What is an Option Pool?
An option pool is an amount of a startup’s common stock reserved for future issuances to employees, directors, advisors, and consultants. The option pool is created pursuant to a written plan in order to satisfy Rule 701 which provides a registration exemption from Section 5 the 1933 Securities Act.
Via the written plan, a startup pre-authorizes a certain amount of the company’s common stock which will be issued by the plan’s administrator (usually the startup’s board of directors or a committee selected by the board). For example, if the startup has 5,000,000 shares of common stock outstanding, it may elect to authorize 1,000,000 shares to be issued pursuant to the plan.
A potentially confusing aspect of the option pool is how the option pool’s unissued portion is treated for financings relative to acquisitions. The unissued portion of the option pool is included in the fully-diluted capitalization of the startup, but the same unissued portion is not included in the outstanding share count upon an acquisition (or distribution). In other words, the entire option pool is included in a startup’s total share count at financings, but only the issued portion of the option pool is included in a startup’s total share count at acquisition.
Keep in mind that a startup’s original option pool will likely not be the last option pool the startup creates. The size of the option pool is typically negotiated at each round of financing, since at that time, the startup will likely need additional equity options to attract and motivate future hires.
About the Author
Ryan Roberts is a startup lawyer and represents technology companies through all phases of the startup process, including incorporation, seed & venture financings, and exit transactions. Click here to learn more about his practice.
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Please consider subscribing to The Startup Lawyer, following @startuplawyer on Twitter, or contact Ryan directly.9 Responses
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So, are option pools mandatory or just that, an "option"? How common is this for new companies if it's optional?
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Jenny – Optional but if likely required if your startup goes through any significant financing. It is not uncommon for a startup to create a pool when they start to bring on developers and consultants, etc.
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Jenny – Optional but if likely required if your startup goes through any significant financing. It is not uncommon for a startup to create a pool when they start to bring on developers and consultants, etc.
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Richard says:
In setting aside a pool for options (say, 10-20% of shares), are these shares considered issued but not outstanding, or are they simply unissued until granted? That is, for voting and quorum purposes, do the unowned shares in the pool simply not count when calculating shareholder voting numbers? How does this work?
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In setting aside a pool for options (say, 10-20% of shares), are these shares considered issued but not outstanding, or are they simply unissued until granted? That is, for voting and quorum purposes, do the unowned shares in the pool simply not count when calculating shareholder voting numbers? How does this work?
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Stephen says:
Would be interesting to read the process by which a startup issues their first employee shares our of this option pool. what are the necessary steps. things to avoid, options to consider, etc.
Cheers
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[...] or looking at different forms of investments, be mindful of things like dilution, option pools, or protective provisions. They are all legal terms that can make huge differences in [...]
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[...] a startup, or looking at different forms of investments, be mindful of things like dilution, option pools, or protective provisions. They are all legal terms that can make huge differences in the [...]
So, are option pools mandatory or just that, an "option"? How common is this for new companies if it's optional?