Corporate Law Newsletter – SEBI Consultation Paper dated March 20, 2025 : April 2025
Introduction
Recently, the Securities and Exchange Board of India through a consultation paper dated March 20, 2025 (“Consultation Paper”), proposed an amendment to the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SEBI SBEB & SE Regulations”) which essentially permits the founders of start-ups and new age tech companies to continue holding options granted to them under an employee benefit plan/scheme post filing of a Draft Red Herring Prospectus (“DRHP”).
Currently, as per Rule 12 of the Companies (Share Capital and Debentures) Rules 2014, (which is applicable only to unlisted companies), promoters or members of the promoter group cannot be granted ESOPs, except in cases where the company holds a valid ‘start-up’ registration certificate1. This certificate may be granted by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India. Typically, the new age tech companies and/or start-ups grant ESOPs to the founder(s) to incentivize and keep them vested in the said company for a longer period of time.
However, the inevitable problem arises when start-ups and new age tech companies choose to go public via an IPO. As per SEBI SBEB & SE Regulations, promoters and members of promoter groups are not entitled to receive ESOPs. Further, the SEBI (ICDR) Regulations, 2018 (“ICDR Regulations”), requires a person to be classified as a “promoter” in case he/she, inter-alia, has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise. Hence, there may be scenarios where founders have to be classified as a “Promoter” at the time of filing the DRHP.
At present, the SEBI SBEB & SE Regulations are not clear as to whether the founders who hold ESOPs, and subsequently are classified as a ‘promoter’, can exercise their granted ESOPs.
The proposed amendment in the Consultation Paper is to include an explanation in the SEBI SBEB & SE Regulations to state that an employee, identified as a “promoter” or “promoter group” in the DRHP, who has been granted ESOPs or any other similar benefits under any scheme prior to being identified as a “promoter” or “promoter group”, shall be eligible to hold and exercise the ESOPs or other such benefit2. However, the ESOPs granted shall have to be one year prior to when the Company decides to undertake the initial public offering3.
Conclusion
The proposed regulatory changes offer both – opportunities as well as challenges, for start-ups, new age tech companies and founders. While market confidence may be enhanced through a push for stronger governance, compliance and disclosure of requirements, the ambiguity on key provisions including but not limited to – the calculation of look back period of one year, gives rise to potential concerns.
To create a more predictable and efficient framework for companies seeking public market access, these ambiguities would need to be addressed, specifically, by aligning regulatory timelines with DRHP filing dates.
With the regulatory landscape being dynamic, it becomes pertinent for stakeholders to align with the evolving landscape by engaging with policymakers so as to create and maintain a balanced approach to foster innovation alongside sturdy investor protections.
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