Option Pools Explained: Size, Timing and Dilution
An option pool is the slice of your company set aside to reward the people you have not hired yet. It sounds simple, but the size of the pool and the moment it is created can quietly move several percentage points of ownership away from founders. Here is how option pools work, how to size one sensibly and how to read the dilution before your next round.
Key takeaways
- An option pool is a block of shares reserved for future employee stock options and grants.
- As a rule of thumb, pools are often 10% to 20% of the company, but the right size depends on your hiring plan.
- Investors usually ask for the pool to be created or topped up before a priced round and counted in the pre-money valuation, which dilutes existing holders, not the new investor.
- A hiring plan that shows who you will hire and what each grant might be is your best tool for negotiating pool size.
If you are heading toward a seed or Series A round this spring, you will almost certainly see an option pool line in your term sheet. It might say something like "an unallocated option pool equal to 15% of the post-money fully diluted capitalization, included in the pre-money valuation." That one sentence can matter more to your personal ownership than a fair amount of haggling over the headline valuation. This guide breaks it down.
A quick note: this article is general information, not legal, tax or investment advice. Equity plans and their tax treatment vary by country, so work with a startup lawyer and a tax adviser before you set up or change a pool.
What an option pool is and why it exists
Startups rarely have the cash to pay market salaries to every early hire. Equity helps close that gap. Instead of issuing new shares each time you hire someone, the company sets aside a pool of shares in advance under an equity incentive plan, approved by the board and usually by shareholders. Grants to employees, advisors and sometimes contractors then come out of that pool.
In the US, those grants are usually stock options. Options give the holder the right to buy shares later at a fixed exercise price. There are two main kinds:
- ISOs (incentive stock options), which are only for employees and can have favorable tax treatment if conditions are met.
- NSOs (non-qualified stock options), which can go to employees, advisors and contractors but are taxed less favorably.
US options are usually priced at fair market value based on a 409A valuation, an independent valuation of your common stock. Exercising options and the taxes that follow can be complex, so employees should get their own advice.
In the UK, EMI options are the main tax-advantaged scheme for small companies. They have qualifying conditions for both the company and the employee, so check the current rules on GOV.UK with an adviser before you promise EMI options to anyone. Elsewhere in Europe, plans and tax treatment differ by country.
How big should your option pool be?
There is no single correct size. The pool should be large enough to cover the hires you plan to make before your next round, plus a sensible buffer, and no larger.
Why does "no larger" matter? Every unused share in the pool still dilutes you if it was created before the round. If you agree to a large pool you will not use before your next raise, you have given up ownership for nothing. Investors know this, and a well-prepared founder can usually negotiate a pool that matches a credible plan.
Build the pool from a hiring plan
The most persuasive way to size a pool is to list the hires you expect over the next 18 to 24 months and estimate a grant for each. Senior and early hires usually receive larger grants than later or junior hires. Add a buffer for surprises, such as a key hire who needs a bigger package or an advisor you did not plan for.
| Planned role | Target hire date | Seniority | Example grant (% of company) | Notes |
|---|---|---|---|---|
| Head of engineering | Q2 | Senior | 1.5% (example) | Key hire, may negotiate |
| Two software engineers | Q3 | Mid-level | 0.5% each (example) | Hire one at a time |
| First customer success lead | Q4 | Mid-level | 0.4% (example) | Could be internal promotion |
The percentages above are made-up examples to show the format, not market data. Add rows for every planned hire, total the column and add your buffer. That total is your evidence when an investor proposes a pool size.
Pro tip
Include existing unallocated options in your math. If you already have an unused pool from an earlier round, it may cover part of your plan, which means the top-up needed now could be smaller than the headline number in the term sheet.
Timing: why the pool is usually created before the round
Here is the part that surprises many first-time founders. Investors usually ask for the pool to be created or topped up before the priced round and counted in the pre-money valuation. Because the pool exists before the new money comes in, its dilution falls entirely on the people who already own shares, mostly the founders and earlier investors. The new investor buys in after the pool exists, so they are not diluted by it.
This is sometimes called the option pool shuffle. The headline pre-money valuation stays the same, but part of it is effectively allocated to the pool rather than to existing holders. That is why founders often talk about an "effective pre-money valuation": the headline pre-money minus the value of the new or enlarged pool.
A worked dilution example
Hypothetical example
Sam and Leah co-founded a startup and own 100% of it between them. An investor offers $2 million at an $8 million pre-money valuation, for a $10 million post-money valuation. The term sheet asks for a 15% option pool, measured post-money and included in the pre-money. All numbers are made up for illustration.
Pool in the pre-money (the usual ask). The investor owns $2 million out of $10 million, or 20%. The pool is 15%. That leaves 65% for Sam and Leah. Their effective pre-money valuation is $8 million minus the $1.5 million pool, or $6.5 million.
Pool created after the round. If the same 15% pool were created after the investment, everyone would be diluted together. The investor would drop from 20% to 17%, and the founders from 80% to 68%.
The difference for the founders is 3 percentage points, which is a lot of ownership for a single sentence in a term sheet.
The point is not that investors are being unfair. Asking for a pre-money pool is common, and it reflects the view that the team being built is part of what the investor is paying for. The point is to see the real number, so you can negotiate the pool size with evidence rather than surprise.
How to negotiate the pool
You will rarely change where the pool sits, but you can often influence its size. Use these steps.
- Prepare your hiring plan first. Bring a role-by-role plan with example grants and dates to the negotiation.
- Ask what the pool is meant to cover. Agree the time period, often until the next round, so the size has a clear purpose.
- Show the effective pre-money. Put the headline and effective valuations side by side so both sides see the trade-off.
- Count existing unallocated options. Make sure the top-up only covers the gap, not the whole plan.
- Trade sensibly. If the investor insists on a larger pool, you might discuss a higher headline valuation to balance it.
- Get the model checked. Ask your lawyer to confirm the share counts in the final capitalization table.
Common mistake
Comparing term sheets on headline valuation alone. An offer with a higher pre-money and a large pre-money pool can leave founders with less ownership than a lower offer with a smaller pool. Always compare founder ownership after the round, not just the headline number.
Running the pool after the round
Once the pool exists, a bit of discipline keeps it working for you.
- Track every grant. Keep a simple register of each grant, the date, the number of options, the exercise price and the vesting schedule, and update your cap table when grants are approved.
- Use standard vesting. Employee grants often vest over several years with a cliff. Founder vesting commonly follows a 4-year pattern with a 1-year cliff as a rule of thumb, and many companies use a similar structure for staff.
- Keep valuations current. In the US, refresh your 409A valuation when needed, particularly after a funding round, so new grants are priced properly.
- Watch returned options. When someone leaves before vesting, unvested options usually return to the pool and can be granted again.
- Plan the next top-up. As your next round approaches, revisit the hiring plan. Expect the same pre-money conversation again.
Also explain equity clearly to employees. A grant only motivates people if they understand it. Share how vesting works, what the exercise price means and that tax treatment can be complex, and suggest they speak to their own adviser.
Your option pool checklist
- List planned hires for the next 18 to 24 months with example grants
- Total the grants, add a buffer and subtract existing unallocated options
- Check whether the term sheet puts the pool in the pre-money or post-money
- Calculate your effective pre-money valuation and founder ownership after the round
- Compare offers on founder ownership, not headline valuation alone
- Confirm the plan type: ISOs or NSOs in the US, EMI options in the UK
- Arrange a 409A valuation in the US before granting new options
- Keep a grant register and update your cap table after every approval
- Ask a startup lawyer to review the plan and the final share counts
Frequently asked questions
Do I need an option pool before my first priced round?
Not always. Some very early companies make a few grants under a small plan, and others wait until the first priced round. If you plan to offer equity to early hires, talk to a lawyer about setting up a plan properly rather than promising shares informally.
Who decides the size of the pool?
It is negotiated between the company and the lead investor, then approved by the board and usually by shareholders. A clear hiring plan gives founders the strongest position in that conversation.
Do unused pool shares come back to the founders?
Generally no. Unallocated options stay in the pool for future grants. They do not return to founders, which is exactly why an oversized pool is costly.
Can advisors receive options from the pool?
Often yes, although the type of option and its tax treatment may differ from employee grants. In the US, advisors usually receive NSOs rather than ISOs. Check with your lawyer.
Related reading
The bottom line
An option pool is how you share the upside with the team you are about to build. As a rule of thumb, pools are often 10% to 20% of the company, but your hiring plan should set the size, and when the pool is counted in the pre-money valuation, its dilution falls on existing holders.
Before your next round, build a simple hiring plan, calculate your effective pre-money valuation and compare offers by founder ownership after the round. With those three numbers in hand, the option pool becomes a conversation you can lead rather than a line you discover later.
