Introduction

As per Initial Public Offer (“IPO”) trends report by EY, during the first quarter of 2025, 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 the public companies which is desirous of listing after undertaking reverse fillip, the Securities 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 Exchange Options (“ESOPs”) even after being reclassified as promoter at the time of IPO, provided such benefits including ESOPs have been granted a year before from the date of filing Draft Red Herring Prospectus (“DRHP”). This one year of cooling-off period aims to restrict the promoters’ enrichment through ESOPs grants immediately before IPO to themselves and to restrict them to increase their shareholding in the company disproportionately. Earlier, the founders on being recognized as the promoter in the DRHP were required to liquidate or forgo their share-based benefits including ESOPs granted to them, at the time of IPO. Moreover, existing framework doesn’t allow companies to give share-based benefits to the promoters and promoter groups, except startups being recognized by Department for Promotion of Industry and Internal Trade (“DPIIT”). The move augurs well for the capital market as it would allow the New Age Technology Companies (“NATCs”) to go for IPO and allow them to tap into the growing capital market of the country.

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

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 initial phase of any startup. So instead of giving them monetary compensation, the 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 that of company’s long-term goals. Additionally, it is common for startups that with each successive funding round their equities get diluted, bringing down their shareholding in one figure. In this backdrop, the SEBI has brought about this move to incentivize the founders of the company by protecting their ESOPs even after listing.

However, the rule 12 of the Companies (Share Capital and Debenture) 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 promoter or persons belonging to promoter group and director who himself or through his relative or through anybody corporate, directly or indirectly, holds more than 10% of outstanding shares of the company. Likewise listed companies are barred under regulation 2(1) (i) under the Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SBEB Regulations”). Rule 12of Share Capital Rules provide exemption to startups recognized by DPIIT for period of ten years from the date of its registration or incorporation.

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

Moreover, as rightly noted by SEBI that with each round of successive funding, the founders’ shares and powers get diluted and the board of the company becomes independent, resultantly the new investors and Private Equity (“PE”) firms start having say in the company’s affair. Consequently, it 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.

Analysis from the Corporate Governance Perspective

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

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

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

Conclusion

In the backdrop of corporate governance and sufficient incentive available for founders-turned- promoters, this move by SEBI to allow the promoters to retain share-based benefits including ESOPs post-IPO is ill-sighted and superfluous. Moreover, given the blurring line between the promoters and founders, a founder not wanting to be promoter would be classified as promoters even if he has no control over the affairs of the company, but crosses the 10% threshold. Resultantly, 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. Public in the capital market invests not relying on the company, rather they pose trust in the institution regulating the market. They believe that institution would keep the standards of corporate governance intact. In turn, posing trust in its firm stance and commitment towards corporate governance, the participation of investors and business institutions increase in the market making it attractive. So, it is the onerous duty of the SEBI to upheld the integrity of the market, while balancing the interest of startups and public investors. There have been instances of fund diversion by the companies post-IPO. Moreover, SEBI should reconsider its move given the available regulatory framework incentivizing the startups and its founders. However, it has introduced one year of cooling-off period for the grant of ESOPs from the date of filing DRHP, yet it is not difficult to strategize it to suit the intent of greedy investors to enrich themselves disproportionately while undermining the value of public shareholders.