Option Pool

Influence on the Business Lifecycle

• Early-Stage Funding and Investment When a startup or early-stage company raises capital from investors, the creation of an option pool is often a key part of the funding deal. Investors typically require that the company sets aside a percentage of shares for the option pool to ensure that future hires are incentivized. The size of the option pool can affect the valuation of the company during fundraising.Example: During a Series A round, investors may negotiate that 10% of the company's shares be allocated to the option pool, which is factored into the pre-money valuation.

• Employee Compensation The option pool is a critical component of employee compensation in many MedTech startups. It provides employees with the opportunity to benefit from the company’s success, typically by exercising stock options at a set price, known as the strike price, which is often lower than the current market value of the company.Example: A senior engineer at a MedTech startup might receive stock options from the company’s option pool, which could convert into equity if the company is sold or goes public.

• Exit Strategy and Liquidity The option pool is important during a company’s exit event, such as an acquisition or IPO. Employees with stock options or equity in the company can realize financial gains when the company is sold or goes public. The size and structure of the option pool can affect the final distribution of proceeds from the exit event.Example: If a MedTech startup is acquired, the employees holding options in the option pool can potentially sell their shares at the acquisition price.

• Recruitment and Retention Companies use the option pool to attract and retain talent. Offering stock options or equity compensation can be a major incentive for key employees to join or stay with a company, especially when salary compensation is lower than in larger, more established companies.Example: A MedTech startup might offer stock options to attract a renowned scientist or medical expert to join their team, offering a future stake in the company as part of the recruitment package.
  

Key Considerations Regarding Option Pools

1. Equity Compensation for Employees:

   • Option pools are primarily used to grant stock options to employees, allowing them to purchase shares at a future date at a predetermined price. This gives employees a sense of ownership and alignment with the company's success.

   • Example: A MedTech startup might offer employees the option to purchase shares at $10 per share, even if the market value of the company’s stock rises to $50 per share in the future.
     

2. Incentive to Retain and Attract Talent:

   • By offering equity, companies create an incentive for employees to remain with the company long-term and contribute to its growth. Employees are motivated by the potential financial gain from their stock options as the company becomes more successful.

   • Example: A CTO might be given stock options that vest over four years to ensure they remain with the company and continue to help drive innovation.
     

3. Vesting Schedules:

   • Stock options typically come with a vesting schedule, which means that employees must remain with the company for a certain period before they can fully exercise their options. This structure helps retain talent and ensures that employees are committed to the company’s long-term success.

   • Example: An employee may be granted stock options that vest over a four-year period, with 25% of the options vesting each year.
     

4. Dilution of Ownership:

   • The creation of an option pool can dilute existing shareholders' equity. The shares allocated to the option pool are generally issued before a new round of funding or after a company’s valuation is set, which can reduce the ownership percentage of current shareholders.

   • Example: If an option pool represents 10% of the company’s total shares, the current owners may see their ownership stake diluted by 10% when the options are granted or exercised.
     

5. Size of the Option Pool:

   • The size of the option pool is typically negotiated with investors, with common pool sizes ranging from 10-20% of the company’s total equity. A larger option pool can be seen as a positive indicator that the company plans to hire and reward talent, but it can also impact the company’s valuation.

   • Example: During a Series B round, a MedTech startup might agree to set aside 15% of its equity for the option pool, which will impact the price per share for new investors.

Related Terms

• Stock Options: A form of equity compensation that grants employees the right to purchase company shares at a set price after a specified period.

• Vesting Schedule: A timeline that determines when employees can exercise their stock options, often designed to incentivize long-term employment.

• Equity Compensation: A form of non-cash compensation where employees receive shares of the company as part of their pay package.

• Dilution: The reduction in ownership percentage of existing shareholders when new shares are issued, often related to the creation of an option pool.

• Convertible Notes: A form of short-term debt that converts into equity, often used by startups to raise seed funding. Option pools can sometimes be impacted by convertible note agreements.