Question

During a cap table analysis, how does the inclusion of an unallocated option pool in the pre-money valuation affect the effective ownership percentage of the founders?

Accepted Answer

When an investor requires an unallocated option pool to be created prior to their investment, they are mandating that a portion of the company&#x27;s equity be set aside for future employees. An option pool is a block of shares reserved for stock options that will be granted to workers. When this pool is included in the pre-money valuation, it is treated as if those shares already exist and are owned by the company before the new investment is injected. This effectively dilutes the founders before the investor&#x27;s capital is even added to the cap table. Dilution is the reduction in an existing shareholder&#x27;s percentage ownership caused by the issuance of new shares. Because the pool is carved out of the pre-money equity, the founders&#x27; shares represent a smaller piece of the total pie compared to a scenario where the pool is created post-money. For example, if a company has 100 shares owned by founders and an investor asks for a 20 percent option pool to be included in the pre-money, the math forces the founders to effectively hold their original equity relative to a base that now includes those 20 new pool shares. Consequently, the founders own a smaller percentage of the company because the pool is counted as part of the total share count used to calculate their ownership stake before the investor provides their funding. By forcing the pool into the pre-money, the investor ensures that the dilution caused by future employee hiring is borne entirely by the founders rather than being shared by the investor.

Home → All Courses → Law and Criminal Justice Courses → Venture Capital and Startup Financing → Flashcard

During a cap table analysis, how does the inclusion of an unallocated option pool in the pre-money valuation affect the effective ownership percentage of the founders?