Employee Equity: Understanding Stock Option Pools in Cap Tables

An employee stock option pool is a block of shares specifically allocated for a company’s employees.

The ability to attract and retain top talent is a pivotal factor in the success of startups. Employee equity is an effective tool for achieving this outcome by aligning employee and corporate objectives.

Stock option pools within capitalization tables offer a framework for fair remuneration and give employees a tangible interest in the company’s success.

So, how does employee equity promote talent retention and business success?

How Does the Option Pool Work?

US and European startup equity markets work differently. The US has high competition, so startups offer equity packages to hire the best talent. Employees find it worthwhile due to the high rate of profitable exits, and many even become entrepreneurs or angel investors. Thriving accelerators like 500 Startups and Y-combinators prove the drive for innovation in the US startup market.

An option pool creates dilution for both founders and investors and therefore is a point of negotiation during a fundraising round.

The option pool is a crucial component that weaves together a number of crucial elements inside the startup ecosystem, going beyond being only a strategic tool.

• Employee equity creates a shared sense of ownership, which makes employees more driven and interested in the company’s future and successes.
• Having a well-structured option pool is a strong indicator of capable management and may boost a startup’s value in the event of an acquisition or public listing.
• Investors, whether angels or VCs are attracted to companies with well-structured option pools. This precondition highlights the startup’s willingness and dedication to collaborate.

Planning the Appropriate Option Pool Size

Here is an approximate idea about the size of the option pool based on company valuation:

*This is approximate data compiled from a survey of about 200 startups in the US.

From our experience, the ideal size of the option pool can only be determined by striking a compromise between recruiting excellent employees and protecting the founders’ equity.

Predicting how many new employees will be needed in the first year of operation is a wise move. Budgeting between 6 and 8 percent for C-suite executives hits a nice middle ground, providing an attractive prospect while maintaining budgetary responsibility.

A bigger option pool can attract top talent but dilutes founder shares, potentially leading to counterproductive compensation.

To issue employee equity, startups should predict recruitment needs for the first 12 months and allocate a 6–8% budget for C-level and junior executives. Allocate conservative equity for the option pool initially, as it can always be increased later.

A Case study Of Eqvista For Equity pool:

On the Eqvista app, you can use the Round Modeling feature to find out how the numbers would break down when setting up your option pool and shares for the new round of funding.

Let’s take the same example of a new company with 5,000,000 founder shares, and put in a pre-money valuation of $2.833 million with a 10% post money option pool, and a new investment round of $500,000. Here is how the inputs would look on the app.

After putting in the variables into the round modeling, it will generate the breakdown of the new total shares for the founders, option pool and new investor.

In less than a minute you can use the Eqvista Round Modeling to calculate the breakdown of your new option pool. In case you have multiple new investors or differences in their investment rights and conversion rates, you can include that too in the model.

Understanding the Role of Employee Equity in Strategic Planning

Equity in a new business typically remains in the hands of the company’s founders when the business begins operations. However, when the firm grows through initiatives such as hiring more people or raising more money, the distribution of ownership becomes more important.

Take the example of a firm with three founders who agree to split the ownership equally (25% each). That means 75% of the options are still available and serve as the pool’s foundation. This strategic asset may benefit potential workers, advisers, consultants, and investors.

Within the cap table, the concept of an option pool symbolizes the delicate equilibrium between ownership and development. The cap table would show the allocation of ownership among various stakeholders, including founders, investors, and employees with stock options.

The option pool is typically carved out from the pre-money valuation, meaning the dilution comes from the founders and existing investors.

Equity Allocation: How to Find Your Balance?

Smart decision-making is required when allocating stock in a startup’s early stages. It is common practice to reward early workers with a larger share of the option pool, who take on the most risk. Employees’ stock interests often decrease as a company develops and gains traction in the market.

From the perspective of potential backers, the startup’s stock pool is crucial. Investors receive a portion of the company’s stock in return for providing funds. Investors weigh the possible benefits against the need to avoid undue dilution of their shares, making it difficult to strike the correct balance.

Capitalization Table Accuracy for Equity Compensation

Transparency, careful distribution of equity, and strategic planning are all necessary for effective management of employee equity.

The cap table is integral to this balanced setup, clearly and precisely outlining the ownership structure. Although equity is a payment type, secrecy is prioritized above full disclosure. However, access to the cap table is necessary for key stakeholders to make sound choices and engage in strategic planning, including the board of directors, the chief financial officer, and the legal team.

Design Your Startups Equity Pool With Eqvista!

Employee equity relies heavily on stock option pools easily available inside cap tables. Both sides can benefit from this symbiotic relationship. Startups may more easily handle complexity with the help of Eqvista’s cap table management tools.

Using Eqvista to improve their workforce, business owners pave the path for a brighter future in which everyone’s dreams may come true. Employ equity and Eqvista to advance your company with just a call!