https://carta.com/blog/how-to-size-employee-option-pool/
Sizing an option pool correctly is a delicate balancing act that many founders get wrong—a potentially costly mistake.
The size of your employee option pool affects how much ownership of your company you retain, as well as the company’s equity valuation and share price. In this guide, we’ll explain what option pools are, what you need to know to calculate your initial option pool, and how to limit dilution.
An option pool (also called an employee stock option pool, employee stock ownership plan, ESOP, or equity pool) is a block of company shares set aside for future employees.
An option pool is created by the Board of Directors and stockholders who authorize a certain amount of shares to be reserved for equity compensation of service providers to the company. For example, if you own 10,000 shares (100% of the company) and create an option pool of 1,500 shares, there are now 11,500 shares of company stock on a fully diluted basis (more on that below).
This video explains how to size your option pool and how it affects dilution.
Offering equity to employees is one of the best ways to attract and retain talent, especially if you can’t afford to pay market-rate salaries yet. By offering employees an opportunity to own part of the company, you encourage them to act like owners and do everything they can to help the company grow so they can eventually share in its success.
Prospective investors will consider whether your option pool is large enough to attract the best talent and continue scaling the business. After all, once they have a financial stake in your company, they want your business to succeed as much as you do. By doing the math to calculate how big of a pool you need before talking to investors, you can make a good impression by showing up prepared.
Creating an option pool is a good strategy for growth, but it also dilutes stock, changes your share price, and can even alter your company’s valuation. You’ll want to consider each of these factors as you calculate the right size.
In an ideal world, you want your option pool to be just large enough to hire enough people to get you to your next round of funding. Too big, and you’ll dilute your ownership more than you have to. Too small, and investors might not be on board. Plus, you might not be able to attract enough talent to meet the operating plan you presented to investors (which can look bad when you begin fundraising again).
Well, technically they dilute all existing shareholders’ ownership. But investors often insist that you create a pool before they invest, so your first option pool usually only dilutes your shares. And dilution can happen faster than you’d expect. To continue with our example, if you own 10,000 shares and create an option pool of 1,500 shares, you’d now own 87% of the company (10,000/11,500), not 100%.
When investors give you a pre-money valuation, they usually include an option pool if one doesn’t already exist. And the bigger your pre-money option pool is, the lower your post-money ownership percentage will be. If an option pool already exists, your investor may ask to increase the size if they think it is not enough shares to cover hiring until the next funding round
Here’s a side -by-side comparison of how an option pool size can affect a company’s valuation:
| Bigger option pool | Smaller option pool |
|---|---|
| $3 million company worth + | |
| $1 million investment |
$4.5 million post-money valuation | | Your ownership percentage: 60% ($3 million / $5 million) | Your ownership percentage: 67% ($3 million / $4.5 million) |