SEBI’s Proposal to Mandate Demat Holdings for Select Shareholders Before IPO: A Regulatory Gamechanger

Introduction

In a progressive step to modernize India’s capital markets and enhance transparency in public offerings, the Securities and Exchange Board of India (SEBI), through its consultation paper dated April 30, 2025, has proposed a regulatory overhaul that could significantly impact IPO-bound companies. The market regulator aims to mandate that select categories of shareholders, including directors, key managerial personnel (KMPs), senior management, selling shareholders, Qualified Institutional Buyers (QIBs), and certain regulated entities, hold their equity shares only in dematerialised (demat) form prior to the filing of the draft offer document.

This proposal intends to bridge the existing regulatory gap that allows some critical pre-IPO shareholders to continue holding shares in physical form—even after the company's listing.

Understanding the Present Regulatory Landscape

Currently, under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), it is mandatory for all promoters' holdings to be in demat form before filing the draft red herring prospectus (DRHP). However, this requirement does not extend to:

• Non-promoter directors

• Senior management personnel

• KMPs and current employees

• QIBs and shareholders with special rights

• Certain categories of financial institutions and stockbrokers

This loophole results in a situation where, post-listing, a company may still have a significant chunk of shares held in physical form, leading to inefficiencies, fraud risks, and transfer delays.

Proposed Changes: Who Must Hold Demat Shares Before Filing the Offer Document?

SEBI proposes extending the dematerialisation requirement to the following categories of shareholders prior to filing the IPO offer document:

Illustrative Examples

Example 1 – Selling Shareholders

ABC Ventures, a private equity fund holding 12% in StartupX Ltd., plans to sell 4% of its stake in the upcoming IPO. Under the proposed norms, ABC Ventures must convert all its physical share certificates (if any) into demat form before the DRHP is filed.

Example 2 – KMP & Directors

Suppose the CFO and Whole-Time Director of a company hold shares issued under ESOPs or sweat equity and continue to hold them in physical form. Under the proposed SEBI framework, they must dematerialise these shares before the IPO process begins.

Example 3 – Regulated Entities

A non-systemically important NBFC, say CapFin Ltd., has invested in the company’s pre-IPO round and holds physical share certificates. Under the new proposal, CapFin Ltd. would be required to demat those holdings before the company can file its IPO documents.

Why the Change? Addressing the Risks of Physical Shares

SEBI's rationale behind this regulatory proposal is grounded in risk reduction and market modernization. Physical shares, by nature, carry the following inherent risks:

• Loss or theft of certificates

• Forgery and duplication risks

• Manual errors in transfers

• Delays in settlement and record updating

• Difficulty in tracing beneficial ownership

In contrast, dematerialisation ensures secure, electronic, and auditable records of ownership—crucial for regulatory oversight in a post-IPO environment.

Broader Market Impact and Alignment with Policy Trends

This proposal aligns with India's broader push toward complete dematerialisation and digital governance in securities markets. Over the past decade, SEBI and the Ministry of Corporate Affairs (MCA) have taken numerous initiatives such as:

• Mandatory demat for all listed company shareholders

• Compulsory demat for unlisted public companies' securities (except small companies)

• E-filing and digital signatures for governance filings

By extending the demat requirement to select critical stakeholders pre-IPO, SEBI is seeking to create a uniform and risk-mitigated shareholder ecosystem from the point of public issue onwards.

Feedback Window and the Road Ahead

The proposal is currently open for public consultation until May 20, 2025. Market participants, legal practitioners, compliance officers, and institutional investors are invited to submit their feedback.

Once finalised and incorporated into the ICDR Regulations, this move will likely require pre-IPO companies to conduct an early internal review of shareholder records and initiate dematerialisation drives for all applicable categories.

Conclusion

SEBI's proposal marks a critical reform in India’s capital market framework, addressing a long-standing operational inefficiency. While the implementation may create additional pre-IPO compliance burdens in the short term, it promises long-term efficiency, reduced fraud risk, and better governance. IPO-bound companies should proactively evaluate their cap tables and initiate demat conversions for all stakeholders covered under the proposed rule to avoid last-minute roadblocks.

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