Option pools

What is an option pool?

An option pool, sometimes known as an incentive pool, is a proportion of a company’s total outstanding shares set aside for future equity grants. This bank of equity is used to motivate and reward employees and other people who contribute to the business – such as advisors, consultants and independent contractors.

While an equity pool typically consists of share options, companies can issue other securities like warrants, growth shares or RSUs instead.

Why do I need an option pool?

Equity compensation has become industry-standard in the startup world. Allowing employees to participate in company ownership can help you attract and retain talent without bloating your cash burn rate. 

If employee retention isn’t enough of a reason, venture capital investors often expect their portfolio companies to grant employees equity. As such, you're likely to create an option pool in connection with raising funds.

How and when you establish the pool will affect existing and future shareholders, so you’ll want to start thinking about it as early as possible – even if you’re not planning to issue equity just yet.

How does an option pool work?

Your option pool is part of your cap table – the record that details and tracks company ownership, including that of founders and investors. You can choose to authorise your pool as a fixed number of shares or, more commonly, as a percentage of the fully diluted share capital. Your decision should be outlined in a board resolution and approved by your board of directors.

An option pool can also be used as a budgeting tool, helping you develop a hiring strategy while maintaining  strong investor relations. By forecasting how much equity you need to reserve for new hires between each funding round, you can show investors exactly what percentage of your company they own and give them more certainty around future dilution.

A common mistake to avoid  

Sometimes founders mistakenly assume that outlining equity compensation in an employee’s offer letter is equivalent to granting options. While it’s a good idea to include equity as part of an employment offer, you may need to secure board consent (or investor director consent) for individual option grants. If this is specified in your shareholders' agreement, it means that directors must formally approve the grant size and exercise price.

Before you can grant equity to employees, you’ll also need an up-to-date company valuation. This is an independent appraisal of the current value of your company’s ordinary shares. 

How big should my option pool be?

As a rule of thumb, your option pool should represent around 10-20% of your company’s total equity – including allocated and unallocated options. Once created, it can be adjusted over time as your business and headcount grow, which usually aligns with an increased company valuation.

Early-stage investors sometimes prefer a larger option pool because it’s less likely to be expanded in the future, which would dilute their stake. However, a smaller pool means giving up less of your ownership percentage early on. This is where your hiring plan comes in handy: by mapping out your employee equity needs for the next few years, you might be able to negotiate a more realistic pool. The trick is to balance investor expectations with your interests as a founder, while being fair to employees.

How to size your employee option pool

Your option pool should be large enough to grant equity to new hires and give refresh grants to existing employees, if needed, until your next funding round. According to Carta data, the average time between early-stage venture rounds in Europe is 19 months (pre-seed to seed) and 18 months (seed to Series A). However, this timeline can shift according to market conditions.

The two main ways to size your option pool are top-down and bottom-up. It’s sensible to try out both strategies: start with the bottom-up approach to assess your company’s needs, then see how your pool compares to industry benchmarks from a top-down view. This will help you make informed decisions and ensure the pool is fit for purpose, especially as your business grows.

Bottom-up

This method allows you to create an equity pool tailored to your company’s compensation plan. There are three main steps involved:

1. Create a hiring plan based on your company’s expansion needs and projected team growth until your next expected funding round

2. Assign estimated equity grants to each role, based on industry benchmarks and factors like function, seniority and skill set

3. Calculate the total number of shares you’ll need for this list of planned hires, plus any potential refresh grants. This will determine the size of your equity pool

When building out your hiring plan, keep in mind that you may need to offer early employees more equity because they’re taking a bigger risk by joining an unproven business. Similarly, if you anticipate hiring C-suite executives before your next fundraise, they’ll probably expect a larger ownership percentage than less senior employees. 

Top-down

This approach uses comparable company data to inform your option pool size. A 10-20% option pool is fairly standard, though this may vary depending on which companies you select for comparison. You can consider those at a similar funding stage or within the same industry, among other factors.

While industry benchmarks can be helpful for establishing a ballpark figure, they don’t account for individual circumstances and therefore lack precision. Some startups are more cash-intensive than others, and some are more reliant on equity to attract talent.

Calculating your option pool

Carta’s free option pool calculator combines the top-down and bottom-up approaches to help you decide how many options to grant new hires. Using your company’s data and equity compensation benchmarks for different roles and levels, you can model out the number and value of shares you plan to issue each employee.

Option pools and ownership dilution

Setting up your pool in connection with a funding round means you’ll need to allocate shares to investors while reserving equity for employees. This process is known as the ‘option pool shuffle’, and it’s important to understand how timing impacts equity dilution for different stakeholders.

The option pool shuffle

If your pool is formed pre-money (i.e. before a funding round), shares are allocated to the incentive pool before investors receive their stake. As a result, only the founders and existing shareholders are diluted by the incentive pool. This is called the investor-friendly approach because investors end up with a greater percentage of your company.

The alternative is the founder-friendly approach. If you set up a post-money pool (i.e. after receiving investment), this will dilute new investors as well as existing stakeholders. For this reason, early investors often insist on the creation of a pool before closing the round; they may even specify a target percentage in the term sheet, based on a pre-money valuation.

Let’s work through an example. Imagine that two co-founders want to allocate 10% of their company’s fully diluted share capital to an incentive pool for future hires. The diagram below illustrates the potential impact of each scenario – setting up the pool before securing investment (pre-money) or after the seed round (post-money) – on their original stakes.

There’s no right or wrong way to approach the option pool shuffle. Just remember that expanding your equity pool at a later date will dilute all stakeholders equally, including investors.

How to proactively manage your option pool 

Setting up your option pool is only half the story. As you scale your business, grow your team and add more stakeholders to your cap table, the work involved in maintaining a single source of truth for company ownership will also increase.

Carta simplifies equity management by automating admin-heavy tasks and allowing you to track all company ownership on a single, secure platform. A glance at the incentive pool overview reveals the exact status of your employee equity bank – automatically updated with every option issuance, exercise and cancellation. When you add a new funding round, your cap table instantly reflects changes in ownership with no need for manual calculations.