Explained: Should founders of listed Startups be eligible for ESOPs?

Should startup founders be eligible for ESOPs?

Zomato, a leading food delivery aggregator, recently announced a significant allocation of Rs 3,780 crore in employee stock options (ESOPs) to incentivise its top leadership, including founder Deepinder Goyal. The move has reignited the debate over whether founders should qualify for ESOPs. There have been similar instances earlier with Paytm and PB Fintech, which operates Policybazaar.com, where the promoters received substantial stock options.

Moneycontrol examines the regulations surrounding ESOPs and the concerns of minority investors.

What do the rules state?

According to the Securities and Exchange Board of India (Sebi), promoters are typically ineligible for stock options. However, some modern startups have adjusted their shareholding structures before going public to ensure that their founders do not fall within Sebi's definition of "promoter." This is achieved by declaring that the company is professionally managed, without a distinct promoter. In such cases, the founder becomes an ordinary shareholder and thus qualifies for ESOPs.

What are the implications of ESOP allotments for minority investors?

ESOP allotments undergo careful scrutiny from shareholders during voting processes. The creation of new ESOPs increases the company's overall capital, thereby diluting the value of existing shareholders' holdings. In the past, proxy advisory firms have advised shareholders to vote against such ESOP proposals, as they enrich founders at the expense of other shareholders. Shriram Subramanian, founder of Ingovern, a proxy advisory firm, emphasises the importance of broad-based ESOP programmes that include many executives, not just founders. Additionally, ESOP programmes should be tied to performance targets, he said.

Should startup founders reclassify themselves as 'promoters'?

Sebi defines a promoter based on the concept of control, which includes individuals with over 10 percent shareholding or those exerting control. In the case of listed startups, founders often reduce their stakes below 10% to present themselves as professionally managed entities. However, many founders still maintain control through various means, such as the right to appoint board members or affirmative/veto rights within the company. Legal experts note that founders exercising such control should be classified as promoters under Sebi rules.

Why are founders of listed startups hesitant to classify themselves as promoters?

Apart from missing out on ESOP allocations, being labelled as promoters of a listed company entails numerous compliance obligations. These include continuous disclosures regarding changes in promoter shareholding and share lock-in requirements following capital market issuances like initial public offerings (IPOs) or follow-on offerings (FPOs). Regulators also have the authority to freeze the promoter shareholdings in cases of serious disclosure lapses. Given these challenges, startup founders often prefer to position themselves as ordinary shareholders.