Option Pool
It is the common stock of start ups reserved for future issuance to employees, directors, advisors and consultants.The best time to set aside an option pool is when you decide to incorporate the company. The option pool should be created pursuant to Rule 701 of the Securities Act of 1933. To adhere to it, no forms or fees need to be filled with the SEC but there needs to be a strict adherence to limits as described in : http://www.sec.gov/rules/final/33-7645.htm
An option pool can only be used to grant stock options when you have a strike price for which a 409A is required. When you run out of options in the pool but need to hire more people, companies issue new common stocks to add to the option pool which dilutes everyone equally.
Usually, the treatment of option pool's unissued portion in cases of acquisitions and financings is an ambiguous aspect. It is to be noted that in case of acquisitions, the unissued portion is not included in the total outstanding share count. Whereas, in the case of financings it is.
Big employee option pool - Good or Bad?
A large option pool makes it less likely that the company will run out of available options. On the other hand, the size of the pool is taken into account to calculate pre-financing fully diluted capital which in turn is used to calculate price/share.
A larger pool lowers the price per share as shown in the example below.
Example:
Pre-Money Valuation = $10m, VC investment = $5m,
Outstanding shares = 6m
Hence,
Post- Money Valuation = $10m+$5m = $15m
Price/share (without an option pool) = $10m /6m = $1.67
Option pool to be created per term sheet agreement is 20% of authorized outstanding stock of 6m = 1,200,000
Price/share (considering option pool)= $10m/(6m+1.2m) = $1.39
About The Author
Arushi Bhandari, CPA, MBA recently published an eBook “STARTUP Financing, Equity and Tax" with insights about the impact of JOBS Act & Dodd Frank Act on startup funding, terms like angel, accredited investors, venture capitalists, stock options, Restricted Stock, RSUs. It gives in depth examples & templates explaining documents like Term Sheet, Cap Table, Convertible Securities plus the importance of 83(b) filing.
Links to Download Arushi’s eBook Apple iBook: STARTUP Financing, Equity and Tax Kindle edition STARTUP Financing, Equity and Tax
DISCLAIMER: The information provided is intended to educate the readers and a more definite answer should be based on a consultation with a lawyer or CPA.It should not be relied upon as legal advise because the information might be incomplete and answers could change depending upon circumstances and if all facts were known.