SEBI Proposes Clarity on ESOPs for Employees Turned Promoters Before IPO

In a significant move aimed at bringing clarity and fairness to employee stock option plans (ESOPs), the Securities and Exchange Board of India (SEBI) has released a consultation paper on March 20, 2025, proposing key amendments to the SBEB & SE Regulations. These changes specifically address a long-standing ambiguity regarding the eligibility of employees who are later classified as promoters at the time of an IPO, and whether they can continue to hold and exercise their ESOPs.

This move is particularly relevant for startup founders, early-stage employees, and companies gearing up for a public listing, where such transitions from employee to promoter status are quite common.

To help investors and stakeholders better understand the implications of this proposal, here’s a simplified Q&A format explaining what the new rule is, why SEBI is introducing it, and who stands to benefit from it.

📌 Q1: What is the current rule regarding ESOPs and Promoters under SEBI Regulations?

Under SEBI (SBEB & SE) Regulations, promoters or members of the promoter group are not allowed to receive ESOPs (Employee Stock Option Plans).

Also, if an employee is later classified as a promoter, it creates confusion about whether they can still exercise their earlier granted ESOPs.

📌 Q2: What’s the issue SEBI is trying to fix?

Sometimes, employees (like Founders) who were earlier granted ESOPs later get classified as "Promoters" at the time of IPO, because public issue norms require such disclosures.

But current rules are not clear whether they can still retain and exercise their ESOPs after being identified as a promoter.

As a result, employees may lose their ESOPs even though they got them fairly as part of their compensation before IPO planning started.

📌 Q3: What change is SEBI now proposing in the new consultation paper?

SEBI wants to allow such employees (founders, key people) to retain and exercise their ESOPs, even if they later become a promoter, but only if:

• Those ESOPs or benefits were granted at least 1 year before the company decides to go for an IPO (i.e., before the Board passes the IPO resolution).

📌 Q4: What exactly will be added to SEBI rules?

A new "Explanation 2 under Regulation 9(6)" will clarify:

If any employee who was granted ESOPs, SARs (Stock Appreciation Rights) or any other share-based benefits before being identified as a promoter, and those grants were done at least 1 year before the IPO decision, then they can continue to hold, exercise, or enjoy the benefit of those grants.

📌 Q5: Why has SEBI put this 1-year condition?

SEBI is concerned that companies may misuse ESOP grants just before IPO filing (to benefit promoters unfairly).
So, a cooling-off period of 1 year will help ensure that such ESOPs are genuine compensation grants — not last-minute rewards before IPO.

📌 Q6: Who benefits from this new proposal?

• Founders or employees-turned-promoters who were fairly granted ESOPs earlier.
• It ensures they are not deprived of their benefits just because they became a promoter later for IPO compliance.

📌 Q7: What does it mean for startup founders or early-stage employees?

This is a very positive step, especially for founders in startups planning IPOs in the near future. It protects their long-term ESOP incentives without being penalized due to promoter classification at IPO time.

✅ Summary – New SEBI Proposal:

If ESOPs are granted at least one year before IPO planning starts, and later that employee is classified as a promoter — the ESOPs will still remain valid.