How many options should a startup allocate to the pool?
Because option plans require allocation of a specific number of shares and count towards the company’s fully-diluted ownership, they effectively dilute any existing equity-holder’s stake. Since founders typically want to preserve as much of their own ownership as possible during fundraising, the dilution effect means that founders should seek to keep their option pool as small as they can without hurting their ability to recruit—and they should be able to justify this plan to their investors.
The actual number of shares founders earmark for their option pool depends on the number of shares they have already issued. Investors typically expect an available option pool somewhere between 5% and 15% of the startup’s ownership after the fundraise, which means founders must earmark a larger portion before the round so that the pool will represent the target percentage after being diluted by the investors’ preferred shares.
If a founder knows the percentage of overall ownership her investors will receive along with her target option pool percentage and her current number of issued shares, she can calculate the number of shares she’ll need to allocate to her pool.
First, the founder will subtract both the investors' stake (as a percentage), IP, and the target pool percentage size, OP, from 100 to find the percentage that her current shares, CP, will translate to:
100 - (IP + OP) = CP
She can then multiply her currently issued sharecount, CC, by the ratio of her option pool to those shares to find out how many shares, OC, will need to be in her option pool:
CC * (OP/CP) = OC
For example, if investors want 20% and a 10% pool after investment, and the founder has issued 7,500,000 shares,
100 - (20 + 10) = 70
7,500,000 * (10/70) = 1,071,428
she must allocate 1,071,428 shares to her option pool (even though it would be a bit over 14% of her current ownership before fundraising).
Fortunately, an option pool is not set in stone once adopted, so if the terms of the founder’s next round aren’t yet known, they can just allocate the shares they know they need when they adopt the equity incentive plan, and then later allocate more as it becomes necessary to do so. It’s much easier to add options to the pool than subtract them, but founders should still try to make sure the pool sufficiently covers their hiring needs for the foreseeable future.