Equity Incentive Plans / Equity Stock Option Plans

Understanding the Basics

What Is an Option Pool?

An option pool is a reserved portion of company shares set aside specifically for future employees, advisors, and contractors. While commonly referred to as an Employee Stock Option Plan (ESOP), this terminology is somewhat misleading since the pool can include various equity instruments beyond just stock options.

Equity Incentive Plans (EIP)

A more accurate term is Equity Incentive Plan (EIP), which encompasses the broader range of equity compensation tools available to startups, including:

• Stock options
• Restricted stock grants
• Restricted stock units (RSUs)
• Other equity-based incentives

The purpose of these plans is to create an ownership culture, attract and retain top talent, and align employee interests with company success.

Key Considerations

Timing and Implementation

Creating an option pool during incorporation is critical. A common founder mistake is issuing all authorized shares to founding team members without reserving equity for future team members. This approach creates complications when you need to incentivize new employees.

The proper sequence is:

1. Determine the size of your option pool (typically 10-20% of total equity)
2. Set aside these shares before distributing equity to founders
3. Divide the remaining shares among the founding team

Sizing Your Pool

Option pool size depends on several factors:

• Company stage and growth trajectory
• Anticipated hiring needs
• Industry standards and investor expectations
• Financial resources available

For example, if three founders incorporate with 10 million authorized shares and decide on a 15% option pool, they would reserve 1.5 million shares for the pool and divide the remaining 8.5 million shares among themselves.

Implementation Process

Approval Requirements

Implementing an Equity Incentive Plan requires formal approval through a specific process:

1. Board of directors designs the plan and determines terms
2. Plan details are documented, including:
   
   • Number of shares in the pool
   • Plan administrators
   • Restrictions on stocks and options
   • Exercise windows and vesting schedules
3. Stockholders review and approve the plan
4. Upon approval, the company can begin issuing grants

In practice, both board and shareholder approval often occur through written consent rather than formal meetings, especially in early-stage companies.

Documentation Importance

Proper documentation is essential for:

• Regulatory compliance
• Transparency with investors
• Clean future fundraising processes
• Protection against disputes

Best Practices

Strategic Planning

• Align your option pool size with your hiring plan
• Consider future funding rounds and potential dilution
• Review competitive compensation practices in your industry
• Reserve appropriate equity amounts for key executive roles

Implementation Guidance

• Work with experienced legal counsel to draft your EIP
• Ensure all equity grants comply with applicable securities laws
• Maintain detailed records of all grants made under the plan
• Review and adjust your plan as the company grows

Looking Ahead

Remember that while this overview provides a foundation for understanding option pools, every startup faces unique circumstances based on industry, growth plans, and competitive landscape.

Need help establishing an appropriate option pool and drafting an Equity Incentive Plan that supports your hiring goals? Our team is here to guide you through the process and ensure your equity structure effectively supports your company's growth. Contact us today to develop an option pool strategy that works for your business.