Deal Terms
Option Pool
Shares reserved by a company to grant as equity compensation to employees, advisors, and service providers — typically representing 10–20% of the fully diluted cap table.
An option pool (also called an employee stock option pool or ESOP) is a block of shares set aside to grant as equity compensation to current and future employees, advisors, and contractors. Most venture-backed companies reserve 10–20% of their fully diluted share count for this purpose before or around the time of fundraising.
The timing of when the option pool is created matters significantly for founders. Investors typically require the option pool to be created pre-money — meaning it comes out of the founders' ownership before the investor's money goes in. This effectively lowers the pre-money valuation from the founders' perspective, a phenomenon known as the option pool shuffle.
As a company grows and hires, it grants options from the pool. When the pool runs low, the company must expand it, which requires board approval and dilutes all existing shareholders.
In Practice
A startup raises a Series A at a $10M pre-money valuation. The investor requires a 15% option pool be created pre-money. Before the investment, the founders must set aside 15% of the company, effectively reducing their pre-money economic value. The $10M pre-money now covers a diluted cap table.
Why It Matters
The option pool is a critical negotiating point in term sheets. A larger pre-money option pool benefits investors (who aren't diluted by it) and hurts founders (who are). Founders should push for a smaller pool sized to actual hiring needs over the next 12–18 months, backed by a headcount plan.