How Option Pools in an Equity Round Create Dilution — and What Founders Need to Know
Understanding how option pools work and where dilution happens in funding rounds is crucial for making informed decisions about your equity structure.
Introduction
When you're negotiating a funding round, one of the most important — and most misunderstood — sources of founder dilution is the option pool. It's not always obvious, but how the option pool is sized and when it's calculated can have a major impact on your cap table.
Let's break it down...
What is an option pool
An option pool is a portion of a company's shares reserved for future employees, advisors, and consultants. It ensures you have enough equity to attract top talent after the round.
Why VCs ask for an option pool
Typically, VCs want to see a 10–20% option pool post-financing, so new hires can be incentivized without further diluting investors.
But here's the twist: where and when the option pool is created matters a lot.
Where the Dilution Happens: The Pre-Money Trick
In most VC term sheets, investors will ask for the option pool to be included in the pre-money valuation.
This means that the founders—not the investors—bear the dilution from the new option pool.
Example:
Let's say:
- Pre-money valuation = $10M
- VC is investing $5M for 33.3% ownership (post-money)
- VC wants a 15% option pool after the round
In effect, the founders are giving up an extra 15% on top of the equity sold to the VC — even though those options haven't been granted yet. Your final cap table will mean the existing shareholders have been diluted by 48.3%.
Understanding what levers to pull in this negotiation can be done through building a great model that will help you understand the math and variables in the deal.
Why Do Investors Do This?
It's not malicious — it's just math. VCs want the company to have enough room to hire a team post-investment, without their equity being diluted. So they push that dilution onto the founders before they invest.
Your job as the founder isn't to minimize the option pool, it's to get it right.
Founders: What You Can Do
- Negotiate the option pool size: If you already have a strong team or existing option grants, argue for a smaller top-up.
- Model the impact: Cap table modeling helps you see exactly how much equity you're giving up. Always run the numbers before signing. Find an expert to help you build and understand the model.
- Use real hiring plans: If you can justify a smaller pool based on your actual hiring roadmap, you may avoid unnecessary dilution.
Quick Rule of Thumb
When you hear "we want a 15% option pool," ask:
To get to this point with a VC, you've had a lot of discussions on use of funds. So: Is that what our plan says we need to allocate?
Final Thoughts
Option pools are a necessary tool — but don't let them become a silent equity giveaway. Understanding how it creates dilution gives you leverage in negotiation and confidence in your fundraising decisions.
Always model your cap table before agreeing to a term sheet. A small line in a legal doc can mean millions in lost ownership down the road.
If you'd like to talk with Bob about cap tables, you can connect with him here – because every point matters.