Option Pools — The Silent Valuation Killer
In the theater of venture capital negotiations, founders often focus their energy on the most visible actor: the valuation. They treat the headline price as the ultimate scoreboard of their success. However, as a lawyer who has spent decades representing founders and investors, I must warn you about a far more subtle, yet equally powerful, mechanism that quietly reshapes your ownership before the ink is even dry on your Series A. This mechanism is the option pool.
Founders almost universally view the option pool—the shares set aside for future employees—as a recruiting and talent-management tool. While that is its administrative purpose, in the context of a term sheet, the option pool is a purely economic term. It is one of the most misunderstood sources of founder dilution because it allows investors to “set the terms” to manage their own risk while letting you “set the price” you find so validating.
Why do option pools dilute founders?
Because investors usually require option pools to be created or expanded before their investment, the new shares dilute founders and existing holders—not the investor—while preserving the investor’s target ownership percentage.
The Economic Reality of the Pool
Investors do not focus on the option pool because they want to help you hire; they focus on it to solve for a specific ownership percentage while minimizing their own future dilution. In a venture deal, the investor has decided that their check must buy a specific slice of your company’s “pie.” To ensure that slice remains exactly as large as they intended, they insist that the “pie” be recalculated to include shares for every person you might hire over the next several years before they cut their check.
This is why the timing of the option pool’s creation or expansion is a critical point of negotiation that founders frequently overlook. If an investor requires you to increase the option pool prior to the financing, that increase does not dilute the investor; it dilutes only the founders and existing shareholders. Every share added to the pool “pre-investment” is effectively a dollar-for-dollar reduction in your company’s actual value, regardless of what the headline valuation says.
The Illusion of the Headline Number
The reason option pools are called “silent killers” is that they feel invisible compared to valuation changes. If an investor offers you a lower valuation, you feel it immediately as a personal slight or a financial loss. But if an investor agrees to your high valuation while simultaneously insisting on a massive 20 percent option pool, you might walk away feeling like you won the negotiation.
This feeling of victory is a mathematical illusion. By expanding the pool to a “market” size—often 15 to 20 percent—prior to the closing, you have increased the total number of shares that exist in the company’s “fully diluted” capital structure. Because the investor’s ownership is fixed based on the price they are paying, the entire weight of that new pool is “squeezed” out of your founder stake. You have accepted a “valuation trap” where the headline price remains high, but your effective ownership percentage drops as if the valuation had been significantly lower.
Conceptual Scenario: The Vanishing Five Percent
Consider a founder who enters a Series A negotiation with a firm belief that their company is worth a specific milestone price. The investor agrees to that price, and the founder is thrilled. However, during the final hours of the term sheet discussion, the investor notes that the current employee pool only has 5 percent of the shares remaining. They insist that for a company at this stage, a 20 percent unallocated pool is “market standard” to ensure the company can attract top-tier executives.
The founder, thinking about the upcoming hunt for a VP of Engineering, agrees. They view this as a strategic win for the team’s growth.
The reality, however, is that the valuation stayed exactly where it was, but the founder’s ownership percentage just vanished in a significant way. Because that extra 15 percent of the company was created and “set aside” before the investor’s shares were issued, that 15 percent came entirely out of the founder’s pocket. The investor still gets their full intended percentage of the company, but the founder’s slice has been reduced by the entirety of the new pool expansion. The founder essentially paid the full cost of the company’s future hiring needs up front, while the investor received the benefit of a well-staffed company without sacrificing a single percentage point of their own.
A Practical Mindset for Founders
To protect yourself, you must stop viewing the option pool as a “talent tool” during the financing and start treating it as a price adjustment. When you see an option pool requirement in a term sheet, apply the following mindset:
- Use an Option Budget: Do not accept a “market standard” number like 20 percent just because an investor says it is customary. Work with your team to list every hire you need to make until your next round of financing and the exact equity grants required to land them. If your “budget” says you on ly need 10 percent, fight for 10 percent.
- Realize the Trade-off: If an investor insists on a large pool, you are effectively negotiating the valuation. You can counter-offer by accepting the larger pool only if the headline valuation is increased to compensate for the “squeezing” effect on your ownership.
- Question the Purpose: Understand that the investor is trying to minimize their risk of future dilution. By insisting on a large pool now, they ensure they won’t be diluted by your hiring needs later. This is an insurance policy for them, paid for entirely by you.
Option pools are not just a hiring tool—they are a price adjustment that founders often pay without realizing it. The size and timing of the pool can materially change the deal you think you’re getting.
If an investor is requiring a “market” option pool and you want to understand the real dilution impact, you can book a consultation focused on structure and trade-offs.
The term sheet is a blueprint for your future relationship. If you allow an outsized option pool to pass through your guard, you are starting that relationship by gifting the investor a portion of your company that you intended to keep. Valuation is the price the world sees; the option pool is the price you actually pay.
Fully Diluted Basis: What It Means, What’s Included, and Why It Matters.