Option Pool: Definition, Purpose, Structure, and How It Works
What is an option pool?
An option pool is a block of a private company’s equity reserved to grant stock options to employees, consultants, advisors, and sometimes early hires or board members. It is a common tool for startups to attract and retain talent before the company generates significant revenue.
Explore More Resources
Why companies use option pools
- Attract and incentivize employees when cash compensation is limited.
- Align employee interests with company success—option value grows if the company’s valuation rises.
- Provide a standardized source of equity for future hires without renegotiating ownership at each hire.
Typical size and timing
- Early-stage option pools commonly range from about 10–25% of outstanding shares; 15–25% is typical for many early financings.
- A pool is often created or expanded at the time of an early funding round and can be increased in later rounds as the company grows and hires more people.
How option pools are structured
- Pool shares are usually taken from founder equity (not the new investors’ shares), which dilutes founders’ ownership.
- Grants from the pool are allocated based on role and timing: senior, early hires tend to receive larger allocations; later or junior hires receive smaller fractions.
- Companies may reuse or top up the pool in subsequent financings, often at the suggestion or requirement of new investors.
Vesting and exercise
- Option grants typically vest over time (commonly multi-year schedules) to encourage long-term contribution; immediate economic benefit is rare.
- Vesting schedules and cliff provisions determine when employees become entitled to their options and thereby have potential upside.
Negotiation implications: pre‑money vs post‑money
Who bears dilution from the option pool depends on whether the pool is created or credited on a pre-money or post-money basis:
* If an investor requires the pool to be established pre-money, the founders are effectively diluted to create the pool, which reduces founders’ percentage ownership and can lower the effective price founders receive per share.
* If the pool is created post-money (after the investor’s capital is accounted for), the dilution is shared with or falls more heavily on new investors.
Negotiating how the option pool is treated can materially affect founders’ and investors’ ownership stakes and the implied valuation.
Key considerations for founders and investors
- Size the pool to cover hiring needs for the near term—too small requires frequent dilutions; too large unnecessarily dilutes founders.
- Negotiate whether the pool will be created pre- or post-money and who bears the dilution.
- Define clear vesting schedules and grant policies to align incentives and manage expectations.
- Expect pool size to evolve with fundraising and hiring plans; plan ahead to minimize disruptive recapitalizations.
Summary
An option pool is a foundational compensation and incentive mechanism for startups. It enables growth by attracting talent while aligning interests through equity participation. However, the pool’s size and whether it’s funded pre- or post-money directly affect founder dilution and valuation, making its treatment a key point in any financing negotiation.