Sizing Your Employee Option Pool: Pre-Money Math, Dilution, Allocation Guide

Pre-Money vs. Post-Money: Understanding the Investor's Ask

Receiving a term sheet is a milestone, but buried in the details is a clause that significantly impacts founder ownership: the employee option pool. Often presented as a standard 10-15% requirement, the specific wording, particularly “pre-money,” has major economic consequences. Miscalculating the pool or misunderstanding the terms leads to unintentional dilution, giving away more of your company than necessary. For founders at SaaS, Biotech, or Deeptech startups, effectively modeling how to calculate employee option pool dilution is not just a financial exercise; it is a critical step in protecting your equity. This guide provides the framework for sizing your pool based on a real hiring plan and calculating its true impact on your cap table. See the Finance for Technical Founders hub for broader context.

An employee stock option pool is a block of shares reserved for future hires, essential for attracting talent when you cannot compete on cash salaries alone. The critical point of negotiation, however, is not its existence but the timing of its creation. Investors almost always ask for the pool to be created on a pre-money basis. This request has a very specific and important impact on founder ownership percentage.

To understand this, you need to know the two primary structures for creating the pool. For more worked examples, see our guide on Fundraising Math: Valuation and Dilution Explained.

1. Pre-Money Option Pool: The pool is created before the new investment money comes in. A pre-money pool dilutes only the existing shareholders, such as founders and prior investors. The new investor's ownership is calculated based on the post-money valuation, effectively shielding them from the dilution caused by creating the pool.
2. Post-Money Option Pool: The pool is created after the new investment. A post-money pool dilutes both existing shareholders and the new investors, meaning everyone shares the dilution proportionally.

Because the pre-money approach is standard, founders must know how to model its impact. The reality for most pre-seed to Series B startups is more pragmatic: you are unlikely to secure a post-money pool, but understanding the math allows you to negotiate the valuation or pool size more effectively.

Case Study: Pre-Money vs. Post-Money Dilution

Consider a SaaS startup with 8,000,000 shares outstanding, all owned by the founders. They receive a term sheet for a $2,000,000 investment at an $8,000,000 pre-money valuation. The investor requires a 10% option pool.

Scenario 1: The Pre-Money Pool (Investor's Ask)

First, we establish the post-money valuation: $8M pre-money + $2M investment = $10M post-money. The investor will own 20% of the company, and the option pool will represent 10%.

The 10% pool is based on the post-money share count, but it is created from the pre-money share base. This is the tricky part. The new pool dilutes the founders before the investor's money comes in. The founders' 8,000,000 shares will no longer represent 100% of the pre-investment company; they will represent only 70% (100% - 20% for the investor - 10% for the pool).

To find the number of shares for the pool, we use a standard formula:

Pool Shares = (Existing Shares × Target Pool %) / (1 - Target Pool % - Investor %)

Plugging in our numbers: Pool Shares = (8,000,000 × 10%) / (1 - 10% - 20%) = 800,000 / 0.70 = 1,142,857 shares.

The total pre-investment shares become 8,000,000 (Founders) + 1,142,857 (Pool) = 9,142,857. The investor pays a price per share of $8,000,000 / 9,142,857 = $0.875. Their $2,000,000 buys them 2,285,714 shares. Total shares are 11,428,571.

• Founder Ownership: 8,000,000 / 11,428,571 = 70.0%

Scenario 2: The Post-Money Pool (Founder-Friendly)

Here, the investment happens first. The investor's $2M buys 20% of the company. With 8,000,000 founder shares representing 80% of the company post-investment, the total share count becomes 10,000,000. The investor receives 2,000,000 shares.

Now, the 10% post-money option pool is created. This pool must represent 10% of the new, final total. To calculate this, new shares are added, diluting everyone. The new total will be 10,000,000 / (1 - 10%) = 11,111,111 shares. The pool size is 1,111,111 shares.

• Founder Ownership: 8,000,000 / 11,111,111 = 72.0%

The 2% difference in founder ownership percentage is significant. The pre-money pool structure is effectively a reduction in the pre-money valuation for existing shareholders.

How to Calculate an Option Pool Size Based on Your Hiring Plan

Instead of passively accepting an investor's number, a better approach to early stage equity planning is to build a hiring plan that justifies your proposed pool size. This proactive step helps you avoid creating an oversized pool that unnecessarily dilutes everyone. This process is typically done in a simple spreadsheet.

First, map out the key roles you need to hire over the next 12 to 18 months, which is the typical period a funding round is expected to last. A Biotech startup might need two senior scientists and a lab manager. A growing SaaS company might need a VP of Engineering, three senior engineers, and a product manager. For UK-based companies, ensure you understand EMI eligibility and notification requirements for tax-advantaged options.

Next, assign an equity percentage to each role using market data, not guesswork. This demonstrates to investors that your request is based on logic. Data from industry sources like Carta or Pave shows typical equity bands for various roles.

• VP of Engineering: 1.0% - 2.0%
• Director of Product: 0.75% - 1.5%
• Senior Engineer: 0.25% - 0.75%
• Account Executive: 0.10% - 0.30%

You can find more practical benchmarks in resources like Index Ventures' note on option grants at seed. Let’s build a sample hiring plan for a Deeptech startup:

• 1x VP of Engineering: 1.50%
• 2x Senior ML Engineer: 2 × 0.50% = 1.00%
• 1x Product Manager: 0.60%
• 2x Business Development: 2 × 0.25% = 0.50%
• Total Required Equity: 3.60%

Finally, add a buffer to this total. A hiring plan equity calculation should include a 15-25% buffer for opportunistic hires, promotions, or performance refreshes. A 25% buffer on our 3.60% plan would be 0.90%, bringing the total calculated need to 4.50%.

This bottom-up number gives you a powerful tool in option pool negotiation. You can present a data-backed plan for a 5% or 6% pool instead of simply accepting a 10% default. In practice, we see that while you may not get exactly what you modeled, this preparation often leads to a more favorable outcome. Your hiring plan helps justify where you should fall within typical ranges, such as 10% for seed-stage companies or 10-15% for Series A/B.

How to Calculate Employee Option Pool Dilution on Your Cap Table

Once the pool size and terms are agreed upon, you must update your cap table to reflect the new reality. This is one of the most important cap table basics for founders, as it provides a clear picture of the final startup equity distribution. You can build a simple equity dilution calculator in a spreadsheet. For guidance on structuring your cap table, see Cap Tables for Technical Founders: US Fundamentals.

Let's use our earlier SaaS company example: 8,000,000 founder shares, raising $2,000,000 at an $8M pre-money valuation, and agreeing to a 10% post-financing option pool created on a pre-money basis.

Step-by-Step Cap Table Update

1. The 'Before' Cap Table

Your starting point is clean and simple, showing only existing shareholders.

• Founder 1: 4,000,000 shares (50.0%)
• Founder 2: 4,000,000 shares (50.0%)
• Total: 8,000,000 shares (100.0%)

2. Calculate New Shares for the Option Pool

The target is a 10% pool after financing. Because the pool is created pre-money, it dilutes the founders directly. We use the same formula as before to solve the circular reference:

Pool Shares = (Pre-Money Shares × Target Pool %) / (1 - Target Pool % - Investment %)

• Investment %: $2M Investment / $10M Post-Money = 20%
• Pool Shares: 8,000,000 × 10% / (1 - 10% - 20%) = 800,000 / 0.7 = 1,142,857 shares

3. The 'After' Cap Table Structure

Now, we build the final cap table by calculating the new share counts and ownership percentages.

• Pre-Money Fully Diluted Shares: 8,000,000 (Founders) + 1,142,857 (New Pool) = 9,142,857
• New Price Per Share: $8,000,000 Pre-Money Valuation / 9,142,857 Shares = $0.875
• Investor Shares: $2,000,000 Investment / $0.875 Per Share = 2,285,714
• Total Post-Money Shares: 9,142,857 + 2,285,714 = 11,428,571

This final structure clearly shows the ownership for all parties:

• Founder 1: 4,000,000 shares (35.0%)
• Founder 2: 4,000,000 shares (35.0%)
• New Investor (VC): 2,285,714 shares (20.0%)
• Option Pool (New): 1,142,857 shares (10.0%)
• Total: 11,428,571 shares (100.0%)

The founders' collective stake has dropped from 100% to 70%, diluted by both the new investor and the pre-money option pool.

Key Takeaways for Option Pool Negotiation

Navigating employee stock options explained through term sheets and cap tables can feel overwhelming, but it boils down to a few key principles. For any founder managing early stage equity planning, focusing on these points can preserve significant ownership.

First, recognize that the request for a pre-money option pool is a valuation negotiation in disguise. The dilution comes directly from you and your existing team. While you may not win a post-money pool, you can use this understanding to negotiate a slightly higher pre-money valuation to compensate. Always model the financial impact in a spreadsheet before agreeing to terms.

Second, do not accept a generic pool size. Build a thoughtful, 12-to-18-month hiring plan and use it as the basis for your counteroffer. A data-driven request for a 7% pool, complete with roles and market-rate equity bands, is far more credible than simply pushing back on a 10% ask. This demonstrates foresight and operational discipline. For more on local requirements, see our guide on Cap Tables for Technical Founders: UK Essentials.

Finally, your cap table is your single source of truth for ownership. Keep it meticulously updated in a dedicated system or spreadsheet. Understanding the mechanics of how to calculate employee option pool dilution is not a one-time task but an ongoing part of financial management. The goal is not to avoid dilution entirely, an impossible task for a venture-backed business, but to ensure every percentage point of equity is allocated intentionally to build value for the company. Continue learning at the Finance for Technical Founders topic hub.

Frequently Asked Questions

Q: What is a typical vesting schedule for employee options?

A: The most common vesting schedule is over four years with a one-year "cliff." This means employees must stay with the company for at least one year to receive their first portion of options (typically 25%). The remaining options then vest monthly or quarterly over the next three years.

Q: How does an option pool "refresh" work in later funding rounds?

A: In subsequent funding rounds (like a Series B or C), investors will often require you to "top up" or refresh the option pool back to a certain level, such as 10% of the post-money shares. Like the initial pool, this is typically done on a pre-money basis, diluting existing shareholders before the new capital comes in.

Q: What are the main differences between ISOs and NSOs for US employees?

A: Incentive Stock Options (ISOs) offer potential tax advantages, allowing employees to be taxed at the lower long-term capital gains rate if they meet specific holding period requirements. Non-qualified Stock Options (NSOs) are more flexible but result in ordinary income tax upon exercise on the spread between the exercise price and fair market value.

Q: Why create an option pool instead of just issuing shares directly to new hires?

A: An option pool provides flexibility. It reserves a block of equity without immediately assigning it, allowing you to grant options as you hire. Options also align incentives, as they are a right to buy shares at a fixed price. Their value grows only if the company's value grows, motivating employees to contribute to long-term success.