Term sheet
The option pool and the shuffle
When a new option pool is counted in the pre-money valuation, its cost falls entirely on existing holders. That can be worth more than a bump in the headline valuation.
An option pool is a block of shares the company reserves under its equity incentive plan for future grants to employees, advisors and directors. Investors want one big enough to hire the team their money is paying for. The questions that move money are how big the pool is and whose ownership it comes out of.
The option pool shuffle
Term sheets usually say the post-money capitalization will include an unissued pool of a stated percentage (say 10%), and that the pool is included in the pre-money valuation. That means the pool is created before the new money arrives, so only existing holders are diluted by it. The new investors' percentage is unaffected: they still get new money ÷ post-money.
The effect is a lower price per share for the same headline valuation. Using the example from our priced round page: $3 million at a $12 million pre-money, with 9,500,000 existing fully diluted shares including a nearly used-up pool of 100,000 shares, and a target of 10% available after the round.
The new pool is worth $1.39 million at the round price. Since it comes out of the pre-money, the founders and existing holders are effectively selling the company for $10.61 million, not $12 million. The arithmetic matches the original 2007 Venture Hacks example ($8 million pre, 20% pool, effective pre-money $6 million), which our engine reproduces on the methodology page.
Calculator
With the inputs shown: pool increase 1,242,858 shares, price $1.1170 instead of $1.2632, effective pre-money $10.61 million. Founders hold 67.0% after the round instead of 75.8%. Turn on JavaScript to recalculate with your own numbers.
Sizing the pool from a hiring plan
A pool should cover the grants the company expects to make before the next round, not a round number. Investors may propose a larger pool than needed, because an oversized pool in the pre-money lowers their price and any unused shares later dilute everyone, investors included. A credible way to negotiate is a hiring plan:
| Planned hire | When | Grant (% of company) |
|---|---|---|
| Head of engineering | Month 2 | 1.50% |
| Senior engineers × 3 | Months 3–9 | 1.50% |
| Engineers × 4 | Months 6–18 | 1.20% |
| Head of sales | Month 8 | 1.00% |
| Sales and support × 4 | Months 10–20 | 0.80% |
| Refresh and advisors | Ongoing | 1.00% |
| Pool needed | 7.00% | |
If the plan supports 7% and the term sheet asks for 10%, the difference is a negotiation about price. Grant sizes depend heavily on role, seniority, location and stage; use your own data or advisers' benchmarks rather than these placeholders.
The pool and SAFEs
Post-money SAFE holders are not diluted by the existing pool or by grants made before the priced round (their capitalization includes them), but they are diluted by the pool increase made in the priced round, alongside the founders. Pre-money SAFE holders are protected from that increase too, so with pre-money SAFEs outstanding the founders bear all of it. See pre-money vs post-money SAFEs.
Negotiating points
- Agree the pool percentage from a hiring plan to the next round.
- Count already-promised but ungranted options inside the pool, so they are not counted twice.
- Compare offers on effective pre-money (headline pre-money minus the value of the new pool), not on the headline alone.
- Remember the option pool is a cost to everyone at the next round if it is not used; an oversized pool now is not free later.
Sources
- Post-Money Safe User Guide, Y Combinator. Cited for facts; not reproduced.
- Model Legal Documents (term sheet, certificate of incorporation, investors' rights, voting and ROFR/co-sale agreements), National Venture Capital Association. Cited for structure; not reproduced.