Basics of Employee Equity Plans
What is an option pool?
An option pool is a number of shares set aside for employees at a private company. Option pools are sometimes called equity pools, equity plans or employee stock option pools (ESOP).
How do option pools work for startups?
Startups often grant employees equity as part of their compensation in order to attract and motivate talent. Having equity compensation as a part of the hiring plan allows employees to benefit from the growth of the company when it IPOs or gets acquired.
Stock option pools are set by founders and typically taken from founders' shares. They are refreshed every time you raise a priced round, like a seed round or a series A, because investors want to know that you have enough ammo to hire talented people, especially key hires.
Once the pool is set up, employee equity is granted by the board of directors as new hires join the company, typically on a four year vesting schedule.
How big should my option pool be?
The standard advice is to set aside 10% of your total shares into an option pool. We think this standard advice is incorrect because it doesn't fit all companies. If you set aside too much of the company's equity, founders may take on unnecessary dilution. If you set aside too little, founders may not have enough company stock to give employees and will need to do complicated paperwork to increase their option pool size.
The goal with the option pool is to set aside enough shares to hire the people you need before your next round of funding. Ask these questions:
- Who do you need to hire?
- How much equity do you need to grant them?
The skillsets of your founders and the needs of the business determine how large your equity pool should be. For example, if you raised a large seed round and need to hire 20 engineers to build the prototype for your product, you may need more than a 10% equity pool. If you do not need to hire anyone because you have a large team of co-founders, you will need a smaller option pool.
Why is an unused option pool bad for founders?
Unused shares in the option pool before your next equity round means more dilution for you and your co-founders if you're fundraising on post-money SAFEs (common for most early-stage startups).
- Post-money safe: unused option pool affects founders and NOT seed investors.
- Pre-money safe: unused option pool dilutes founders AND seed investors. There is no difference between founder ownership with an excess option pool.
What does the slight difference in dilution mean? That depends on how much your company winds up being worth in the future.
How do I set up my option pool?
Creating a stock option pool means filling out paperwork to set aside a portion of your shares. You can get these documents through your lawyer or Pulley. We do not recommend googling and using random docs online to create your option pool - there are too many poorly written documents online.
You can record your option pool on Pulley's cap table platform and start issuing options. Pulley gives you option templates, handles the signing, and the subsequent board issuance.
What happens to your option pool at series A?
The size of your initial option pool will increase over time as your company grows. As you hire great people, you will give them options and have fewer options remaining in the pool. You top off your option pool at each round of funding. The increase in the size of the option pool is a term negotiated at your series A, series B, and each subsequent funding round. So for a hypothetical startup at the seed stage looking to do a Series A, any venture capital firm or other investor that joins the Series A will not be diluted. Only existing stakeholders (yourself, employees, existing angel investors, etc) will take on dilution.
Confused? Equity can be complicated and not related to your primary role of growing your business. We can help you create your option plan and issue options to hire & grow.