Option pools & dilution explained (simply)

Hi! I’m glad you’re here. You’ve made it to issue #75 of VC Demystified🪄.

My name’s Nicole - I’m a Principal at an early stage venture fund, and I know firsthand that VC can often be a black box. Breaking into the industry may feel daunting and resources can seem scarce and inaccessible. I wanted to put together a newsletter to give others the playbook I wish I had when I first started.

Today’s deep dive: Breaking down pre-money vs. post-money option pools with simple math

^{My personal mission is to open as many doors as possible for other people and this newsletter is just one avenue to do that. As always, I will continue to post VC insights daily for free across my socials. This newsletter may contain paid partnerships or affiliate links.}

Read time: 6 minutes

Breaking down pre-money vs. post-money option pools with simple math

Most founders understand that raising money means giving up equity. Fewer understand how dilution actually plays out in practice, especially when it comes to option pools.

And most candidates in VC interviews can’t explain the math either, which is exactly why this is worth covering.

Today’s post breaks down option pools, dilution, and why this seemingly small term in a term sheet can swing founder and investor outcomes by millions.

What Is an Option Pool?

An option pool is equity set aside for future employees. Instead of issuing stock today, companies reserve a percentage of shares to grant as options over time.

Think of it as a hiring budget but paid in equity instead of cash.

• Early hires get options, vesting over 4 years (usually)

• Pool sizes typically range from 10%-20% of the company

• Pools are replenished in later rounds as needed

On the surface, option pools make sense. Startups need talent, and equity is a big part of compensation. The nuance is who bears the dilution when the pool is created or expanded.

Pre-Money vs. Post-Money Pools

Here’s the critical distinction:

• Pre-money pool → The option pool is created before the new investor’s capital goes in. Dilution hits the founders and existing investors.

• Post-money pool → The pool is created after the investor’s capital goes in. Dilution is shared by everyone, including the new investor.

Guess which structure most VCs prefer? (Hint: pre-money because they don’t get immediately diluted.)

Mini Math Example

Step 1: Start simple
Imagine a startup is worth $20M today. The founders own 100%.

Step 2: Bring in an investor
A VC invests $5M at that $20M pre-money valuation.

• Now the company is worth $25M (20 + 5).

• Investor owns 20% ($5M / $25M).

• Founders keep 80%.

So far, so good.

Case A: No Option Pool

Since there is no option pool issued, there is no more dilution to existing shareholders.

• Founders: 80%

• Investor: 20%

Case B: Add a 15% Option Pool Pre-Money

Here’s the key: when the option pool is added pre-money, it’s carved out before the new investor buys in. Investors insist their 20% is protected, so the pool comes entirely from the founders’ side.

Results:

Subscribe to Premium to read the rest.