What is an Option Pool?

Startups use an Option Pool to set aside stock (or other equity-related securities, such as options) to compensate and incentivize key employees of the company. In reality, it is just a percentage of company ownership that is allocated for this purpose. When these shares are later issued to employees, it does not affect the ownership percentages of existing owners (i.e., nobody is being diluted when these shares are issued or committed to employees).

How an Option Pool is Used

Generally, a startup will create an option pool when it is going through a round of inventor financing. The investors will demand a specific percentage of company ownership in exchange for their investment. They will also demand that the company set aside shares in an option pool. The typical size is between 15-25% of total authorized shares. 

Whenever the startup hires a key employee who demands an ownership percentage in the company as compensation, this ownership percentage is drawn from the option pool. Investors realize that any time that a company issues additional shares, it will reduce that investors percentage of ownership in the company. This is known as dilution. 

To combat this, the investors demand the creation of the option pool. Setting up the option pool will affect the total outstanding shares of the company. As such, it will affect the price per share, as the price per share is based upon the total value of the company divided by the number of outstanding shares. The option pool will be accounted for in the capitalization table or Cap Table.

It is worth noting that ownership of the shares in the option pool are rarely directly issued to employees. Generally, these shares are subject to vesting over time. This means that the employee does not become the full owner of these shares until a specific amount of time or specific company milestones are accomplished. Once this time has passed or milestones are accomplished, the shareholder becomes owners of the shares.