Should a pre-seed stage startup set aside option pool? Say, you are in a program like YC or Angelpad. Should you set aside an option pool? What are the questions that should be involved?

You should certainly think about setting an option pool as it is often a requirement with many incubators such as YC or Angel Pad, but it’s imperative that it’s done correctly. Investors are notorious for trying to dictate the size of the option pool to benefit themselves. You should use a hiring plan to illustrate why you need a small pool.

There are three ways in which an option pool in pre-money benefits the investors. A pre-money pool dilutes the common stockholders whereas a post-money pool would dilute both preferred and common shareholders.

The second reason is that the option pool also dips into the pre-money more than one would expect. For example, an $8 million dollar pre-money with a 20% option pool would equal 20% of post-money but 25% of pre-money. Finally, if you sell the company before the Series B, all un-issued and un-vested options will be null and void. This in turn sends some of the pre-money valuation straight into the investor’s pocket.

The best way to combat this is with a hiring plan. Discuss with the investors reasons as to why they want an option pool that large. They’ll probably state that it is industry standard or something along those lines. Next, create a hiring plan for the next 12 months and determine the options that all new hires will receive. The total will most likely be below what they’re stating, and you now have sufficient evidence as to why the option pool should be lower which in turn increases the effective valuation of the company.

You should also discuss what is needed to get to the next valuation event as you only need enough options to reach that point. If you only need to raise enough money for a years’ worth of operations than 10% should be plenty. Anything in excess of that might not be totally necessary.

This stuff can get overwhelming (as it was for myself). If you ever wanted to discuss your particular situation with a startup lawyer near you, feel free to check out LawTrades.