How do Pre-Seed Option Pools work?

In 2015, I moved from San Francisco to London and joined a Fintech startup, WordlFirst. They eventually got acquired by Ant Financial for $700m and despite being hired as the first Product Manager, I had no equity and didn’t benefit from the upside of the exit.

It taught me a lesson about remuneration at high-growth companies.

There are 3 ways individuals can generate wealth from startups. This was a key revelation to me; it’s all about owning equity and ownership. Here are the ways you can own equity in a startup:

  1. Start a startup, having majority ownership as a founder
  2. Invest in a startup, having minority ownership as an angel investor
  3. Earn equity in a startup, usually as an employee, you can benefit from equity as part of your remuneration package from an Option Pool

What are Employee Option Pools?

An option pool consists of shares of stock (also known as equity) reserved for employees of a private company (also known as a startup). The option pool is a way of attracting talented employees to join a startup company. It also helps attract top talent as startups often operate on a tight budget especially in the early days so using a mixture of pay and equity helps. The aspiration is that employees can help the company do well enough to go public or get acquired so that they will be compensated with stock.

What are the benefits of Option Pools?

Incentivising top talent to join you early. 

You’re unlikely to have the budget to pay market-rate salaries (i.e. what Google, Meta etc. pay). These future employees should be driven by aligned incentives. You want/need them to buy into your vision and live and breathe that long journey. Equity is the best way to balance this all out.

Let’s take a European company raising £2m pre-seed round at a £10m pre-money valuation (for simplicity, these numbers have been used). Post-money valuation at £12m.

Please note, below is an illustrative example, there is no 1-size fits all approach to this, context matters. Deep Tech will differ from consumer goods and so on.

The Option Pool:

A 10% option pool is standard and should be created at the pre-seed round (you don’t have to use it all immediately!). It is common to see this implemented BEFORE funding comes in (i.e. before the equity distribution to incoming investors). The main reason for this is that VC investors don’t want their ownership reduced immediately after investing in the round, they want to protect themselves.

2 founders with 50% of the business each. A 10% pool is created pre-funding, diluting the Founders down to 45% each before cash comes into the business.

Post funding, this 10% option pool will be diluted by 20% to 8% net, so you will have 8% to utilise.

Example Roles / Allocations (% = total company shares. 100% gross):

Technical Team 🧑‍💻

Note: I’m basing the option allocation as 80% of the annual salary (Senior) :

Senior Fullstack Eng

Salary = £120k

Options = 0.72%

Non-Technical Team 💰

Note: I’m basing the option allocation as 70% of the annual salary (Senior) and 60% (Mid-level):

Senior Head of Biz Dev:

Salary = £70,000

Options = 0.49%

Product Manager (mid-level):

Salary = £60,000

Options = 0.36%

These are some limited examples and I could go on, but this is a benchmark on what I’m seeing. Obviously, you won’t be hiring for all of these roles, so the full allocation won’t be swallowed up before your next round, but this is an example using data from a number of portfolio companies and the wider community. 

It is unlikely you will use all of your option pool allocations before the next funding round.

How do Vesting Equity Schedules work?

When employees receive equity from an options pool, it isn’t given to them all on day one of joining the company. The main reason for this is that you want to incentivise and reward them for staying with the company and helping it grow over a number of years. Rather than receiving equity and leaving within 6 months. Founder vesting is pretty common too.

A vesting schedule is a predetermined plan that outlines the percentage of equity available to an employee at specific intervals during the vesting period.

The most common vesting structure I see is 4-year vesting, with a 1-year cliff. This means you get 0% vesting for the first 12 months, 25% vesting at the 12th month, and 1/48th (2.08%) more vesting each month until the 48th month.

Interested in crunching the numbers for your business? Check out Index Ventures Option Plan Calculator. To learn more, read our previous article on What is Dilution? with a neat Dilution & Exit Calculator at the end of that article too.

Thank you to our friend Kieran Hill, Partner at 20VC who originally posted this article on Linkedin which we have adapted slightly with his permission.

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