Understanding Employee Option Pool in Company Valuation

What is the purpose of having a sufficient equity or stock options reserved by a company?

How does a large employee option pool affect the pre-money valuation of a company?

In the given example, what will be the effective pre-money valuation if the VCs want to see a 20% option pool?

What is the typical range for an early stage company option pool?

Why is the size of the employee option pool often a key point of pricing negotiation?

What is the primary allocator of the option pool in a company?

How can the CEO effectively reduce the dilution from the use of the option pool?

What is the result of suggesting that the increase in the option pool gets added to the deal post-money?

How does a larger option pool affect the old shareholders in terms of ownership?

In what circumstance should an entrepreneur propose to expand the option pool before the next financing?

What are the three negotiating approaches mentioned in the text?

Who is often the primary allocator of the option pool?

What is the effect of managing the grants to employees to 10% by the CEO?

How does a larger option pool coming out of the pre-money valuation impact new investors?

What should an entrepreneur propose if they believe there are enough options to cover their needs?

The investors believe that the option pool of the company should be increased, they will insist that the increase happens prior to the financing, resulting in the existing shareholders, rather than the incoming investors, being diluted by the new options. You have several negotiating approaches: You can fight the pool size, trying to get the VCs to end up at 15% instead of 20%; you can accept a 20% pool, but negotiate on the pre-money valuation (for example, by asking for a $22 million pre-money valuation); or you can suggest that the increase in the option pool gets added to the deal post-money, which will result in the same pre-money valuation but a higher post-money valuation. Recognize that in all three of these cases, you are simply negotiating over __________.

The primary allocator of the pool is often the CEO of the company, although option grants have to be approved by the board of directors of the company. So while the pool size could be 20%, the CEO can manage the grants to employees to 10% so that at a time of acquisition the effective dilution from the use of the pool would be only 10%. The unissued options simply vanish into thin air in this situation, giving everyone an incremental 10% ownership of the company (on a pro-rata basis, if you owned 1.0% of the company but 10% of the options vanished, you would now own 1.11% of the company). The valuation and the size of the option pool should be part of the same discussion during the negotiation. There are three common ways that this shows up, either in the two just listed in the valuation and price section, While in both cases the investors end up with 20%, the old shareholders have 10% less ownership in the case of the 20% option pool. Although the additional ownership will ultimately end up in the hands of future employees, it is effectively coming from the old shareholders rather than being shared between the new investors and the old shareholders. This will result in a lower _______ per share for the new investors and effectively a lower pre-money valuation.

If the VC is pushing for a larger option pool to come out of the pre-money valuation but the entrepreneur feels that there is enough in the pool to meet the company’s needs over the time frame of this financing, the entrepreneur should say, “Look, I strongly believe we have enough ______ to cover our needs. Let’s go with it at my proposed level and if we should need to expand the option pool before the next financing, we will provide full antidilution protection for you to cover that.”

The unissued shares in the option pool are allocated periodically to new and existing employees. The primary allocator of the pool is often the CEO of the company, although option grants have to be approved by the board of directors of the company. So while the pool size could be 20%, the CEO can manage the grants to employees to 10% so that at a time of acquisition the effective dilution from the use of the pool would be only 10%. The unissued options simply vanish into thin air in this situation, giving everyone an incremental 10% ownership of the company (on a pro-rata basis, if you owned 1.0% of the company but 10% of the options vanished, you would now own 1.11% of the company). The valuation and the size of the option pool should be part of the same discussion during the negotiation. There are three common ways that this shows up, either in the two just listed in the valuation and price section, While in both cases the investors end up with 20%, the old shareholders have 10% less ownership in the case of the 20% option pool. Although the additional ownership will ultimately end up in the hands of future employees, it is effectively coming from the old shareholders rather than being shared between the new investors and the old shareholders. This will result in a lower price per share for the new investors and effectively a lower _______ valuation.

If the investors believe that the option pool of the company should be increased, they will insist that the increase happens prior to the financing, resulting in the existing shareholders, rather than the incoming investors, being diluted by the new options. You have several negotiating approaches: You can fight the pool size, trying to get the VCs to end up at 15% instead of 20%; you can accept a 20% pool, but negotiate on the ________ valuation (for example, by asking for a $22 million pre-money valuation); or you can suggest that the increase in the option pool gets added to the deal post-money, which will result in the same pre-money valuation but a higher post-money valuation. Recognize that in all three of these cases, you are simply negotiating over price.