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What’s A Reasonable Starting Point For An Option Pool?

Q: In modeling out an early-stage deal, do you think it would be reasonable to start with a 20% option pool  (Round A) and then plan to refresh that on subsequent rounds (ie, make an assumption about having key hires in place by round C or B)?  Or should we just allow that option pool to get crammed down?

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.  This often ends up being a three way negotiation – between the founders/management, old investors, and new investor(s).  The new investor will want the options to be “pre-money” so the burden of the increase of the option pool is pushed back on the old investors and existing founders/employees; the old investor / founders want this to be “post-money” (or after the financing) so that dilution is shared by everyone, and non-founder management often are indifferent (especially if they are getting additional options in the financing), but want to make sure the size is large enough to cover the option grants they think they will need for the next wave of employees.

There is no simple rule of thumb here – it’s a negotiation.  However, the amount needed to incent employees going forward is usually a number that can be determined approximately.  Everyone will be incented to have the “correct amount of options” (although the definition of “correct” may vary between parties.)  But – the idea that the original 20% option pool will last the entire life of a company is not logical and is pretty unusual.

February 27th, 2007 by     Categories: Equity    
  • Kirill

    Hello,
    What happens to the unallocated option pool in case of liquidation event? Let’s say we have 20% belonging to the angel, me and my cofounder have 30% each and 20% is allocated for the pool of which only 1% is granted, but not vested. And tomorrow my company gets bought for $100M cash. Where does $19M go?
    Kirill
    P.S. Btw. your Movable Type doesn’t allow to post comment from inside the RSS reader (Thunderbird). I see the form, fill it up, but when I press submit it says ‘No entry_id’

  • http://www.feld.com Brad Feld

    The unallocated equity “vanishes.” So – in your case, you’d own 30% / (100% – 19%) of the company – or (30% / 81%) = 37% and you’d end up getting $37m of the $100m. Of the “extra $19m”, $7m (or 37% of it) would be yours.

  • http://fashionsmasher.com Ken Feldman

    I did my last startup in 2001. As a follow on, what is the average stock option grant range these days for execs (CEO, COO, CTO, CFO, VP of Marketing, Sales, Biz Dev), and how do these amounts adjust based on rounds?

  • http://www.feld.com Brad Feld

    Ken – look for some posts on this coming soon.

  • http://www.venturelaw.blogspot.com suzie dingwall williams

    I agree wholeheartedly – when you aply the basic rules of compensation desgin the 0% rule does not work. Nor, necessarily does the 4-year vest strategy. See:
    http://venturelaw.blogspot.com/2006_11_01_archive.html

  • http://TBD Marc Burch

    The option pool needs to be at least 25% when you first set up the CAP table. If not, then you just end up raising the CAP tabe on the Series B round more then you might need to.

  • David

    Brad,
    What are your thoughts on this situation? A startup is hiring new senior managers and offering options. However the company is overvalued and any options granted will be underwater. Any other means of granting equity that avoids this problem (e.g. direct grants of stock)? Thanks.
    David