What it means
Start-ups rarely have cash to match large-company pay, so they offer a slice of future success instead. The option pool is the reserve of shares that makes this possible, so that the company does not have to create new shares and negotiate with existing owners each time it hires someone important.
The pool is normally expressed as a percentage of the fully diluted share count, which means all shares that exist plus all shares that could exist once every option and convertible security is used. Investors often ask for the pool to be sized for the next 12 to 24 months of hiring plans before they invest.
Who bears the cost is the part that surprises many founders. When the pool is created before a funding round, it is counted in the company's value before the new money arrives, so it dilutes the existing owners and not the new investors.
This is why a larger pool can quietly reduce the real price a founder receives for the business. Options granted from the pool usually vest, meaning they are earned gradually over several years, often with a one-year waiting period.
If an employee leaves before their options vest, the unvested options go back into the pool and can be granted to someone else. Finance teams also track the pool for accounting reasons.
The cost of options granted is generally recognised as an expense over the vesting period, based on their estimated fair value on the grant date, even though no cash leaves the business. Pool sizes vary widely by stage and by industry.
Early companies often reserve a larger share to attract senior hires, while mature private companies tend to refresh smaller pools. There is no single correct number, only one that matches the hiring plan.
In practice
Real-world examples
Example 1
A financial technology start-up is about to close a funding round. Its investors ask for a 12% pool to cover the engineers and sales leaders it plans to hire, and the founders negotiate the size down after showing a detailed hiring plan.
Example 2
A biotech company uses its pool to hire a chief scientific officer who would otherwise cost far more in salary. The options vest over four years, which keeps the new hire tied to the company through its long research cycle.
Example 3
A growing logistics software firm finds that its pool has dropped to 1.5% after two years of hiring. The board approves an increase, which dilutes every existing shareholder in proportion, and the finance team updates the ownership table.
Think of it
Imagine baking a cake for a party, but instead of cutting it all up immediately, you leave a few slices in the tin. Those remaining slices are kept aside to give to special guests who help you clean up and decorate later.
Formula
Calculation
Pool shares to create = Existing shares x Target pool % / (1 - Target pool %)
A company has 9,000,000 shares outstanding and wants the pool to equal 10% of the fully diluted total. Pool shares = 9,000,000 x 0.10 / 0.90 = 1,000,000 shares. The fully diluted total becomes 9,000,000 + 1,000,000 = 10,000,000 shares, and the pool is 1,000,000 / 10,000,000 = 10%. If the pre-money valuation is $20,000,000 and the pool is included in it, the price per share is 20,000,000 / 10,000,000 = $2.00.Case study
Seen in the real world
Brightwater Labs is an illustrative, fictional software start-up preparing a $6,000,000 funding round. The lead investor proposed a pool of 15%, to be included in the valuation before the new money arrived.
The founders, who together owned 80% of the company, built a hiring plan showing only eight planned senior hires in the next 18 months. They argued that a 10% pool was enough.
After a short negotiation the parties settled at 10%, with a promise to top it up in the next round if needed. In this illustrative case, the founders kept more of their company because they could justify the pool with a concrete plan.
Watch out
Common mistakes
- Assuming new investors share the dilution from a pool created before their investment, when the cost usually falls on the existing owners.
- Sizing the pool as a round number without a hiring plan, which can leave it either too small to use or too large to justify.
- Forgetting that unvested options return to the pool when employees leave, which affects how much is really left to grant.
Questions
People also ask
Is the option pool the same as the options already granted?
No, the pool is the total reserved, while granted options are the part of it that has already been promised to named people.
Does the company pay cash when it creates an option pool?
No cash changes hands at creation, although the cost of options granted is expensed over the vesting period.
Can the pool be increased later?
Yes, with board and shareholder approval, but every increase dilutes existing owners, so it is usually timed with a funding round.