Key Takeaways
- Shares reserved to attract and retain talent.
- Typically 10-20% of fully diluted equity.
- Options vest over time, aligning interests.
- Pre-money pools dilute founders, post-money dilute all.
What is Option Pool?
An option pool is a reserved portion of a company's shares, typically 10-20% of fully diluted equity, set aside to grant stock options or other equity incentives to employees, advisors, and directors. This mechanism is common in startups, especially C corporations, to attract and retain talent when cash compensation is limited.
By aligning employee interests with company growth, option pools help foster long-term commitment and participation in the company's success.
Key Characteristics
Option pools have distinct features that impact company equity and hiring strategies.
- Size: Usually 10-20% of fully diluted shares, adjustable over time by the board.
- Purpose: Provides equity incentives to key contributors, aligning them with shareholder value.
- Vesting: Options typically vest over several years, often with a one-year cliff to encourage retention.
- Impact on Cap Table: Affects dilution for founders and existing shareholders depending on pre-money or post-money creation.
- Legal Approval: Expansions of the pool generally require shareholder consent, especially in C corporations.
- Types of Awards: Includes incentive stock options (ISOs), non-qualified stock options (NSOs), and sometimes restricted stock units.
How It Works
Option pools are created and sized during early funding rounds or pre-hiring phases to ensure equity is available for new talent. The board of directors approves the pool, which is then reflected on the company’s capitalization table.
Options granted from the pool vest over time, encouraging employee retention and aligning incentives with company performance. The pool size can be adjusted during subsequent funding rounds, impacting dilution differently depending on whether it’s established pre-money or post-money.
Examples and Use Cases
Option pools serve various strategic roles in different company stages and industries.
- Early-Stage Startups: A seed-stage company might reserve 15% of shares to attract engineers and executives, similar to how companies in the best growth stocks category structure incentives.
- Funding Negotiations: Founders often negotiate option pool size and timing with investors to balance dilution, a critical point in VC deals.
- Public Companies: Some mature firms, akin to those in the best large-cap stocks segment, maintain option pools for ongoing employee retention and performance rewards.
Important Considerations
When managing an option pool, consider its size carefully to avoid excessive dilution while maintaining hiring flexibility. The timing of pool creation—pre-money versus post-money—significantly affects founder and investor dilution, so understanding the capital structure is essential.
Additionally, understanding concepts like early exercise rights and the role of paid-in capital can help in managing the financial and tax implications of option grants effectively.
Final Words
An option pool sets aside equity to attract and retain key talent while managing dilution. Review your company’s current pool size and projected hiring needs to ensure it aligns with growth plans and investor expectations.
Frequently Asked Questions
An option pool is a reserved percentage of company shares set aside to grant stock options to employees and advisors. Startups use it to attract and retain talent by offering ownership stakes that can increase in value if the company succeeds.
The board of directors typically approves the option pool size, which usually ranges from 10-20% of fully diluted shares. Early-stage startups often set it around 10-15%, while pre-Series A rounds may see pools as large as 20%.
A pre-money option pool is created before new investment and dilutes existing shareholders but not investors, often causing more founder dilution. A post-money pool is created after investment, diluting all shareholders equally, including new investors.
Stock options granted from the option pool usually vest over time, commonly on a four-year schedule with a one-year cliff. This means employees earn their shares gradually to encourage long-term commitment.
Yes, the option pool can be expanded or contracted through board approval and usually requires stockholder consent if expanded. Adjustments often happen during funding rounds to meet hiring needs.
An option pool may include various equity types such as incentive stock options (ISOs), non-qualified stock options (NSOs), restricted stock awards (RSAs), or restricted stock units (RSUs) to suit different compensation strategies.
Shares allocated to the option pool dilute existing shareholders since these shares are reserved for future grants. The timing of the pool’s creation—pre-money or post-money—determines whether dilution impacts founders only or all shareholders, including investors.
Investors view the option pool as part of the hiring budget that helps build a strong team essential for growth. They often require the pool to be sized appropriately pre-funding to avoid unexpected dilution after investment.
