SEBI’s Relaxation of ESOP Rules: A Game Changer for Start-Up Founders
On Wednesday, the Securities and Exchange Board of India (SEBI) announced a significant relaxation of rules surrounding Employee Stock Options (ESOPs) for start-up founders. This change is poised to have a profound impact on the entrepreneurial landscape in India, particularly for those classified as promoters. Previously, these founders were required to liquidate their share-based benefits before filing the Draft Red Herring Prospectus (DRHP) for an Initial Public Offering (IPO). However, under the new guidelines, founders who received share-based benefits at least one year prior to filing the DRHP can now retain or exercise these benefits post-listing.
The Previous Framework
Under existing regulations, promoters were ineligible to hold or be granted share-based benefits, including ESOPs. If they held such benefits at the time of filing the DRHP, they were mandated to liquidate them prior to the IPO. This requirement was seen as a barrier, particularly affecting start-up founders who often rely on these benefits as part of their compensation and incentive structure. The SEBI board meeting document highlighted that this provision was adversely impacting founders classified as promoters, prompting the need for a revision.
Enhancing Market Transparency
In addition to the relaxation of ESOP rules, SEBI has introduced measures aimed at enhancing market transparency. One of the key initiatives is the mandatory dematerialization of securities for a broader range of stakeholders, including promoter groups, employees, directors, and institutional investors, prior to filing the DRHP. This expansion of the demat mandate is expected to mitigate fraud, prevent the loss or damage of physical shares, and improve regulatory oversight.
Streamlining the Public Issue Process
SEBI’s recent decisions also include amendments to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, and the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021. These amendments aim to simplify the rules for companies planning to go public, particularly those looking to shift their base back to India—a process known as "reverse flipping."
One of the notable changes addresses a long-standing issue regarding equity shares arising from the conversion of fully paid-up Compulsorily Convertible Securities (CCS). Previously, only equity shares acquired under approved schemes were exempt from a one-year holding period before being offered for sale in an IPO. The new regulations extend this exemption to shares arising from CCS conversions, thereby encouraging greater investor participation in public issues.
Flexibility for Relevant Contributors
Moreover, SEBI has allowed certain “relevant persons”—including alternative investment funds, foreign venture capital investors, and public financial institutions—to contribute equity shares from CCS conversion towards the minimum promoter contribution (MPC). This flexibility, which was previously granted only to promoters, is expected to enhance the capital-raising capabilities of start-ups and other companies preparing for an IPO.
Commitment to Modernization
These measures were finalized following public consultations held in March and April 2025 and were reviewed by SEBI’s Primary Markets Advisory Committee. This reflects SEBI’s ongoing commitment to modernizing India’s capital markets and making them more accessible and efficient for all stakeholders involved.
Conclusion
The recent changes introduced by SEBI represent a significant step forward in fostering a more conducive environment for start-up founders and enhancing the overall transparency and efficiency of the capital markets. By relaxing the rules around ESOPs and streamlining the public issue process, SEBI is not only supporting the entrepreneurial spirit but also paving the way for a more robust and dynamic market landscape in India. As these regulations take effect, the impact on start-ups and their ability to attract investment will be closely watched, marking a new chapter in India’s financial ecosystem.