Cash is king, according to an old startup cliché. I am not sure that is still true. Options are more precious than cash in today’s cash-rich society. Many instructions exist for founders on how to acquire funds, but there is not enough information available on how to preserve your startup’s option pool. The most critical component for success as a startup is attracting talent. Managing your option pool, as a result, maybe the most effective way to ensure you can recruit and retain talent.
Managing your option pool, on the other hand, is no simple feat. However, with a little foresight and planning, you can take advantage of some of the tools available to you and avoid typical traps.
I will go over the following topics in this article:
- Over successive investment rounds the mechanisms of the option pool.
- Typical stumbling blocks startup founders.
- What you can do to protect your option pool or correct course if you have made early blunders.
Before we go any further, let us go over a small case study to establish the scene. In this case, three equal co-founders decide to leave their employment to create their own business. Because they know they will need to hire people, the trio starts with a 10% option pool at the start. They then scrape together enough money from angel, pre-seed, and seed rounds (all with a 25% cumulative dilution) to reach product-market fit (PMF). They raise a Series A now that PMF has been secured, resulting in a further 25% dilution.
They are now out of alternatives after hiring a few C-suite execs. As a result, during Series B, the company adds a 5% option pool top-up pre-money, in addition to giving up 20% of the new capital injection’s equity. When the Series C and D rounds arrive, with dilutions of 15% and 10%, respectively, the company will have reached its stride and will be preparing for an IPO soon Success!
For the sake of simplicity, I will assume a few things that do not usually happen but will help me illustrate the arithmetic here:
- After their original investment, no investor participates in their pro-rata.
- Every round, half of the available pool given to new hires and/or used for refreshes.
Obviously, each scenario is different, and your results may vary. However, this is a reasonable approximation of what happens to many businesses in practice. The available choice pool will look like this during the course of the rounds:
Allen Miller contributed to this image. Take note of how rapidly the pool thins out, especially in the beginning. The 10% may seem like a lot at first, but it is difficult to make the initial few hires when you have nothing to show the world and no money to pay salaries. Furthermore, early rounds erode everyone’s equity, including your option pool, not just yours as a founder (both allocated and unallocated). The available pool is already less than 1.5 percent when the business raises its Series B.
