How Big Should Your Option Pool Be?
We’re swimming in an ocean of information about Stock Option Pools and the promise of future liquidity. Each year, a new wave of advice washes upon the shore.
Let’s dive right into the deep end…
The market figure for a Series A option pool — by far — is an unissued and available option pool that represents 10% of the company as of immediately following the closing of the Series A.
However, some investors may ask you for a higher pool. Alternatively, you may wish to keep the pool smaller than the market norm, either to limit dilution or because your company is based in, or recruiting from, a geographic location outside of Silicon Valley, where the equity compensation expectations are generally lower.
the most important thing founders can do is to take the time to understand their cap table and how outstanding safes and convertible notes, as well as the Series A new money and option pool increase, will change the cap table.
Typically, the dilutive effect of safes, notes and option pools are interdependent with the Series A valuation and investment round terms. This is because safes and notes conversion terms are impacted by the Series A valuation, and the option pool is pegged to a percentage of the post-Series A cap table (e.g. 10% of the post-Series A cap table).
The starting point — on average — for an option pool after the Series A financing is 15% to 20% so this is certainly a reasonable starting point. Recognize that there is a nuance here between “pre-money” and “post-money”. I like to talk about the option pool as “post-money” so the valuation doesn’t impact the pool as part of the financing — it makes it a little simpler to discuss.
In each subsequent round, the new size of the option pool will likely be part of the financing negotiation. Most Series A investors expect you to use up most of the option pool for early hires so that when it is time to raise a new round, you’ll likely need additional options to incent your future employees.
Discuss your hiring plan with your prospective investors before you discuss valuation and the option pool. They may offer the truism that “you can’t hire good people as fast as you think.”
Traditionally, ESOPs are set to 10% at seed. This is the recommendation of Seedcamp, and still the norm in both Europe and the US. However, some accelerators, including Y Combinator and The Family, now advocate 20%. They recommend that seed investors should increase their valuation of the company to accommodate the larger ESOP.
This doesn’t mean you should allocate or promise all of this amount to your early employees. But it recognises the importance of stock options for securing top talent when company cash is particularly constrained.
the option pool request needs to be reasonable and based on some kind of budget. I generally ask the entrepreneur to put enough options into the “pre-money pool” to fund the hiring and retention needs of the company until the next financing. My thinking on this is that I don’t want to get diluted between financings. So I like to see a headcount based hiring plan with expected options against each hire combined with a retention plan for all current employees who will need additional option grants.
In most of the early stage financings I’ve done in the past few years this work on the option pool has shown a need for around 10% in unissued options. I’ve seen it as big as 15% but that is rare. I’ve also seen it as low as 5%, but that is even more rare. But the point is this; don’t guess or negotiate this number. Do the work, figure it out, and put it in the pre-money and then negotiate price.
agree with the entrepreneur that the option pool will have enough unissued options to fund all the hiring and retention grants that need to happen between the current financing and the next one. Then we’ll do the same thing at the time of the next financing. That makes sense to me. And it is pretty easy to do.
One problem is that startups try to have very small option pools after their A rounds, because the dilution only comes from the founders and not the investors in most A-round term sheets. The right thing to do would be to increase the size of the option pool post-A round, but unfortunately this rarely happens — no one wants to dilute themselves more, and this leads to short-sighted stinginess much of the time.
Option pools are complete fiction; boards can increase them whenever they want. It should never be used as a reason for not making a grant.
Since I started in VC, the percentage of a company that non-founder employees owned was always in the 15–20% range after the team is fully built out. In recent years, I have seen that number creep up to the 20–25% range and if you extrapolate current trends out a few years, it could easily be 30%.
At some point, the company will have granted most of the shares in the ESOP to employees, and will have to create new shares for the next wave of hiring. This is called expanding the pool. A Series A company would likely expand its ESOP as part of a Series B financing, adding perhaps another 5–10%, depending on the hiring plan of the company. Series C and later companies tend to add 1–2% each year to the pool; or more if they plan to hire executives who can command about 1% or more of outstanding shares.
your goal should be to minimize founder dilution by creating the smallest option pool needed. Your actual hiring plan and the equity you need for those future employees should drive the size of the pool, not any supposed standard.
Overall I don’t think there’s enough value given to startup options in Europe. Perhaps this is down to the risk tolerance of us Europeans and our tendency to favour a certain salary over equity. I’d like to see European startups be more aggressive with their option grants and spend more time educating employees as to the potential value that such option grants could present. It feels like there’s value being left on the table there. The US market appears to be ahead in this regard probably buoyed by the fact founders there can point to more success stories of startups scaling to exit. For any startup, one thing is for certain, talent is absolutely critical and therefore spending time devising a strategy around how options can be used to attract and retain world-class talent is time well spent!
Our data shows that over 50% of startups reserve between 10 and 20% of their capitalization table for the option pool. You can also see how the option pool increases at each successive stage of financing, due to VC demands, and what type of compensation premiums non-founding CEOs command relative to founding CEOs.
The range of percentages exemplifies how determining option pool size is more art than science. Ideally, you want to create an option pool that is sufficient for your anticipated hiring purposes until your next financing round. But finding the right balance involves skilled negotiation.
the company creates an ‘option pool’ where it sets aside options that can be allocated to employees. The standard option pool size is often 10% of the fully diluted capital in the Company, but it can vary. The documents required to set up an ESOP include:
• The Plan Rules, and
• The Individual Offer Letters.
On the whole, somewhere between 5% and 15% of a company’s total equity is a normal option pool size. This is entirely up to the founder, and is an important business decision, which will likely be driven by whether you are issuing options to co-founders or to employees more broadly.
The complexity around the calculations for pre-money SAFEs is why YC strongly recommends using post-money SAFEs. This approach lets you estimate your dilution plus or minus 10% because it ignores the option pool. This estimate is a rough way to know how much of your company to give away, but it should not be the final estimate to rely upon when you close your A.
Your stock option pool is a percentage of the value of your company — not a percentage of available shares. So, if you add shares to your company through subsequent rounds of funding, if you want to maintain the relative value of your pool, you’ll need to add shares to it as well.
Otherwise, as the overall number of shares in your company increases, the value of your stock option pool will go down. That’s why employees who join your company earlier on — say, before Round A — may end up with more shares than employees who join later on.
companies often face the challenge of forming a solid strategy to attract new talent that will contribute to building and scaling the business. In a company’s early days, it is often impossible to compete with established businesses based on salary, so founders have to approach recruiting in other ways. For example, they can offer attractive working lifestyles, flexible working hours, better company culture, or promise share options and thereby give employees the opportunity to participate in the company’s value.
Option pool sizes are significantly larger than the 10% reported by Index Ventures. An average of 17.3% (median 19.9%) of the fully diluted equity was found to be dedicated to employee option pools. We believe this represents [an] evolution of the market, moving in line with the example set by American startups…
We conducted our own research and came to similar results. On average, Swiss startups allocate 9.73% of shares to participation plans, German startups 11.07%, French startups 14.59%, and the UK startups 12.78%.
Investors prefer larger option pools because that usually means your option pool will last longer, potentially reducing their dilution. Because of this, they may pressure you into creating a larger pool than you need, citing industry benchmarks. This is where your hiring plan comes in — by thoughtfully mapping out your key hires over the next year or two and how much equity they need, you can show investors how you came to your number and may be able to negotiate a smaller, more realistic pool.