The Ultimate Guide to Start-Up Option Pools
An option pool is composed of shares set aside for employees of a private company. It’s a strategic way to attract top-tier talent to startups. If the employees contribute to the company’s success leading to an IPO, they stand to be compensated with valuable stock. Early employees typically receive a more substantial share of the option pool compared to those who join later.
The initial size of an option pool often diminishes through subsequent funding rounds, primarily due to investors’ ownership demands. Creating an option pool generally dilutes the founders’ shares because investors, including angels and venture capitalists, usually stipulate its creation.
Key Points to Remember
- An option pool represents a block of company equity reserved either for early investors or employees of a startup.
- It is designed to attract investment or talent crucial for growth when the company is not yet generating adequate revenue or cash flows.
- Option pools can range from 15–25% of initial equity but tend to dilute founders’ and early investors’ holdings over time.
How Are Option Pools Structured?
The shares making up an option pool typically come from the founder stock rather than the shares earmarked for investors. This pool can represent 15–25% of the total outstanding shares. The size is often determined during the startup’s earliest funding rounds as part of the overall agreements.
Over time and with additional funding rounds, the company may establish more option pools. Venture capital backers often dictate or advise the size of the pool based on pre-money or post-money valuation. Negotiations regarding the option pool can influence the startup’s valuation. For example, investors might prefer an option pool calculated at pre-money valuation, reducing the company’s overall price.
Key Considerations
The shares from the option pool are often allocated based on employee roles and their hiring time frame. Early senior management might receive significant percentages of the entire pool, while later junior employees get just fractions.
Option pool shares typically come with a vesting period, similar to other types of stock options. This time delay incentivizes employees to contribute to the company’s success, aiming for maximum gains once shares vest.
Inspiring Future: Vision Realized Through Option Pools
Setting up an option pool can play a critical role in a startup’s ability to attract high-quality talent while balancing investor demands. Properly structured, it aligns employee incentives with company growth and ensures the journey toward a successful future is collaborative and optimistic.
Related Terms: dilution, vesting, pre-money valuation, post-money valuation, stock options.
