Feb 27 2007

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.