow New Age Technology Companies (“NATCs”) to go for an IPO and tap into the growing capital market of the country.

However, this move seems to be redundant in light of the incentive schemes already available to the founders of the company as employees. The founders possess more than financial stakes in the company, including major decision-making powers, control over the board and Superior Voting Rights (“SVR”) under a Dual Class Share (“DCS”) structure. In addition, they may be entitled to sweat equity, which duly acknowledges the expertise, time and effort of the founders in creating value for the company. Furthermore, the move would undermine the interest of minority shareholders, thereby undermining corporate governance.

II. The Blurring Line between Founder and Promoter

It is the founders and co-founders who happen to be the employees and guiding force behind the making of the company in the initial phase of any startup. So instead of giving them monetary compensation, NATCs incentivize their employees through share-based benefits, which allows them to invest this opportunity cost for further growth of the company while keeping the founders’ skin in the game so as to align their vision with the company’s long-term goals. Additionally, it is common for startups that with each successive funding round their equity gets diluted, bringing down their shareholding to a single figure. In this backdrop, SEBI has brought about this move to incentivize the founders of the company by protecting their ESOPs even after listing.

However, Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 (“Share Capital Rules”), read with Section 62(1)(b) of the Companies Act, 2013 (“CA”), bars an unlisted company from issuance of ESOPs to a promoter or persons belonging to the promoter group, and to a director who himself, or through his relative, or through any body corporate, directly or indirectly holds more than 10% of the outstanding shares of the company. Likewise, listed companies are barred under Regulation 2(1)(i) of the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SBEB Regulations”). Rule 12 of the Share Capital Rules provides an exemption to startups recognized by DPIIT for a period of ten years from the date of registration or incorporation.

Under Section 2(69) of the CA and Regulation 2(1)(oo) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”), promoters have been defined on three limbs. Firstly, a person identified as promoter in the prospectus of the company or identified by the company in its annual report filed under Section 92 of the CA. Secondly, the person who has control over the affairs of the company. Thirdly, the person on whose advice, instructions or directions the Board of Directors (“BoD”) is accustomed to act. If any founder fulfils any of these three criteria, then he would be classified as a promoter of the company. The definition of promoter group is open to interpretation in the absence of its definition under the CA, while reference is made to Regulation 2(1)(pp) of the ICDR Regulations. Moreover, stock exchanges apply an additional set of criteria for identifying promoters, and may classify a founder as a promoter even if he does not have control of the company. As per one report, a person would be classified as a promoter if he has the right to be appointed as an executive of the company and holds 10% or more of the IPO-bound company, individually or collectively. This indicates that a founder may be classified as a promoter even if he does not have control over the company’s affairs but crosses the 10% threshold by holding options.

Moreover, as rightly noted by SEBI, with each round of successive funding the founders’ shares and powers get diluted and the board of the company becomes independent; consequently the new investors and Private Equity (“PE”) firms start having a say in the company’s affairs. This may result in founders not being recognized as the promoters of the company, thereby defeating the intention of this exemption aimed at incentivizing the founders, because now the new sophisticated investors and PE firms would be enriching themselves from this if they possess ESOPs as employees of the company.

III. Analysis from the Corporate Governance Perspective

The aim of SEBI is to keep the founder of the company integral to the vision of the company while retaining their ESOPs post-IPO, and to keep their commitment to the company intact through such incentives even if they lose the status of employee. It is common that a NATC’s founder loses control over the company with successive funding rounds by the time it reaches the stage of an IPO. They hesitate to go public, as there are looming compliances with respect to corporate governance and they lose control over the company’s affairs once it goes public. To promote an IPO culture and allow startups to reap the benefits of equity financing, this move has been introduced.

Was it necessary, where there are already incentive schemes available for founders-turned-promoters of the company? Section 54 of the CA clearly allows companies to compensate, in terms of sweat equity, promoters and Key Managerial Personnel (“KMP”) for creating value for the company. This intention is reflected in Regulation 12 of the SBEB Regulations, wherein promoters are disqualified from receiving ESOPs. Unlike ESOPs, which are meant to incentivize and retain employees, sweat equity specifically recognizes and rewards promoters and KMPs for their vision, expertise and contribution made to the company. Moreover, there is the availability of SVR under DCS, introduced in India in 2019, to promoters and KMPs under the law, whereby founders can easily maintain strategic control over the affairs of the company without any extra financial benefit through stock options. Moreover, the DCS structure does not dilute the value of shareholders. Thus, founders-turned-promoters who already wield financial and decision-making power and get the benefit of capital appreciation would be enriching themselves disproportionately. In light of the extant regulatory framework allowing promoters to have strategic control as well as financial benefits, the new move becomes superfluous, and seems to enrich the promoter at the expense of minority shareholders while missing its objective of incentivizing the founders of NATCs.

In this backdrop, bringing stock options to promoters post-IPO disproportionately increases the chances of conflict of interest under the corporate governance structure, as their influence extends beyond board control and decision-making power through sweat equity and SVRs under DCS. There is one clear example of Paytm, wherein Vijay Shekhar Sharma received stock options post-IPO, who is founder but not the promoter of the company. Even though he is the non-retiring director of the company, chairing the board, and further has the right to a seat on the board if he holds 2.5% of the equity of the company. While he enjoys perks like those of a promoter, through regulatory arbitrage he evades the responsibilities and restrictions applicable to promoters. This had raised concern among investors. Thus, this new move by SEBI may lead to disproportionate enrichment of the promoters and KMPs of the company, while diluting the value of public and minority shareholders without any checks on corporate governance.

IV. Conclusion

In the backdrop of corporate governance and the sufficient incentives available to founders-turned-promoters, this move by SEBI to allow promoters to retain share-based benefits including ESOPs post-IPO is ill-sighted and superfluous. Moreover, given the blurring line between promoters and founders, a founder not wanting to be a promoter would be classified as one even if he has no control over the affairs of the company but crosses the 10% threshold. Consequently, it would affect such founders’ interest, as once classified as promoter their right to receive ESOPs ceases. This holds true even under the new clarificatory amendment.

The public in the capital market invests not by relying on the company, but rather by posing trust in the institution regulating the market. They believe that the institution will keep the standards of corporate governance intact. In turn, by posing trust in its firm stance and commitment towards corporate governance, the participation of investors and business institutions increases in the market, making it attractive. So it is the onerous duty of SEBI to uphold the integrity of the market while balancing the interests of startups and public investors. There have been instances of fund diversion by companies post-IPO. Moreover, SEBI should reconsider its move given the available regulatory framework incentivizing startups and their founders. However, it has introduced a one-year cooling-off period for the grant of ESOPs from the date of filing the DRHP; yet it is not difficult to strategize around it to suit the intent of greedy investors to enrich themselves disproportionately while undermining the value of public shareholders.