Every startup offer letter that promises "options" is drawing from the same bucket: the option pool. Understanding what that bucket is (and, more importantly, who pays for it) is one of the highest-leverage pieces of cap-table knowledge a founder can have. Get it wrong and you can hand over several points of ownership in a term-sheet clause most people skim.
What is an option pool?
An option pool is a block of shares the company authorizes and sets aside to grant as equity compensation (usually stock options, sometimes restricted stock or RSUs) to employees, advisors, and other service providers. The board adopts an equity incentive plan, authorizes a fixed number of shares under it, and that number becomes the pool.
The defining feature: pool shares are authorized but unissued. Nobody owns them. They are a reserve, a promise the company has made to itself that it can grant up to that many shares without going back to shareholders for approval each time. A share leaves the reserve only when an option over it is granted, and it only becomes a real, issued share when someone exercises that option and pays the strike price.
So if you ask "what is an option pool" in one sentence: it's the pre-approved headroom for future equity compensation, sitting on the cap table as a reserve rather than as issued stock.
Authorized, granted, exercised: three different numbers
Pool conversations go wrong when people conflate three distinct quantities:
- Authorized pool: the total reserve approved under the plan. The ceiling.
- Granted (allocated): options that have actually been awarded to people. Most will still be vesting; none are issued shares yet.
- Exercised: options that holders have paid to convert into real, issued shares. Only these appear in the issued share count.
The gap between authorized and granted is the unallocated pool, what you have left to hire with. And there's a helpful recycling rule: when an employee leaves before vesting, or lets vested options expire unexercised, those shares typically return to the pool and can be granted again. Forfeitures are why a pool often lasts longer than a naive projection suggests.
The pool dilutes you the day it's created, not the day it's granted. Investors price rounds on the fully diluted share count, which includes the entire authorized pool, granted or not. An oversized pool isn't "dilution later, maybe"; it lowers your price per share today. That's exactly why pool size is worth negotiating with real numbers.
Sizing the pool from a hiring plan
The lazy default is "make it 15%." The better approach is to size the pool bottom-up from the hires you actually plan to make before the next round, because, per the callout above, every unnecessary point of pool is a point of real dilution for existing holders.
Common planning midpoints for per-hire grants (as a percentage of post-round fully diluted shares) run roughly: executives 0.5–1.5%, senior engineers or leads 0.2–0.5%, mid-level hires 0.1–0.2%, junior hires under 0.1%. These are planning numbers, not offers. Actual grants vary by market, stage, and cash trade-off. Multiply each level by the number of planned hires, add a buffer of 20–30% for refresh grants and off-plan hires, then subtract whatever is already unallocated in your existing pool. What remains is the top-up you actually need.
Worked example: pool sized from an 18-month hiring plan.
A seed-stage company plans, before its Series A: 1 VP of Engineering at 1.0%, 4 senior engineers at 0.35% each (1.4%), and 6 mid-level hires at 0.15% each (0.9%). Raw plan: 3.3%. Add a 25% buffer for refreshes and surprises: 3.3% × 1.25 ≈ 4.1%. The existing pool still has 1.2% unallocated, so the round needs a top-up of about 2.9%, not the 15% a default would suggest. Given that the pool is usually created pre-money (next section), the difference between asking for 4.1% and accepting 15% is roughly ten points of ownership kept by existing shareholders.
If you want to run this math on your own plan, the free ESOP pool calculator does exactly this arithmetic.
The pre-money top-up: who actually pays
Here's the convention that makes pool size a negotiation rather than an accounting detail. Most term sheets require the option pool to be topped up to a target percentage of the post-money fully diluted shares, but created in the pre-money. That phrase means the new pool shares are added to the share count before the investor's price per share is calculated.
The consequence: the pool's dilution lands entirely on the existing shareholders (founders and earlier investors) while the new investor's percentage is untouched. Economically, a pre-money pool top-up is a reduction in your effective pre-money valuation. This is sometimes called the option pool shuffle, and it's worth seeing in actual share counts.
Worked example: the same round, with and without a pre-money pool.
Founders hold 8,000,000 shares. Term sheet: 8,000,000 pre-money valuation (dollars), 2,000,000 of new money, and a 10% post-money unallocated pool created in the pre-money.
Post-round ownership must come out as: investor 20% (2M / 10M post), pool 10%, founders 70%. Founders' 8,000,000 shares = 70%, so total post-round shares = 11,428,571, meaning a pool of 1,142,857 shares and 2,285,714 new investor shares. Price per share = 8,000,000 ÷ (8,000,000 + 1,142,857) = 0.875.
Without the pool requirement, the price would have been 8,000,000 ÷ 8,000,000 = 1.00, and founders would hold 80%. All ten points of the pool came out of the founders; the investor holds 20% either way. Check the economics: 8,000,000 founder shares × 0.875 = 7,000,000, so the "8M pre" was effectively a 7M pre.
If the pool were instead created post-money, shared by everyone, the pool would be 1,111,111 shares on top of 10,000,000, leaving founders at 72.0% and the investor at 18.0%. Two points of founder ownership ride on one word in the term sheet.
Two practical takeaways. First, when comparing term sheets, always compute the effective pre-money after the pool top-up. A higher headline valuation with a bigger pool demand can be the worse deal. Second, this is why sizing from a hiring plan matters: the smaller the justified top-up, the less pre-money dilution you eat. The option pool shuffle post walks through the negotiation side, and Dilution math covers the general mechanics.
Tracking pool utilization
Once the pool exists, it needs bookkeeping. At any moment you should be able to answer: how much is authorized, how much is granted, how much has returned from forfeitures, how much is promised in outstanding offer letters but not yet board-approved, and therefore how much is genuinely free. Companies that don't track the "promised but not granted" category routinely discover they've committed more equity than the pool holds, an awkward conversation to have with a new hire or, worse, in diligence.
This is one of the places software earns its keep over a spreadsheet. In Vquity, the options module tracks each grant through its lifecycle (offer, acceptance, vesting, exercise or expiry), and a pool-utilization chart shows granted versus unallocated at a glance, with forfeited shares flowing back to the pool automatically.
Good utilization hygiene also feeds directly into the next fundraise: your top-up ask is only credible if you can show current utilization and a hiring plan behind the number.
Refreshing the pool at each round
Pools aren't sized once. At every priced round, the process repeats: count what's left unallocated, build the hiring plan to the round after this one, and negotiate a top-up to cover the gap, almost always as a pre-money condition in the term sheet, so the same "who pays" logic applies each time.
A few patterns to expect. Early rounds tend to need bigger refreshes because headcount growth is steepest and the starting pool was small. Forfeitures from departed employees reduce the top-up you need, another reason accurate tracking pays. And each refresh typically requires board approval and, depending on your documents, stockholder approval to increase the shares authorized under the plan, so treat it as part of round mechanics rather than an afterthought. Some companies adopt "evergreen" provisions that automatically add a small percentage to the pool each year; these are standard for public companies but rare and generally investor-disfavored at startup stage, precisely because they create automatic, unbudgeted dilution.
Over several rounds, a well-run pool follows a sawtooth: drawn down between rounds, refreshed at each close, always sized to a plan. A pool that's persistently huge and idle is a red flag in both directions: dilution taken too early, and a signal that equity planning isn't happening.
ISO vs NSO in one honest paragraph (US)
In the United States, options granted from the pool come in two tax flavors. Incentive stock options (ISOs) can go only to employees; if the holder meets the holding-period rules (two years from grant, one year from exercise), gains can be taxed as capital gains rather than ordinary income, and there's no regular income tax at exercise, though the exercise spread can trigger the alternative minimum tax, and only 100,000 dollars' worth (by strike value) may first become exercisable per year. Non-qualified stock options (NSOs) can go to anyone (advisors, contractors, directors), and the spread at exercise is taxed as ordinary income, with withholding for employees. Both must be granted with a strike price at or above fair market value, which is why US companies maintain a 409A valuation. This is a US-specific summary, the details have many edge cases, and none of it is tax advice. Grantees should talk to a tax professional, and non-US companies use different instruments entirely (see Regional equity differences).
Next in the course: putting all of these pieces (share classes, vesting, and the pool) together and actually reading a cap table end to end.