Structuring Employee Option Pool Reserves Pre Money Financing
Pre money option pool reserves expand the fully diluted share count before investment, reducing share prices and forcing common owners to bear hiring dilution.
option reserve
Meaning
Setting aside a designated portion of equity for future issuance to employees establishes the capacity of a firm to recruit talent without using cash. The option reserve functions as a pool of unissued shares that do not carry voting rights until they are granted and exercised. It stops applying when the pool is exhausted or the company undergoes a change of control.
Hiring Power
Recruiting highly skilled talent often depends on the ability to offer a stake in the long-term success of the venture. With a well-sized option reserve, a founder can attract specialized engineers without spending immediate capital. This provision shifts the cost of compensation from current liquidity to future equity value.
Cap Table Mechanics
Boards typically require the creation of this pool before a financing round to ensure the new investors are not diluted by subsequent hiring. Since the option reserve is often created out of the pre-money valuation, the founders bear the initial cost of its formation. It represents a commitment of potential ownership to the workforce.
This requirement is often a non-negotiable term in venture deals. The size of the set-aside affects the valuation of the firm before the new capital enters the bank account.
Retention Logic
Grants from the pool are usually subject to a vesting schedule that encourages personnel to stay with the firm over several years. This mechanism ensures that the value created is shared with those who contribute to the growth over a sustained period. It aligns the interests of the staff with those of the shareholders.