Option Pool Management: a high-stakes balancing act for size, allocation and refresh

Foundational Concepts: What is an Employee Option Pool?

An Employee Stock Option Pool (ESOP) is a portion of a company's shares reserved for issuance to employees, directors, and advisors. You should think of it as a pre-approved equity budget for hiring and retention. When you grant someone stock options, you give them the right, but not the obligation, to buy a number of shares at a predetermined price, known as the strike price. In the United States, this price is typically set by a 409A valuation, which is a formal appraisal of your company's Fair Market Value (FMV) required under US GAAP.

This pool is a formal line item on your capitalization table, or cap table, which is the complete ledger of your company's ownership. Every option grant reduces the unallocated portion of the pool, and every share eventually issued from it contributes to the overall equity dilution for all shareholders, including founders. Effective option pool management is a core component of startup equity planning, directly impacting your ownership percentages, incentive compensation plans, and your ability to scale the team.

How to Manage Your Startup Option Pool: Sizing the Initial Pool

Choosing the initial size of your option pool is one of the first major financial decisions you will make. It directly addresses the challenge of attracting key hires without causing avoidable founder dilution. This decision often happens before you have a CFO, guided by market norms and conversations with early investors. The goal is to create a pool large enough to fund the key hires you plan to make between your current stage and your next funding round, typically an 18 to 24 month horizon.

A standard starting point for a company's first formal option pool at the Pre-Seed or Seed stage is 10-12.5%. This is a widely accepted benchmark that signals to investors and potential hires that you are serious about building a strong team. You don't want to exhaust your options and be forced to ask your board to increase the pool before you have the leverage of a new, higher valuation.

When you raise your first priced round, this figure often gets formalized in the term sheet. The reality for most startups is pragmatic: the final size is a negotiation. According to data from Carta and Cooley, companies raising a seed round often end up with a post-raise option pool of around 10-15%. This size is generally sufficient to hire your first 10 to 20 employees, including a few senior roles. Proper startup equity planning means mapping your hiring needs for the next 18-24 months and ensuring your initial pool can support that roadmap.

Employee Equity Allocation: Granting Options Fairly

Once your pool is established, the next challenge is allocating grants in a way that is fair and consistent for both early and later-stage employees. Inconsistency can breed resentment and damage morale. The key is to establish market-based guidelines for different roles and seniority levels. While you may track this in a spreadsheet initially, this framework is crucial for managing startup ownership as you scale. As your company grows, consider using dedicated cap table software to reduce manual errors and maintain grant consistency.

Benchmarks provide a solid foundation for your allocation strategy. While every company is different, market data suggests some common ranges for new hire equity grants:

• Early Engineers/Product (Hires #1-10): 0.5% - 2.0%
• VP/Director Level (First executives): 1.0% - 2.5%
• Later Stage Hires (Post-Series A): 0.1% - 0.75%

These percentages reflect the risk and impact associated with joining at different stages. An early engineer at a SaaS startup building a product from scratch takes on significantly more risk than one joining a Series B company with product-market fit. What founders find actually works is creating an internal matrix that maps roles, levels, and equity ranges. This provides a consistent, defensible framework for making offers and helps communicate the grant's potential dollar value as the company's valuation grows.

Managing the Option Pool Refresh in Funding Rounds

As your company grows and you approach a new funding round, you will likely need to replenish, or refresh, your option pool. This is a standard part of the process and a key negotiation point with new investors. Forecasting and negotiating this option pool refresh is critical to prevent surprise dilution. At Series A and B, investors typically ask for the option pool to be increased to equal 10-15% of the post-money capitalization. According to Carta 2023 data, the median post-raise unallocated option pool is approximately 13-14% at Series A.

The most critical distinction to understand is the difference between a pre-money and a post-money option pool increase. This detail determines who bears the dilution from the new shares: just the existing shareholders, or the existing shareholders plus the new investors.

• Pre-Money Increase: The pool is increased before the new investment is finalized. The dilution is borne entirely by existing shareholders (founders and prior investors).
• Post-Money Increase: The pool is increased as part of the new round's capitalization. The dilution is shared among everyone on the new cap table, including the new investors.

Let’s walk through an example. A SaaS startup is raising a Series A with the following terms:

• Pre-Money Valuation: $20 million
• New Investment: $5 million
• Existing Fully Diluted Shares: 10,000,000
• Current Unallocated Option Pool: 2% (200,000 shares)
• Investor Request: The new pool must be 15% of the post-money capitalization.

Scenario 1: Pre-Money Increase

1. The post-money valuation is $25 million ($20M pre-money + $5M investment). The new investor will own 20% ($5M / $25M). The option pool needs to be 15%. This leaves 65% for existing shareholders.
2. Let X be the total number of post-money shares. The existing 10,000,000 shares must represent 65% of X. Therefore, X = 10,000,000 / 0.65 = 15,384,615 shares.
3. The new option pool must be 15% of X, which is 2,307,692 shares. Since 200,000 shares already exist in the pool, the increase is 2,107,692 shares.
4. This increase occurs before the new money comes in, diluting only the existing shareholders.

Scenario 2: Post-Money Increase

1. First, the new investment occurs. The investor buys 2,500,000 new shares (($5M investment / $20M pre-money) * 10,000,000 existing shares). The total shares before the pool increase is 12,500,000.
2. The cap table now includes existing shareholders and the new Series A investors.
3. The pool is then increased to 15% of the new total. Let Y be the number of new option pool shares. The equation is (200,000 + Y) / (12,500,000 + Y) = 0.15.
4. Solving for Y gives us 1,970,588 new shares. The total pool becomes 2,170,588 shares.
5. This increase dilutes everyone on the cap table, including the new investor.

Founders and existing shareholders clearly benefit from a post-money increase, as the dilution is shared. This is a crucial negotiating point. You should build pro-forma cap tables to test term sheet outcomes and see how different structures shift ownership.

Key Actions for Effective Option Pool Management

Effectively managing your startup option pool is a continuous process of planning, allocation, and negotiation. It is a core element of your financial strategy, directly tied to your ability to attract and retain the talent needed to win.

1. Size Your Initial Pool for Your Roadmap: When establishing your first pool (typically 10-15%), model your hiring plan for the next 18-24 months. Ensure the pool is large enough to land the key hires you need before your next funding round.
2. Create a Consistent Allocation Framework: Avoid deciding equity grants on a case-by-case basis. Use market benchmarks to build a simple matrix of roles, levels, and equity ranges. For UK-based companies, this framework must also align with Enterprise Management Incentive scheme rules, where EMI valuations are typically valid for only 90 days.
3. Understand Grant Mechanics: Differentiate between initial grants to attract new hires and smaller refresh grants to retain top performers. Communicate the potential value of the equity, not just the percentage, using your latest 409A valuation.
4. Model Your Dilution at Every Stage: Your cap table is a living document. Before any funding round, you must model the impact of an option pool refresh. Always advocate for a post-money increase to share the dilution with new investors.
5. Plan Ahead for Refreshes: Do not let an option pool refresh be a surprise. Anticipate that investors will ask for a post-raise unallocated pool of 10-15%. Proactively build this into your financial model in your accounting software, like QuickBooks or Xero, so you understand its impact on your ownership ahead of the negotiation.

Managing employee stock options is one of the most important responsibilities for a founder. With careful planning and a clear framework, you can turn your equity into a powerful strategic asset for growth. For more on cap table management, explore our resources on cap table basics.

Frequently Asked Questions

Q: What is the difference between an option pool and an ESOP?

A: The terms are often used interchangeably, but "option pool" refers to the block of shares set aside. An ESOP (Employee Stock Option Plan) is the formal legal plan that governs how those options are granted, vested, and exercised. The pool is the "what" and the plan is the "how."

Q: How does vesting affect employee stock options?

A: Vesting is the process by which an employee earns their options over time. A typical vesting schedule is four years with a one-year "cliff." This means an employee receives no options if they leave within the first year, but gets 25% of their grant on their first anniversary, with the rest vesting monthly thereafter.

Q: What happens to options if the company is acquired?

A: It depends on the acquisition terms and your option plan documents. Often, unvested options are accelerated, meaning they vest immediately. In other cases, they may be converted into options of the acquiring company. This is a critical detail determined during the acquisition negotiation.