SEBI’s ESOP rules for promoters need a rethink

Regulators must decide whether to uniformly permit or prohibit ESOPs for promoters.

By Bharath Reddy 

India Inc’s new-age technology companies (NATCs) have historically received significant criticism from proxy advisory firms and public shareholders over 'Silicon Valley-style' large Employee Stock Option (ESOP) grants to top executives right before their initial public offerings (IPOs), due to commercial and governance-related concerns.

SEBI has recently affirmed the criticism above in its settlement order against Paytm, its founder, and his brother, for violations of its rules regarding listed companies granting ESOPs. SEBI alleged that Paytm’s founder had undertaken certain actions to avoid being considered a ‘promoter’ of the company in its IPO-related filings. As a result, this reduction in stake enabled the founder to bypass regulatory limits that would have otherwise barred him from receiving a ₹2.1 crore ESOP grant as a ‘promoter’ of Paytm.

‘Promoters’, under the current regulatory framework, are barred from receiving ESOPs in both the listed and unlisted space, as regulators view these individuals/entities as occupying the ‘driving seat’ of a company, by virtue of their controlling stakes or management rights. In their view, a concentration of economic incentives (in this case, ESOPs) and governance rights within the ‘driving seat’ of the company is not aligned with public shareholder interests.

However, in an attempt to play regulatory catch-up, this rule (a blanket ban on ESOPs to ‘promoters’) evolved in the unlisted space via the ‘start-up’ exemption, where ‘promoters’ were made eligible for the grant of ESOPs in privately held start-ups. This amendment was introduced in the context of the current venture-backed start-up environment, where founders bear the ‘cost’ of acquiring institutional capital, which typically results in large dilutions of their holdings over multiple fundraising rounds.

Therefore, contrary to the traditional regulatory view, the grant of ESOPs to start-up founders (including ‘promoters’) is often explored as a structure in NATCs, to keep founders invested in the growth story of the start-up. Founder ESOPs benefit from valuation upsides during institutional funding rounds, and this is seen as a key takeaway. In this regard, as long as the NATC continues to remain a privately held start-up, ESOPs issued to ‘promoters’ are not affected in any traditional exit, including block sales or corporate buyouts.

That said, NATCs are often required to provide exits to institutional investors, and in many cases, such exits take the form of an IPO. SEBI, in its attempt to remain aligned with evolving market realities, has released a consultation paper proposing a change to the listed company ESOP rules. The proposed amendment seeks to clarify that ESOPs held by founders will continue to remain valid once these founders enter the ‘driving seat’, i.e., become ‘promoters’ of their companies following an IPO.

The current regulatory landscape surrounding ESOPs reveals a fundamental inconsistency: while the broader framework prohibits ESOPs for ‘promoters’, carve-outs like the start-up exemption in the unlisted space and SEBI’s proposed amendment in the listed space have blurred the lines. This raises a critical question—should founders, once designated as ‘promoters’, be entirely excluded from ESOP participation upon assuming the ‘driving seat’, i.e., fiduciary responsibilities post-listing? Critics argue that the start-up exemption exists as a necessary evil, owing to the absence of the enhanced governance framework that is applicable to listed entities.

To resolve this regulatory dichotomy, a more comprehensive approach is needed. Regulators must decide whether to uniformly permit or prohibit ESOPs for ‘promoters’, without fragmented exceptions. In doing so, they can draw from international best practices, which typically allow ESOPs issued to founders to remain valid post-listing, provided they are transparently disclosed to shareholders. While the concept of ‘promoters’ is unique to the Indian jurisdiction, international markets recognise ‘founders’ and ‘major shareholders’.

Accordingly, it is time for regulators to close the loop and establish a clear, consistent stance—one that reflects both the realities of modern entrepreneurship and the expectations of public markets.

(Bharath Reddy is Partner, Cyril Amarchand Mangaldas.)

Views are personal and do not represent the stand of this publication.