Equity · Equity distribution

Best way to establish an employee option pool?

Bernard Loke Commercial Operations at STA Engines

October 27th, 2015

To create the employees option pool, should all founders and investors contribute (or dilution) in accordance with their share-holding? What are the pros and cons.
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Dimitry Rotstein Founder at Miranor

October 27th, 2015

This question should really be addressed in advance in the co-founders and investment agreements. If it's not, then it's a problem (you should fire whoever wrote these agreements), but the solution lies with the founders and investors themselves. If they all agree to chip in, great. But I wouldn't be surprised if they didn't.

Lonnie Sciambi

October 27th, 2015

Sometimes, when you are starting out, you don't consider all the possibilities...like if and when we bring on employees, do we want them to be owners? It's not really such a big deal.  Typically, you, initially, authorize more shares than you issue.  Regarding dilution, all that matters is what is issued.  To set up an option pool you first need to put an Option Plan together that describes its term and conditions relative to vesting, exercise, etc., and sets aside a certain portion of authorized shares.  You need to determine whether it will be used for just employees or for outsiders as well (contractors, advisors, etc.) or whether there will be separate plans for each.  There are tax ramifications for the option holders, depending on the plan(s) you set up.  Once you decide the basics, your corporate attorney should be able to easily put it together.  However, so you're clear on this, options, typically  come out of the authorized pool, not the issued pool.  So existing shareholders need do nothing except approve the size of the pool. Options are really shares that could be issued, not shares that are.  Once they are exercised, then they dilute existing shareholders equally.  So, to keep simple, if the authorized shares are 1,000 and 500 have been issued to the founders and then an option pool of 50 shares is set up, and all these shares are, ultimately exercised, the total issued shares would be 550 and founders would have been equally diluted (accordingly to their shareholdings) by 9% (50/550).  If less than 50 are exercised, the founders are diluted accordingly.  And one last point on dilution. Number of shares or percentage are way less relevant than the value of those shares/percentage.  So when you're looking to set up an option plan you should be expecting that the associated dilution will be made up in a corresponding increase in value that the employees will generate.  That's a good business way to look at options.

Best bet, though, is to talk to your corporate counsel and your accountant to get both the legal and tax implications of an option plan.  

Hope this helps. 

Rob G

October 27th, 2015

each round of investors will want you to 'top up the options pool' before they invest. you will want to create/top up the options pool after they invest (to spread the wealth... er pain) ... like anything else with investors it's a negotiation. 

Neil Gordon Board Member, Corporate Finance Advisor and Strategy Consultant

October 29th, 2015

There are no pros vs. cons, just a negotiation between current owners and investors. Common practice is for the option pool to be reserved "pre-money," i.e., it dilutes the founders but not the investors, but exactly the same result could be obtained by lowering the investors' price and reserving the pool "post-money."