🎯 Introduction: Why Trusts Matter for Unlisted Startups

Unlisted startups often face a tricky dilemma—how to offer attractive employee benefits, particularly equity-based rewards, without overwhelming their cap table or creating legal and operational headaches.

This is where trusts come into play. Think of them as the backstage crew in a theatre production—managing the lighting, props, and transitions so the stars (the company and its employees) can shine.

Unlisted startups typically grapple with:

• 🎯 Cap table complexity—especially when dozens or hundreds of employees hold shares directly
• 📉 Liquidity limitations—private company shares aren’t easily sold or monetized
• 💸 Cash constraints—especially in early stages, high salaries are tough to sustain
• 📜 Regulatory burdens—especially when issuing or transferring equity
• 🤝 Governance and trust—employees want transparency and fairness

Using a trust-based structure, particularly an Employee Benefit Trust (EBT) or an ESOP Trust, provides a legally secure, scalable, and tax-efficient framework to manage employee equity and benefits.

📚 What is a Trust in the Context of Employee Benefits?

At its core, a trust is a legal arrangement where one party (the trustee) holds and manages assets (e.g., company shares) for the benefit of another party (the beneficiaries, i.e., employees).

The company sets up and funds the trust, which then handles the equity-related aspects on behalf of employees—such as granting stock options, handling vesting schedules, managing exercises, and facilitating liquidity.

🏷️ Types of Trusts Commonly Used

• Employee Benefit Trust (EBT): General-purpose trust used to hold and distribute shares to employees.
• ESOP Trust: Specifically created to administer Employee Stock Option Plans (ESOPs).
• Employee Ownership Trust (EOT): A model where the trust owns a controlling stake in the company on behalf of all employees (common in the UK and gaining traction elsewhere).
• Rabbi Trust (common in the US): A type of deferred compensation trust, though with creditor exposure risks.

Regardless of the jurisdiction or name, these trusts share a unifying purpose—making employee equity easier to manage, legally sound, and operationally scalable.

🧩 Why Use a Trust in a Startup?

🧾 1. Clean and Clear Cap Table

Without a trust, each employee granted equity becomes a shareholder on the company's cap table. This becomes messy, especially with large teams or frequent turnover. A trust keeps things clean:

• The trustee is the only shareholder on record.
• Employees hold beneficial ownership, not legal title.
• Simplifies investor due diligence and fundraising processes.

🗃️ 2. Administrative Efficiency

All equity-related actions—vesting, exercising, buybacks, and even secondaries—can be managed from one centralized entity (the trust). This avoids:

• Repetitive paperwork for every employee
• Legal complexity in issuing or transferring shares
• Errors in reporting or compliance

💰 3. Support for Cashless Exercises

Cashless exercise allows employees to receive shares without having to pay for them upfront. The trust can:

• Front the purchase of shares
• Allocate them to employees
• Recover its investment during a buyback or liquidity event

This is particularly useful in startups where employees may not have the cash to pay for exercising options but still want ownership.

🛡️ 4. Greater Transparency and Employee Trust

Having an independent trust creates an added layer of fairness. Employees feel more secure knowing:

• An independent trustee is overseeing the equity pool
• Their rights are documented and managed under a legal trust deed
• Equity programs are professionally administered

⚙️ How Does a Trust-Based Employee Benefit Scheme Work?

🏗️ Step 1: Trust Creation

• A trust deed is drafted and executed by the startup.
• The trust is typically registered under the applicable Trusts Act in the jurisdiction.
• A trustee is appointed—either an individual or a professional trustee firm.

👤 Step 2: Parties Involved

• Settlor: Usually the startup itself; initiates the trust by contributing assets or shares.
• Trustee: Legal owner of trust assets. Has fiduciary responsibility.
• Beneficiaries: Eligible employees as defined in the trust deed and ESOP scheme.

📜 Step 3: Scheme Approval

• The startup's board and shareholders approve the ESOP plan.
• This plan outlines grant terms, vesting schedules, and rules for exercises.

💼 Step 4: Share Transfer to Trust

• The startup allots or transfers a pool of shares to the trust.

• These could be:

  • Freshly issued shares
  • Secondary shares purchased from founders or investors

🧾 Step 5: Independent Valuation

• An independent valuation is obtained to determine the fair market value (FMV) of shares.

• This is crucial for:

  • Grant pricing
  • Exercise cost
  • Tax implications

🎁 Step 6: Granting and Vesting

• Employees are granted options or rights to acquire trust-held shares.
• Vesting schedules typically span 3–4 years.
• Upon vesting, employees can exercise their options.

🔁 Step 7: Exercise and Share Allocation

• The trust allocates shares to employees once exercised.
• If cashless, the trust covers the cost and recovers later during a buyback or secondary sale.

💵 Step 8: Liquidity Events

• On buyback, acquisition, or IPO:

  • The trust facilitates sale of shares
  • Proceeds are distributed to eligible employees as per their entitlements

🌟 Benefits for Startups

👥 1. Talent Acquisition and Retention

Trust-based equity plans enable startups to offer compelling, long-term rewards even when cash compensation is modest. Equity incentives:

• Attract top talent
• Encourage long-term commitment
• Create a sense of ownership

🔐 2. Capital Conservation

Instead of large salaries, startups can allocate part of compensation through equity:

• Lower upfront cash burn
• Higher employee satisfaction when aligned with long-term vision

🔄 3. Scalability

As startups scale and headcount increases, trust-based systems continue to handle the complexity with ease. A single trust can serve hundreds of employees.

📊 4. Professional Governance

Trusts operate under a documented trust deed with clear rules, which builds confidence among:

• Employees
• Auditors
• Investors

⚖️ 5. Tax Efficiency

Depending on jurisdiction:

• Trusts may enable deferral of tax liability until actual sale of shares
• Proper valuation and compliance help minimize tax disputes

⚠️ Risks and Challenges

⚖️ Regulatory Complexity

Trust creation involves:

• Drafting trust deeds
• Filing regulatory forms
• Obtaining shareholder and board approvals
• Annual compliance and tax reporting

This can be legally intensive and needs expert oversight.

🧑‍⚖️ Trustee Selection Matters

Appointing an unsuitable trustee—such as a major shareholder or company director—can create conflicts of interest. Independent or professional trustees are recommended.

⏳ Liquidity Timing

Employee expectations need to be managed. Liquidity events might be years away, and employee frustration can grow if they don’t see actual gains.

💼 Valuation Disputes

Unclear or poorly documented valuation processes can lead to:

• Tax challenges
• Perceived unfairness among employees
• Regulatory scrutiny

It’s critical to work with experienced valuation professionals.

🧾 Ongoing Admin Overheads

Trusts require:

• Regular accounting
• Reporting of grants and exercises
• Fair value disclosures in financials
• Coordination during buybacks and exits

💣 Creditor Exposure (in some trust types)

In certain trust types (like Rabbi Trusts), trust assets can be exposed to company creditors during bankruptcy. Always align trust design with jurisdictional laws to avoid this risk.

🧠 A Sample Startup Scenario: “InnovaX”

Let’s illustrate how this works in practice.

Background:

• Startup: InnovaX, a SaaS firm with 60 employees
• Stage: Series A completed, looking to hire aggressively
• Objective: Offer ESOPs without complicating cap table

What They Did:

1. Created an ESOP Trust under local Trusts Act.
2. Transferred 5% equity to the trust (fresh issue).
3. Hired a third-party trustee.
4. Set up a 4-year vesting schedule with 1-year cliff.
5. Enabled cashless exercise by funding trust initially.
6. Communicated clearly with employees about the benefits and liquidity timeline.

Result:

• Employees felt genuine ownership.
• Investors appreciated the clean cap table.
• During a secondary sale in Series B, the trust facilitated partial liquidity for 12 employees.

🔁 Summary Icons & Takeaways

• 🛠️ Trust Setup: Legal trust registered under applicable laws.
• 🧾 Cap Table Simplification: Only trustee shows up as shareholder.
• 🧠 Professional Governance: Clear, compliant management of ESOPs.
• 💼 Cashless Exercises: Employees get shares without upfront payments.
• 📊 Centralized Administration: One entity handles all grants and transactions.
• 🏦 Liquidity Management: Buybacks and secondaries are smooth.
• 👥 Talent Engagement: Equity used as a retention and performance tool.
• ⚖️ Tax Planning: Helps reduce or defer tax obligations.

🧭 Final Thoughts

Trusts are not just a legal construct—they are a strategic tool for startups.

They help you:

• Align talent with your growth
• Keep your cap table investor-friendly
• Plan for future liquidity
• Reduce legal friction as you scale

However, trusts aren’t plug-and-play. You need:

• A sound trust deed
• Experienced advisors
• Proper trustee selection
• Transparent communication with your team

With these elements in place, a trust-based approach becomes a powerful framework to align vision, reward employees, and build a lasting company culture of shared ownership.

Created & Posted by Aashima Verma

Accounts Executive at TAXAJ

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