Understanding Promoter Lock-In: Importance for Investors

PROMOTER LOCK-IN

Promoter or Founder Lock-In is a standard clause in most Shareholder Agreements that prohibits the promoter/founder group to sell their shares to anyone without the prior written consent of the Investor.

WHY DO INVESTORS INSIST FOR A PROMOTER LOCK-IN?

Retain Skin in the game (SITG): Promoters have the maximum stake/SITG in their company. Investors would want to keep it that way to keep their interest aligned. Any premature sale would send out the wrong signal to the market.

Investors desire exit before promoters: It’s not surprising that investors, who put their LP-funded money just on the basis of founder’s vision, team and plan, would insist to enjoy the first pound of flesh whenever an opportunity to sell their shares arise! Hence Promoter Lock-in prevents the founders to sell first.

Preamble and Objective Behind Promoter Lock-In

The preamble to the regulatory framework governing promoter lock-in clauses in India is based on the following principles:

Market Integrity and Stability:

To prevent promoters from liquidating their holdings immediately after fundraising (through IPOs or other capital-raising events), which could destabilize the market or erode investor confidence.

Promoter Commitment:

To ensure that promoters remain invested in the company for a defined period, signaling their long-term commitment to the business.

Protection of Minority Investors:

To safeguard retail and institutional investors by preventing actions that might dilute shareholding or harm valuations.

Transparency:

To establish clear rules regarding promoter obligations in shareholding retention, improving trust in the regulatory environment.

History of Promoter Lock-In in India

1. Pre-SEBI Era (Before 1992)

• During the unregulated phase of India’s capital markets, there was no formal mechanism to restrict the sale of promoter shares post-IPO or funding.
• Promoters often diluted their stake or exited immediately after fundraising, leading to volatility in valuations and erosion of investor trust.

2. Introduction of SEBI and Regulatory Reforms (1992)

• The establishment of SEBI in 1992 marked a turning point. The focus shifted to regulating public markets and protecting investor interests.
• The SEBI (Disclosure and Investor Protection) Guidelines, 2000 introduced the lock-in requirement for promoters in public offerings to address post-IPO share volatility.

3. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations)

• These regulations consolidated earlier guidelines and included detailed provisions for promoter lock-in:
  • 3 Years Lock-In: At least 20% of the promoter’s post-issue capital to be locked in for three years.
  • 1 Year Lock-In: Remaining promoter shares (beyond the 20%) were locked in for one year.
• Objective: To bring clarity, promote fair practices, and enhance transparency during public offerings.

4. SEBI (ICDR) Regulations, 2018

• The regulations replaced the 2009 framework and made further refinements, including specific provisions for startups listing on the Innovators Growth Platform (IGP):
  • Relaxed Lock-In: For startups, the entire pre-issue capital held by promoters is locked in for only 6 months, acknowledging the need for liquidity in a dynamic startup ecosystem.

courts in India have recognized and enforced contractual agreements between shareholders, including those in Shareholders’ Agreements (SHA), provided they comply with the Companies Act, 2013 and are aligned with the company’s Articles of Association (AoA).