Share option pools — what are they and how do they work?

  • Swim Limited was set up a year ago and the founders have now employed five staff. They want to set up an EMI scheme so they discuss how much equity they will allow for an option pool
  • The founders agree that the pool will be 15% of the company
  • Swim has 100,000 issued shares, so a 15% pool would equal 17,647 option shares, calculated by ‘grossing up’ the issued shares (100,000/85%) to get the correct percentage i.e. 17647/117647 = 15%
  • The EMI scheme is put in place and Swim grants 5,000 options between the employees. At this point, the company has 100,000 issued shares and 5,000 granted options, with 12,647 ungranted options left in the pool
  • The next year, Swim grants another 5,000 options to new additional staff, so the company has 100,000 issued shares and 10,000 granted options, with 7,647 ungranted options left in the pool (at this point, if there was an exit and all employees exercised their options to buy their shares, there would be 110,000 shares bought by the acquirer and therefore the founders would be diluted by 10/110 = 9.1%)- the 7,647 engrafted options just evaporate, as it were, and are not relevant
  • Then Swim raises funding from a VC and sells 25% for £2m; the investor gets 36,667 shares, being 25% of the fully diluted equity (110,000/0.75). In the investment agreement that is signed, it is agreed that the option pool is increased to 20% including the 10,000 granted options. The pool is calculated as follows:
  • Note that the VC’s shares were calculated based on 110,000 shares so that they were not diluted by the granted option shares, and effectively they will only be diluted by any future option grants out of the 24,167 left in the pool. The extent to which an investor gets diluted by options is often a key negotiating point during a funding round and for the founders, it’s obviously better if the VC agrees to more rather than less dilution. In our example the VC has agreed to be diluted by the ungranted pool, but many investors will want their equity percentage based on fully diluted shares including both the granted and ungranted option shares
  • The number of granted options will increase every time new options are awarded to employees, but if an employee leaves the company they will often lose their option rights and in that scenario their granted option shares revert to being ungranted and go back into the pool so that they can be used again
  • This example is illustrated numerically in the table below

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Jerry Davison

Jerry Davison

Specialist in strategy, share options, entrepreneurship, multiple CEO and CFO and non-exec roles. Worked in UK, US and Africa.