Meaning
Equity reserves set aside for future employees prior to an investment round reduce the effective valuation of a startup for its existing shareholders. Creating a pre-money option pool is a standard requirement from venture capital firms to ensure the company has enough incentive equity to attract talent without diluting the new investors. This mechanism places the entire dilution burden on the founders and existing shareholders.
The size of the reserve typically ranges from ten to twenty percent of the company’s total equity, depending on the hiring plan for the next eighteen months.
Dilution Burden
Investors avoid dilution from future hires by insisting that the pool be created before they invest. This means the option allocation comes entirely from the founders’ share of the business. It reduces the post-money ownership of the founders before any business expansion begins.
Valuation Impact
The choice of pool size directly alters the effective price per share. A larger reserve reduces the price per share that the investor pays, even if the headline valuation remains the same. Negotiating the size of this reserve is therefore as critical as negotiating the valuation itself.
Allocation Limit
Founders must balance the need for future hiring against the cost of over-allocation. Any unused options in the pool after the investment round do not return to the founders, but rather remain in the pool, maintaining the dilution. Accurate talent planning prevents unnecessary loss of ownership.
