What is an Employee Option Pool?
An employee option pool or employee stock option pool (ESOP) is a reserve of shares that is set aside for employees to receive as part of a compensation package. These options can be offered to employees based on tenure, or how long they have been with the company, or the contribution they make to the business, such as level of seniority.
Employee participation pools are created once a startup is ready to hire and the value of the pool is based on the individual share value.
How Are Options Pools Structured?
Unlike ordinary stock, ESOP shares have certain conditions applied to them, limiting the dilution of future shareholders. These conditions can be the length of service or a performance milestone, which makes the shares exit-only rather than exercisable. This usually means the employee can only sell their shares and does not have any voting rights.
How Large Should an Employee Option Pool Be?
The size of the option pool is usually based on the company’s expected hiring needs until the next funding round. If the company expects to hire aggressively, then a larger pool may make sense. If not, then a smaller pool would likely be adequate. Also, the size of the employee option pool is will impact the level of dilution for other shareholders.
How Does an Employee Option Pool Dilute Other Shareholders?
Each time a share is allocated, it will dilute the percentage of shares allocated to other shareholders.
So, if 100% of the shares of a startup are owned by the founders and the company then creates an employee option pool for 15%, the founder will be left with 85% of total shares. In other words, the employee option pool dilutes the founder’s stake immediately.
If a company already has existing shareholders, then the level of dilution is different. For example, if a founder has 60% of the shares, and two shareholders own 20% each, then an option pool of 15% of total shares would dilute the founder to 51% and the shareholder's stakes each dilute to 17%.
**Learn More about ESOP Sizing and Considerations here.