By Nesil Staney
In a major boost for startup founders and listed companies, the Securities and Exchange Board of India (Sebi) has permitted them to retain their Employee Stock Option Plans (ESOPs) The measures are ‘founder-friendly’ and are expected to bring more startups into the public market and align with global best practises, said experts.
“The clarity on ESOPs for startup founders marks Sebi’s strong commitment to innovation, deeper capital access, and sustained alignment among investors, founders, and fund managers,” said Gopal Srinivasan, chairman and managing director of TVS Capital Funds, also a senior board member of IVCA, the venture funds industry association.
Earlier, startup founders classified as “promoters” at the time of IPO filing were ineligible for ESOPs. Sebi has now relaxed this rule, allowing them to retain their ESOPs post-listing, provided the options were granted at least one year prior to the IPO filing. In the last three years, India has seen 23 startup IPOs, but only 7 of these are currently trading above their listing price. This highlights the challenges new-age companies face in sustaining valuations post-listing. Flipkart, PhonePe, Oyo, Pine Labs, Lenskart and PharmEasy are among the startups preparing for IPOs.
The SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (new SEBI ESOP Regulations) govern share-based employee benefits, including ESOPs, for listed companies. Under SEBI guidelines, an “employee” includes permanent employees, directors (whole-time or not), and employees of subsidiaries or holding companies, both in India and abroad.
To prevent misuse, Sebi introduced a one-year cooling-off period, whereby no new ESOPs can be granted within the year before the IPO filing. The new rules aim to ensure ESOPs remain a genuine long-term incentive rather than a tool for pre-IPO enrichment. The new SEBI regulations allow group companies to formulate common share-based benefit schemes, recognising the broader definition of ‘employee.’
Sebi’s regulations apply only to listed companies, while unlisted companies are regulated by the Companies Act, which provides a narrower definition of eligible employees, said a corporate lawyer. Listed companies must follow more stringent compliance and reporting requirements, including the appointment of merchant bankers for certain ESOP activities.
Sebi’s definition of an employee includes permanent employees, directors, and employees of subsidiaries/group companies, both in India and abroad, while the companies act recognise only permanent employees of a company.
For companies planning an IPO, it is crucial to ensure that their ESOP schemes align with Sebi regulations before filing the draft red herring prospectus. These rules are designed to provide clarity, prevent misuse, and align with global best practices while supporting the growth of startups and listed companies.
Sebi also announced that it allows group companies to have common share-based benefit schemes, while the Companies Act does not give this freedom. Unlisted companies planning an IPO must align their ESOP schemes with SEBI regulations before filing the draft red herring prospectus to ensure transparency standards regarding ESOPs.
Independent directors are excluded from ESOP eligibility under the new Sebi rules primarily to preserve their independence and avoid conflicts of interest. Granting ESOPs to independent directors would potentially tamper with their ability to provide unbiased, objective oversight.
“Allowing them to hold stock options could align their financial interests too closely with management or promoters, undermining the checks and balances they are meant to provide,” the lawyer said. This exclusion of board members is consistent with global corporate governance best practices for integrity and independence of the board.