What is Option Pool?

Explanation of option pool

An option pool is commonly created by early-stage and growth companies to attract, retain and incentivise key individuals. The pool is usually established before or during a funding round and is expressed as a percentage of the company’s fully diluted share capital.

From a founders’ perspective, creating or increasing an option pool reduces their percentage ownership because the pool is factored into the company’s capital structure. This dilution can occur even before options are granted.

In the UK, options granted from an option pool may form part of a formal share scheme such as an Enterprise Management Incentive (EMI) scheme. Where EMI options are used, HMRC valuation considerations often apply to determine the market value of shares at grant, particularly in venture-backed businesses.

Option pools therefore sit at the intersection of capital structuring, founder dilution, investor negotiations and tax-efficient employee incentivisation.

Key characteristics of option pool include:

• It is typically expressed as a percentage of fully diluted share capital.
• It represents unissued shares reserved for future option grants.
• It can be created or expanded as part of an investment round.
• It reduces existing shareholders’ percentage ownership on a fully diluted basis.
• It may be used to grant tax-advantaged options under schemes such as EMI, subject to eligibility criteria.

How option pool works

1. The company determines the proportion of share capital to reserve for employee incentives.
2. Shareholders approve the creation or increase of the reserved pool.
3. Individual option grants are made from the pool under agreed terms.
4. When options are exercised, new shares are issued and the holder becomes a shareholder.

Example of option pool in practice

A UK technology start-up raising external investment agrees with investors to establish a 10% option pool on a fully diluted basis. The pool is created before completion of the funding round. As a result, the founders’ percentage ownership reduces to reflect the enlarged share capital, even though no options have yet been granted. The company later grants EMI options to senior employees using shares reserved within that pool.

Common misconceptions about option pools

An option pool does not mean shares have already been issued to employees.
An option pool does not automatically qualify as a tax-advantaged scheme.
An option pool does not prevent further dilution in future funding rounds.

Common questions

How large is a typical option pool for an early-stage company?

The size varies depending on hiring plans, growth strategy and investor expectations. Early-stage venture-backed companies often establish pools in the range of 5% to 15% of fully diluted share capital, although there is no standard percentage.

What is the difference between an option pool and an employee share scheme?

An option pool is a reserve of shares set aside for potential option grants. An employee share scheme, such as an EMI scheme, is the legal and tax framework under which options are granted. The pool provides the shares; the scheme governs the terms.

How is an option pool created?

An option pool is created by shareholder approval to reserve a specified number or percentage of shares for future option grants. This may involve amending the company’s articles of association and updating its capitalisation table.

Does an option pool dilute existing shareholders?

Yes. When measured on a fully diluted basis, the creation or expansion of an option pool reduces the percentage ownership of existing shareholders, even before options are exercised.