The market regulator has suggested revising the guidelines governing Employee Stock Option Plans (ESOPs) to ensure that company founders can still benefit from their ESOPs, even if they are classified as promoters when the company prepares to go public.
Background: Promoter Classification and ESOP Restrictions
According to a consultation paper issued on March 20, the Securities and Exchange Board of India (SEBI) proposed that individuals who stop being employees after being labeled as promoters should still be allowed to retain their ESOPs. This is conditional upon the ESOPs or other benefits being granted at least one year prior to the company initiating its Initial Public Offering (IPO).
Currently, under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations—commonly referred to as SBEB and SE—those designated as ‘promoters’ or part of the ‘promoter group’ are ineligible to receive ESOPs. Additionally, any employee considered a promoter or part of the promoter group cannot be granted these benefits.
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There are scenarios where founders are categorized as promoters due to their shareholdings, including vested stock options, to comply with IPO disclosure norms. In such cases, the existing regulations lack clarity on whether these individuals can exercise their previously granted ESOPs.
Proposed Amendment for Greater Clarity
To eliminate this uncertainty, SEBI has recommended adding a clarification under Regulation 9(6) of the 2023 SBEB Regulations:
“Explanation 2: An individual identified as a ‘promoter’ or part of the ‘promoter group’ in the company’s draft offer document for an IPO, who was awarded stock options, stock appreciation rights (SARs), or similar benefits prior to this identification, shall be permitted to retain and exercise these rights as long as they were granted at least one year before the company’s board decided to proceed with the IPO, and are otherwise compliant with the regulations.”
Rationale Behind the One-Year Cooling-Off Period
The consultation paper highlights the issue that under the present framework, a former employee who is later classified as a promoter might lose their ESOP entitlements—even if those were part of their employment compensation.
SEBI also warned that offering stock-based benefits shortly before filing the Draft Red Herring Prospectus (DRHP) could be exploited. To prevent potential misuse, the regulator has proposed a one-year “cooling-off” period between the issuance of such benefits and the IPO decision.
Industry Response and Implications
This move has been welcomed by several startup founders and legal experts who argue that the existing rules often inadvertently penalize founders who have contributed significantly to a company’s early growth. These individuals may cease to be employees in a formal sense, yet continue to play a critical role in the strategic direction of the firm. Denying them the benefits of ESOPs—granted during their tenure—has long been viewed as unfair.
Legal analysts point out that the proposed change strikes a necessary balance between preventing regulatory arbitrage and recognizing genuine employee contributions. The one-year holding requirement ensures that ESOPs are not misused as a last-minute incentive just before a public offering while still protecting long-term contributors.
Looking Ahead
Additionally, this clarity could bring more transparency and confidence to both founders and investors during the IPO process. For companies, it provides a structured approach to comply with SEBI rules without compromising the ability to reward talent. For employees-turned-promoters, it removes the ambiguity that might otherwise result in the forfeiture of deserved benefits.
SEBI has invited public comments on the proposal, and depending on feedback, the suggested amendment may be finalized in the coming months. If implemented, it could significantly improve how startups and pre-IPO companies manage equity-based compensation for key personnel.
