The markets regulator has allowed founders to retain their Employee Stock Option Plan (Esop) when a startup is listed on the exchange. This ends the ambiguity around Esop rules while ensuring the share-based benefits do not become a tool for pre-IPO enrichment, explains Ananya Grover
What was the problem in the existing rules?
Unde the extant provisions of the Securities & Exchange Board of India’s (SEBI) Share Based Employee Benefits and Sweat Equity Regulations, 2021, ‘promoters’ and ‘members of promoter group’ were not entitled to receive or hold Esops as an employee cannot be a promoter. But the Companies (Share Capital and Debentures) Rules exempt startup companies up to 10 years from the date of their incorporation or registration from the same provision. So there was legal ambiguity as the company had to comply with the SEBI rules at the time of filing the Draft Red Herring Prospectus (DRHP) and was ineligible to avail the exemption under the Companies Rules.
The regulator has now taken into consideration that in many new-age tech companies, with each successful round of fund-raising the founders’ shareholding in the company already gets diluted and then they have to let go of the share based benefits issued to them as performance-linked incentives as soon as they turn promoters as per the DRHP.
How has SEBI solved this issue for startups ?
After deliberation by the Primary Markets Advisory Committee and factoring in the feedback to its March 2025 consultation paper, SEBI, in its second board meeting after Tuhin Kanta Pandey took over as chairman, decided to allow promoters to hold on to their Esops granted at least a year prior to the filing of their DRHP. It, however, prohibited any fresh Esop issuances in the run-up to the filing. This brings clarity on the treatment of the outstanding share options granted to these founders-turned-promoters, enabling them to take benefit of the performance of the company after listing. “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, CMD, TVS Capital Funds.
What was the rationale behind these changes?
In its consultation paper, the markets regulator had said the classification of the founders as promoters arises out of the practice of considering the shareholding level, which is 10%, including stock options which are either vested or granted. These options/ other benefits are part of the remuneration of the employee and are offered to keep them motivated and invested in the company. Thus, a view that an employee, who is later categorised as promoter due to his shareholding in the company, would have to forego his benefits may not be justifiable. At the same time, allowing options/ other share based benefits just prior to filing of the DRHP may be prone to misuse. Thus, it is necessary that a suitable cooling-off period is maintained between the grant of such options/ other share-based benefits and the time when the company decides to pursue an Initial Public Offering (IPO).
Tweak in CCS norms facilitates reverse flipping
While equity shares acquired under approved schemes for an Offer for Sale (OfS) in a public issue were exempt from the one-year minimum holding period rule, this was not applicable to equity shares derived from the conversion of fully paid Compulsorily Convertible Securities (CCS). This clause prevented certain investors such as alternative investment funds and foreign venture capital investors from participating in the OfS in public issues. SEBI has now extended this exemption to CCS-derived equity shares, which will encourage reverse flipping. Under reverse flipping, Indian startups that had incorporated their holding companies in foreign jurisdictions to take benefit of flexible rules move their legal headquarters back to India. Eight companies–six from Singapore – PineLabs, Udaan, Zepto, Flipkart, KreditBee and InMobi – and two from the US – Razorpay and Meesho — plan to move back to India this year, as per a report by Bay Capital.
How Paytm had violated the ESOP rules
Last month, Vijay Shekhar Sharma, founder and CEO of One 97 Communications, the holding company of Paytm, and his brother settled their Esops case with SEBI. The regulator had found out that Sharma, to circumvent the provisions of the then existing SEBI Esop guidelines, reassigned himself as a non-promoter of One97 Communications just prior to the filing of IPO documents on July 15, 2021, and created a scheme through arrangement of transfer of a portion of his equity to a family trust controlled by him to continue to exercise control over more than 10% equity directly and indirectly. The company and Sharma paid Rs 1.1 crore each for settlement whereas his brother, Ajay Shekhar Sharma, paid Rs 57.11 lakh. In addition, Sharma has been barred from accepting any Esops for the next three years.