The option pool, and who actually pays for it.

What an option pool actually is

An option pool — also called the equity incentive plan reserve, or just "the plan" — is a quantity of shares the board sets aside so the company can grant equity without a fresh authorization every time it hires. This page assumes the US default, a Delaware C-corporation; other jurisdictions and entity types work differently. The shares come out of authorized but unissued stock, because a Delaware corporation can only issue what its certificate of incorporation authorizes; those rules sit in Title 8, Chapter 1, Subchapter V of the Delaware General Corporation Law.

So there are three populations of shares at any moment: authorized, reserved under the plan, and issued and outstanding. Reserved shares are the middle one. Nobody owns them — no vote, no dividend, no holder of record — and they move to the issued column only when someone pays the strike price and exercises. They still appear in the fully diluted count, which captures everything that could become a share. /equity/authorized-vs-outstanding-shares works through all three denominators; /equity/cap-table covers why a company keeps more than one view.

Granted versus unallocated

Once a plan exists, the reserve splits in two. Some has been granted — signed award agreements naming specific people, with strike prices and vesting schedules. The rest is unallocated: still in the plan, promised to nobody, available for the next hire. Internally people call the unallocated part "the pool" and the granted part "outstanding options," though both sit in the same reserve. That usage is where the expensive misreading happens. A term sheet line reading "a 10% option pool" states what must be available and ungranted at closing. If the existing reserve is mostly granted out, topping it back up to that percentage means creating new shares on top of everything already outstanding — far more dilution than the headline suggests.

How a pool is sized in practice

Averages circulate for pool size, and they are quoted far more often than they are measured. A percentage that fits a company hiring two engineers does not fit one building a sales organisation. Work bottom-up instead.

1. Fix the window. A pool is sized for the runway the round is meant to buy — closing until the next financing, not forever.
2. List every role expected to be hired inside it. Named roles, not aggregate headcount: grant sizes differ enormously between a first engineering hire and a twentieth.
3. Attach a grant to each role as a percentage of post-round fully diluted capitalization, using offers the company has made or lost rather than a published benchmark.
4. Add refresh and promotion grants for people already on the team.
5. Total it, then add a margin for the hire that was not on the plan.

The pool percentage is a price term wearing the costume of an operational one. A role-by-role total moves the conversation from "investors usually ask for X" to a specific plan that can be defended or trimmed.

The option pool shuffle

Take a company with 7,000,000 shares of common held by its founders, who own 100% of it before the round. An investor offers $4,000,000 at a $16,000,000 pre-money valuation, so the post-money is $20,000,000 and the investor is buying 20%. What follows depends entirely on where the pool sits relative to the pre-money.

With no new pool, the price per share is the pre-money divided by existing shares: $16,000,000 ÷ 7,000,000 = $2.2857. The investor buys $4,000,000 ÷ $2.2857 = 1,750,000 shares. The company ends with 8,750,000 shares — founders 7,000,000 = 80.0%, investor 20.0%.

Now add a pool equal to 10% of the post-money, created out of the pre-money. That is the standard term, and "pre-money" does all the work: the 1,000,000 pool shares join the share count before the price is calculated. The pre-money count becomes 7,000,000 + 1,000,000 = 8,000,000, so the price is $16,000,000 ÷ 8,000,000 = $2.00, and the investor buys $4,000,000 ÷ $2.00 = 2,000,000 shares. The company closes at 10,000,000 shares: founders 70.0%, pool 10.0%, investor 20.0%. Check it from the other side — $20,000,000 ÷ 10,000,000 = $2.00 — and the two calculations agree.

Finally, place the same 10% pool out of the post-money. The price is set as if there were no pool ($2.2857), the round closes at 8,750,000 shares, and only then is a pool created equal to 10% of the new total: 8,750,000 ÷ 0.9 = 9,722,222 shares, of which the pool is 972,222. Founders hold 7,000,000 ÷ 9,722,222 = 72.0%, the pool is 10.0%, the investor 1,750,000 ÷ 9,722,222 = 18.0%.

Read the table against column A. A pre-money pool costs the founders the full ten percentage points and the investor nothing — they still hold exactly 20.0%. A post-money pool splits the same ten points pro rata: eight from the founders, two from the investor, precisely the 80/20 they held before. Same pool, same company, two different bills. That difference is the option pool shuffle.

Sharper still: in Scenario B the founders’ 7,000,000 shares are priced at $2.00 each, valuing them at $14,000,000 — not the $16,000,000 printed on the term sheet. The $2,000,000 gap is exactly 10% of the $20,000,000 post-money: the cost of the pool, charged entirely to the pre-money. The founders’ effective pre-money is $14,000,000.

None of which makes a pre-money pool unreasonable: the hires it funds are needed to execute the plan the valuation rests on. But it is a price term, negotiable on three separable axes — the size of the pool, whether it is measured pre- or post-money, and whether unallocated pool is topped up at the next round. /equity/dilution covers what those choices compound into.

How a pool is actually created

What happens to the pool afterwards

Grants shrink the unallocated balance. Unvested options forfeited on termination normally return to the reserve, as do options that expire unexercised; the plan document sets the specifics. A pool drawn down over a couple of years is typically expanded at the next round, and that expansion dilutes exactly like the first, with the same pre-money question attached. Hence a pattern founders notice late: ownership falls at each round by more than the new money alone explains. /equity/cap-table-management covers keeping the trail accurate.

Tax and compliance edges attached to the pool

A pool is a cap table object, but the grants made from it sit on top of several distinct rules. Strike prices are set at or above the common stock’s fair market value on the grant date because of 26 U.S.C. §409A: a below-FMV option can create adverse tax consequences for the holder, which is why a board obtains a valuation rather than picking a price. Whether a grant qualifies as an incentive stock option turns on the conditions in §422, which are numerous and fact-specific. The grants are themselves securities, and 17 CFR §230.701 — Rule 701 — is the exemption non-reporting companies commonly rely on for compensatory equity, with disclosure conditions above certain thresholds. On exercise of an ISO, the corporation files Form 3921.

One distinction is worth stating flatly, because it is the most common mistake here: an 83(b) election has nothing to do with an unexercised option. Under 26 U.S.C. §83(b)(2) the election must be made no later than 30 days after the date of transfer, and there is only a transfer to elect on once property has changed hands — restricted stock, or shares acquired through an early exercise of unvested options. An unexercised option transfers no property, so there is nothing to elect on. /equity/common-vs-preferred-stock and /equity/share-classes cover the underlying security.

For the downstream questions a pool creates for grant recipients: /tools/vesting-calculator for how much of an award has vested at a given date, and /tools/option-exercise-calculator for what exercising costs at a given valuation.