[By Ayushika Sinha]
The author is a student of Symbiosis Law School, Pune.
Introduction
India’s IPO market in 2025 has shown remarkable resilience despite global uncertainties, with 108 IPO deals raising $4.6 billion in the first half of the year and a surge expected in the second half. A key factor is the trend of reverse flipping where startups are redomiciling their holding companies from overseas jurisdictions back to India. The Securities and Exchange Board of India (SEBI) held its 210th board meeting on 18 June 2025, following the public consultation undertaken in March 2025 introduced changes to simplify the IPO path in India’s maturing capital markets.
This article examines SEBI’s recent regulatory overhaul to accelerate startup listings and ease capital flows. It focuses on three areas, including ESOP retention for founders, OFS eligibility for converted securities and accreditation under the AIF regime. While the reforms strengthen India’s position as a global innovation hub, the article critically examines both the opportunities and challenges it poses.
Catalyzing Innovation: SEBI’s Bold Steps
Firstly, SEBI approved a proposal for founders to retain Employee Stock Options (“ESOPs”) even after being designated as promoters and the company becoming a listed entity. It addressed the ambiguity of ‘one year look back period’ surrounding the proposed amendment on March 20, 2025, clarifying that now for retaining ESOPs must be granted at least one year prior to the filing of Draft Red Herring Prospectus (“DRHP”).
Secondly, it has clarified regulation regarding investors holding Compulsorily Convertible Securities (“CCS”) under an approved scheme. According to previous guidelines such investors were subject to wait for at least a year following the IPO before selling their equity in the OFS. With the revised norms, SEBI has now permitted equity shares arising from converted CCS to be included in the OFS. Additionally, certain non-promoters (AIFs, FV, insurance companies, etc) can contribute converted shares towards the Minimum Promoter Contribution (“MPC”).
Thirdly, SEBI mandated accreditation of all investors in Angel Funds without the requirement of a minimum investment threshold and will be conducted by SEBI-recognized agencies based on their financial strength and risk appetite. Under the new framework, an investor must meet one criterion: annual income exceeding ₹2 crore, annual income above ₹1 crore and a net worth exceeding ₹5 crore (including at least ₹2.5 crore in financial assets), or a net worth exceeding ₹7.5 crore (including at least ₹3.75 crore in financial assets), replacing the earlier qualification based on net tangible assets of ₹2 crore, experience-based eligibility and a minimum ₹25 lakh investment.
Lastly, Accredited investors (AIs) will be treated as “Qualified Institutional Buyers” (QIBs) solely for investments in angel funds pursuant to consultation paper issued on February 21, 2025. This circumvents the 200-investor cap imposed under Section 42(2) of the Companies Act, 2013.
Decoding the Reforms
This development has been welcomed across the startup ecosystem as it resolves regulatory hurdles ensuring that provision including amendments allowing startup founders to retain ESOP post-IPO under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, exemptions for equity converted from CCS from open offer requirement under Regulation 10(1)(d)(ii) of the SEBI Takeover Regulations and facilitation of accreditation of investors for participation under the SEBI (Alternative Investment Funds) Regulations, 2012 to incentivize long-term commitment rather than short-term structuring From a market standpoint, the reform will accelerate the IPO pipeline by making the public listing process more founder and investor friendly and reducing key deterrents such as ESOP forfeitures, compliance of heavy cap tables, delayed exits due to OFS and CCS restrictions and accredition hurdles for early investors for domestic IPO for high growth startups. The regulatory shift modernizes capital markets and attracts more startups to Indian exchanges in the current increase of volume of startups preparing for IPOs in India, especially companies like PhonePe, Zepto and Pine Labs..
ESOP Retention:
Previously, SEBI listing rules made no distinction between traditional promoters and startup founders barring both from holding ESOPs once made public. Under Rule 12 of the Companies (Share Capital and Debenture) Rules, 2014, and Regulation 2(1)(i) of SEBI (Shared Based Employee Benefits and Sweat Equity) Regulations, 2021 promoters are not considered employees and thus cannot receive ESOPs, except in the case of startups within 10 years of incorporation. However, under Section 62(1)(b) of the Companies Act, 2013 and ICDR norms, founders are reclassified as promoters upon DRHP filing, As promoters they are no longer considered employees making them ineligible to hold ESOPs creating confusion and forcing them to forfeit ESOPs before an IPO.. This regulatory conflict hindered founders of startups because they often earned lower salaries depending upon ESOPs after equity dilution. This would happen across multiple fundraising rounds, especially in tech-driven startups. This forced many to rework their cap tables ahead of IPO just to maintain eligibility increasing complexity and uncertainty for deferred compensation. The recent approval aims to protect legitimate remuneration preventing regulatory misuse. The change enables founders to maintain their ESOPs post-listing aligning their incentives with the long-term performance of the company and remaining committed post-IPO.
Although through new rules existing ESOPs can be retained, there are still no provisions for granting ESOPs post-IPO. Such limitation discourages long term incentives to promoters resulting in further dilution of their ownership with each new issuance. Approval of fresh ESOPs grants after listing would therefore provide greater protection and incentive for founders. Furthermore, critics also argue from a corporate governance standpoint that this can lead to double dipping wherein promoters already benefit from control, voting rights, Dual-class shares and often sweat equity (Section 54 of the Companies Act, 2013). This change will allow them to retain from employee-focused ESOPs creating conflict of interest. As it will enable promoters to extract disproportionate wealth at the expense of minority shareholders and prioritizing personal gains over company performance. For example, ESOPs could allow promoters profit from stock price appreciation driven by their strategic decisions along with their existing control potentially leading to self-benefitting actions such as inflating valuations or delaying exits to maximize ESOP gains. These may also dilute minority shareholder value by increasing the share pool without matching contributions jeopardising equitable wealth distribution. Globally, governance frameworks like the UK’s Corporate Governance Code and the US’s Sarbanes-Oxley Act place strong emphasis on such checks for compensation to prevent such conflict.
Certain cases illustrate post-IPO grants triggering shareholder pushbacks and raising governance concerns including Paytm in 2024 where SEBI issued a show-cause notice after founder Vijay Shekhar Sharma received 21 million ESOPs post-IPO (despite being reclassified as a non-promoter and retaining CMD influence) raised shareholder concerns over undue enrichment. Similarly in 2025 Gokaldas Exports faced shareholder backlash after proxy advisory firm IiAS opposed ESOP grants to executives with substantial control stating that it led to excessive allocations that favored insiders. In Religare Enterprises, the ₹480 crore ESOP grants to chairpersons within 3-4 years caused controversy for conflicts because strategic control raised questions about fairness to public shareholders.
Convertible Securities:
By understanding investor real risk exposure and global practices, SEBI has introduced an important relaxation to remove the legal and regulatory bottleneck impacting fintech and ecommerce startups undergoing reverse flipping. They clarified exemptions under Regulation 10(1)(d)(ii) of the SEBI Takeover Regulations that previously applied only to shares received via court approved schemes (e.g., mergers or amalgamations) for mandatory open offer requirements when an investor’s stake exceeded 25% in a listed company’s voting rights. Equity shares converted from Compulsorily Convertible Securities (CCS) like compulsorily convertible debentures (CCDs) or compulsorily convertible preference shares (CCPS), were not explicitly covered creating ambiguity. As a result, investors holding CCS converted equity to make an open offer to public shareholders, increased compliance costs also delaying exits especially for startups reverse flipping from foreign jurisdictions. The proposed amendment exempts equity shares from CCS conversions from open offer requirements if it complies with Regulation 15, that mandates a Minimum Public Shareholding (MPC) of at least 20% of the company’s shares held by the public post-IPO to ensure market liquidity and regulatory compliance allowing such securities to be included as MPC and avoiding regulatory arbitrage.
This enables smoother integration into India’s regulatory and capital markets framework by simplifying compliance for companies that have issued convertible instruments through their foreign holding structures. The timing of these reforms is crucial wherein several high profile startups including Meesho, Pepperfry, Groww and Flipkart have either completed or initiated the process of reverse flipping in preparation for upcoming IPOs. These companies represent a growing segment of the Indian startup ecosystem moving towards domestic capital markets as a long term growth strategy. They are also improving liquidity in startup equities by easing the exit process and strengthening reinvestment cycles across the venture ecosystem. According to the ICDR Regulations, 2018, investors had to wait an additional year after the initial public offering (IPO) before they could sell the converted equity in an OFS, even if their capital had been locked in through a convertible instrument for years. For investors (private equity or venture funds), causing delays that impede prompt exits and capital recycling.
However, there is no clarity on amendment benefits provided to CCS conversions through legitimate corporate actions such as board-approved restructurings or pre-IPO investment, leaving out certain innovative capital raising structures and making the regime less agile for rapidly growing startups. Additionally, while the move enhances secondary liquidity for early investors and institutions, it can increase the risk of post-IPO price volatility although this is mitigated by the continued requirements for disclosures and minimum public shareholding.
Angel Funds under AIFs:
Furthermore, approval of comprehensive set of reforms to SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) and the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), aims at enhancing capital flow into startups in the aftermath of abolition of angel tax by requiring mandatory accredition for angel investors. For smooth application, SEBI will grandfather existing investments previously made by investors through self-decalaration model that allowed them to participate in angel funds with minimal verification of financial capacity or expertise. Hence, the new provisions of mandatory third party verified accredition will exempt earlier investments made by such non-accredited investors ensuring that they remain valid to avoid disruption and provide one year period for compliance encouraging smooth transition.
The move ensures participants can take on startup risk that will boost overall investor confidence in the initial growth phase. This is done by providing a clear regulatory framework and one-year compliance buffer for de-risking investments by reducing uncertainity arounding regulatory changes ensuring only investors with finanical sophistication is participating, minimizing unsuitable risk exposure aligining with international standards to prevent systemic vulnerabilities. These reforms promote investors’s confidence enabling rigorous due-dilligence because of financial threshold requirement. Furthermore, the removal of diversification cap and investment limits ensure greater allocation flexibility for better participating in IPOs and encouraging sustained sutained engagement in high-risk startup funding during their initial growth phase. Henceforth, this will provide startups with a stable source of funding and increased professionalism ensuring better due-diligence, more structured support and improved governance aligning with international standards followed in the US and Europe.
However, the financial threshold limit for accreditation based on market level is ambiguous and impacts first-time/small ticket investors, slowing down as investors and syndicates adjust. It is expected to temporarily slow early-stage startup funding especially for pre-seed and seed rounds in Tier 2 and Tier 3 cities, where founders depend heavily on informal angel networks and first-time investors.Furthermore, the accreditation procedure is also manual, complex and slow, especially for foreign investors opposing SEBI’s broader agenda. Streamlining and digitizing the accreditation process could reduce complexity, particularly facilitating cross-border investments and compliance. Secondly, there can be startup categorization with investor sub-categorization. The accredited investors could be sub-classified based on domain expertise or investment history ensuring better alignment between investor capability and startup risk exposure. This dual framework would close the current suitability gap and reinforce investor protection by preventing mismatched capital allocation. Globally, Australia’s ESVCLP regime apply selective investor eligibility and exposure caps, affirming that sector-specific filters enhance transparency and capital efficiency. There can be short-term disruptions including slowed syndicate activity and founder deal flow however it will be temporary as the ecosystem adapts.
The designation of AIs as QIBs dilutes the traditional risk-screening intent of QIB classification, which globally includes entities with institutional governance. Extending it to individuals solely on wealth can introduce systemic risk bypassing fiduciary checks, opposing the original intent of QIB status, that is for institutions with strong governance. Removing the diversification cap allows for highly concentrated bets in a risky startup environment exposing investors to disastrous losses.
Conclusion
SEBI’s recent reforms are necessary for India’s startup financing landscape aligning regulatory frameworks with the evolving needs of high growth ventures. By easing ESOP retention for founders, clarifying OFS eligibility for CCS conversions and overhauling Angel Fund, it aims at strengthening capital access and IPO readiness for startups undergoing reverse flipping. However, the future steps must focus upon implementation clarity, digital simplification of compliance and sector-aligned investor protections.