Meaning
Valuation adjustment processes that occur when an employee stock pool is created or expanded before a funding round affect the final price per share. The option pool shuffle takes place during term sheet negotiations when investors require the option pool to be set up prior to the investment. This arrangement forces the existing shareholders to bear the entire dilution of the pool, rather than sharing it with the new investors.
It lowers the pre-money valuation of the business.
Dilution Placement
The timing of the pool creation determines which parties pay for the employee incentive shares. In an option pool shuffle, the pool size is subtracted from the pre-money valuation, which reduces the share price. Consequently, the founders see their personal equity stakes decrease before the investment capital arrives.
Negotiation Dynamics
Founders and investors often debate the required size of the employee pool during the financing process. Investors typically ask for a larger pool to ensure the company can hire executives without needing another pool expansion soon. A larger pool means more dilution for the founders during the option pool shuffle.
Financial Consequence
The effective pre-money valuation is lower than the headline number on the term sheet. Understanding this mechanism is essential for founders to calculate the true cost of their capital.
