The market regulator’s expansive definition of promoters for companies going public may put them in a bind over how to reward founders. Since promoters are ineligible to be granted employee stock option plans (ESOPs), the new-age firms may turn to alternatives such as phantom stock units, warrants and sweat equity to compensate founders.

The market regulator has been insisting that founders of IPO-bound companies holding 10 per cent or more classify themselves as promoters. Even founders collectively holding 10 per cent are to be considered promoters if they are key managerial personnel (KMP) or a director in the company.

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Payout of phantom stock units — where the units only track the upside of share value and the benefit is paid out in cash — may gain traction. These structures adhere to the commercial requirements in terms of ensuring that the benefit will accrue to the unitholders only if there is a growth in share value.

‘No specific terms’

“As this is unregulated, there are no specific terms under law that will have to complied with, like obtaining shareholders’ approval, minimum one-year cliff/vesting period and payment of exercise price, and it becomes purely contractual in nature. This will give the companies and founders a lot more flexibility in structuring how and when the benefits will accrue,” said Bharath Reddy, Partner, Cyril Amarchand Mangaldas.

Through its informal guidance issued to MindTree and Saregama, SEBI has clarified that pure cash-based benefit schemes which don’t deal in securities are not governed by its share-based employee benefit regulations. “Even before an IPO, the Companies Act, 2013, does not permit the granting of stock options to a founder identified as a promoter, except for promoters of start-ups recognised by DPIIT. As a result, unlisted companies have been incentivising such founders by granting phantom stock options,” said Shabnam Shaikh, Partner, Khaitan & Co.

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In instances where a company is cash-strapped or investors want founders to have more at stake, new structures are being explored. Founders are being granted convertible instruments such as optionally convertible preference shares or warrants. “These instruments closely resemble employee stock options. If the vesting conditions are not met, the warrants are forfeited or cancelled and the OCRPS are redeemed at the acquisition price,” said Shaikh.

The conversion of warrants into shares, however, may create tax issues, and if the share price is already high, the issuance of convertible shares could require the employee to incur significant upfront costs, added Shaikh.

Sweat equity

Another option is sweat equity, which can be issued both pre- or post-IPO. Sweat equity shares are equity shares issued to the directors or employees at a discount or for a consideration other than cash for their know-how or expertise brought to the company.

Pre-IPO issuance, however, will add to the founders’ shareholding which will further contribute to them being classified as a promoter, said Kriti Kaushik, Partner, Shardul Amarchand Mangaldas & Co.

Last year, proxy advisory firm IiAS had petitioned SEBI to relook at whether Paytm founder Vijay Shekhar Sharma was eligible to receive stock options. Sharma’s direct equity holding at the time of the IPO had reduced to 9.1 per cent from 14.7 per cent earlier.

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