Promote governance over capital controls

The Securities and Exchange Board of India (Sebi) is stepping in to declare founders with a stake of 10% or more in startups as promoters when filing for public issues. This follows halving the lock-in period for promoter holdings post-issue, a move designed to facilitate listing for startups. The idea was to ease rules that ensure promoters have skin in the game after taking their companies public so that startup founders are not deterred by blocked capital. This has had a considerable effect on public issues of startups that have spawned a healthy crop of unicorns. Now, Sebi is tightening requirements on promoter status in the interest of investor protection that is raising the hurdle for listing by startups.

By lowering the threshold for declaring founders as promoters, the markets regulator is aligning oversight to the shareholding patterns of startups where founders repeatedly dilute their stakes in multiple funding rounds leading up to a listing. On paper, startup founders have little control over the management of their companies with holdings far below the 25% cut-off for promoters that ensures board representation. Yet, they typically have a larger say in management than shareholders with similar holdings in traditional companies. The concept of control is fluid, and Sebi is making its intervention as of now on merits.

Regulation of startups has to keep pace with the rate of their evolution, and setting new shareholding thresholds for promoters may be premature. The regulator’s intervention is pooling in a bloc of equity held by founders and strategic investors, which serves the original intent of locking in promoter holdings to protect shareholder interests. The ensuing compliance burden on startup founders may not be sizeable to deter them from listing. Particularly, if Sebi provides carve-outs for startup founders that can establish their distance from management control. Improvements in governance outweigh the bigger capital controls in Sebi’s move.