A question most founders will face is whether to set aside a percentage of their company’s stock to be reserved for employees.
An employee option pool (also known as an equity pool or an incentive pool) is the number of shares a private company reserves from which it can grant stock options or restricted stock to award to its employees. Although these awards are technically stock options or restricted stock, the word “pool” is used because it represents the grouped sum of all stock that is set for the company’s employees.
Both restricted stock awards and stock option awards provide conditional equity compensation to the company’s employees. A restricted stock award provides the employee with an outright stock ownership in the company, which is often subject to vesting and other conditions on the timing of their sale so that the employee does not leave the company. On the other hand, a stock option award provides the employee with the right (not the obligation) to purchase shares of stock in the company, and such options are also subject to conditions like vesting. Used by most startups, a stock option award requires the employee to pay a price if they elect to exercise their stock option.
Although there are a number of factors to consider when creating an employee option pool, the most obvious question is the size of the option pool. Most startups with an option pool reserve about 10-20% (although some sources say 15-25%) of their stock for the employee option pool. However, it is important to note that the size of the option pool will likely increase at each successive stage of the company’s financing.
So why create the pool? Employee option pools can be used to recruit talent. The pool provides the company with the ability to offer an incentive outside of money if low on capital. Additionally, the pool provides employees with a reason to work hard enough so that the company goes public (thereby increasing the value of the pool).