The Securities and Exchange Board of India ("SEBI") issued a consultation paper dated March 20, 20251 ("Consultation Paper"), proposing certain amendments to the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 ("SBEB Regulations"), and inviting comments from the public on the same. In the consultation paper, the SEBI observed that in many new age tech companies, the shareholding of the founders is diluted as and when the company raises a fresh round of investment. In order to incentivize these founders, companies typically offer employee stock option plans ("ESOPs") to maintain each founder's shareholding in the company and motivate them to grow their company. The founders tend to prefer equity-linked incentives rather than cash-based incentives as the former would keep their shareholding intact. As per the Consultation Paper, the SEBI proposes to clarify the applicability of ESOPs granted to founders who are subsequently classified as 'promoters' after the filing of Draft Red Herring Prospectus ("DHRP").
Existing Regulation:
As per the current regulatory framework, only 'employees' are eligible to hold ESOPs. In case of a private limited company, as per Section 62(1)(b) of the Companies Act, 2013 read with Rule 12 of the Companies (Share Capital and Debenture) Rules, 2014, 'promoter' and 'promoter group' are kept outside the purview of the term 'employee' and hence, are not eligible for ESOPs. However, the said restriction is not applicable to a start-up company for a period of 10 (ten) years from the date of its incorporation.
Similarly, in the case of a listed company, as per the SBEB Regulations, 'promoter' and 'promoter group' are excluded from the definition of 'employee'. Additionally, under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 ("SEBI ICDR Regulations"), any person who has control over the affairs of the company shall be termed a 'promoter'. This may give rise to a situation wherein many founders maybe classified as a 'promoter' at the time of listing, thereby not being eligible for any fresh issuance of the ESOP. However, the current framework does not clarify whether a founder who has been granted the ESOPs, can exercise the same upon subsequently falling under the definition of a promoter (i.e. at the time of filing DHRP) ("Deficiency").
In order to bring more clarity to the existing framework and to incentivize the founders in their efforts to scale the company, the SEBI has proposed to amend Regulation 9(6) of the SBEB Regulations to clarify the Deficiency.
Proposed Amendment:
The SEBI has proposed the addition of an explanation to Regulation 9(6) of the SBEB Regulations, which is as follows:
"Explanation 2: an employee, identified as a "promoter" or "promoter group" in the draft offer document filed by a company in relation to an initial public offering, who was granted options, SARs or other benefits under any scheme prior to being identified as a "promoter" or "promoter group", as the case may be, shall be eligible to continue to hold, exercise or avail any such option, SAR or benefit, in accordance with its terms and granted, prior to one year from the date when the Company (i.e. its' Board) decides to undertake Initial Public Offering and, in compliance with these Regulations."
It should be noted that the proposed amendment only allows promoters to exercise ESOPs which have been granted 1 (one) year (or more) prior to the date when a company decides to undertake an IPO. The cooling off period is introduced in order to restrict misuse of the proposed amendment and prevent founders from issuing the ESOPs immediately prior to the IPO to unduly increase their shareholding. As per the current framework, in case a founder is deemed to be a promoter, such founder is not eligible for any 'new issuance of ESOP'.
Conclusion:
With a sharp increase in new age technology companies aiming for an IPO to raise funds, the proposed amendment is a welcome step by the SEBI to incentivize the founders. In case the proposed amendment is passed by the SEBI, it will be beneficial for both, the founders and the investors as the founders can exercise their existing ESOPs even after the company goes through an IPO. This will help the founders maintain their shareholding in the company while complying with the requisite corporate governance framework of the SEBI.
Footnote
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