Free sample lesson · Advanced Venture Term Sheet Strategy
Option Pools
How did an expanded unallocated option pool silently cut a founder's effective pre-money valuation by $4 million?
Lesson 1 of the Wondering course Advanced Venture Term Sheet Strategy
The Silent $4M Haircut
A term sheet says $20 million pre-money. The investor then asks for a 20% unallocated option pool, sized pre-money.
That pool is carved out of your share count before the money lands. Nothing in the headline number changes.
But your effective pre-money valuation drops by roughly $4 million. The price you thought you negotiated was never the price you received.
- Headline pre-money: The number printed on the term sheet.
- Pool requested: Unallocated, sized pre-money before the money lands.
- Effective haircut: The drop in effective pre-money valuation nobody wrote down.
The price you negotiated was never the price you received.
Where The Pool Sits
The whole fight is one word: pre-money or post-money.
A pre-money pool is added to the pre-money share count. Founders and existing holders absorb every share of it.
A post-money pool sits inside the fully diluted capitalization after financing, so the new investor shares the dilution alongside you.
- Pre-money pool
- Post-money pool
Same percentage. Very different owner of the pain.
Unallocated Is The Key Word
Not every pool share hurts equally.
Already-granted options are historic dilution. They belong to hires you have made and are usually inside your existing count.
Unallocated shares are different. They are reserved for people who do not work for you yet.
- Granted options
- Unallocated shares
A pre-money unallocated pool makes today's holders prepay for tomorrow's team.
Run The Arithmetic
Take the $20 million pre-money with a 20% pre-money unallocated pool.
One fifth of the pre-money capitalization now belongs to unhired employees. Your existing shares are valued as if they were only 80% of the pre-money company.
So the founders' pre-money equity is effectively priced at about $16 million.
- Start: Take the $20 million pre-money with a 20% pre-money unallocated pool.
- Carve out: One fifth of the pre-money capitalization now belongs to unhired employees.
- Reprice: Your existing shares are valued as if they were only 80% of the pre-money company.
- Result: Founders' pre-money equity is effectively priced at about $16 million; the lost $4 million never appears in the term sheet.
The lost $4 million never appears anywhere in the term sheet.
Why Investors Push Pools Up
Pool sizing is a price negotiation dressed as a hiring plan.
Every extra point of pre-money pool lowers your effective price without touching the headline valuation the investor can quote to peers.
It also pre-funds the hiring the investor expects you to do, at your expense rather than theirs.
Read a large pool request as a discount request.
Anchor The Pool To A Plan
The strongest counter is not a smaller number. It is a hiring plan.
Build a role-by-role table for the next 12 to 18 months, with grant sizes attached. Then size the pool to that plan and nothing more.
A pool justified by named roles is hard to inflate. A pool justified by a market rule of thumb is easy to inflate.
- Build the plan: Create a role-by-role hiring table for the next 12 to 18 months.
- Attach grants: Assign grant sizes to each named role.
- Size the pool: Size the pool to that plan and nothing more.
- Move first: Bring the plan before the investor brings the percentage.
Bring the plan before the investor brings the percentage.
Move The Pool Post-Money
The second lever is placement rather than size.
Ask that the unallocated pool sit in the post-money fully diluted capitalization. The investor then shares hiring dilution with you instead of buying in ahead of it.
If placement will not move, price the pool explicitly. Raise the pre-money number so your effective valuation lands where you intended.
- Pool on the table: Unallocated pool sized against you.
- Ask post-money placement: Request the pool sit in the post-money fully diluted capitalization.
- Placement moves?
- Dilution shared: Investor shares hiring dilution instead of buying in ahead of it.
- Price the pool: Raise the pre-money number so your effective valuation lands where you intended.
- Value restored: This route makes the investor admit the discount.
Either route restores the $4 million. Only one requires the investor to admit the discount.
Edge Cases And Misreads
A common misconception: a smaller pool is always better. Undersized pools force a painful top-up round later, often at the next financing when you have less leverage.
Another misread: refreshes are free. A pre-money refresh at the next round repeats the same carve-out against a larger holder base.
And beware double counting granted options already sitting in your fully diluted count.
The Founder's Checklist
Pre-money pool sizing forces existing holders to absorb all anticipated hiring dilution alone. That is the whole mechanism.
So negotiate three things together: the headline valuation, the pool percentage, and where the pool sits.
- Negotiate together
- Headline valuation: The quoted pre-money number alone is not the price.
- Pool percentage: Every pre-money point shifts value from existing holders.
- Pool placement: Pre-money or post-money decides who absorbs hiring dilution.
- Before signing
- Compute effective pre-money: Do it before you sign, not after.
- No calculation, no price: A term sheet without it is an unpriced deal.
Pre-money pool sizing makes existing holders absorb all anticipated hiring dilution alone.
Then compute your effective pre-money before you sign, not after.
A term sheet without that calculation is an unpriced deal.
Check yourself
An unallocated option pool sized pre-money is absorbed entirely by founders and existing holders before the investment arrives.
- True
- False
Answer: True
Correct. A pre-money pool is added to the pre-money share count, so existing holders bear its dilution before the investor purchases shares.
A pre-money pool is added to the share count before financing, so _____ absorb its dilution. A post-money pool is included after financing, so the _____ shares that dilution.
Answer: A pre-money pool is added to the share count before financing, so existing holders absorb its dilution. A post-money pool is included after financing, so the new investor shares that dilution.
Pre-money placement makes founders and other existing holders bear the pool dilution alone. Post-money placement makes the investor participate in the dilution as well.
A company negotiates a USD 20 million pre-money valuation and accepts a 20% pre-money unallocated option pool. What is the approximate effective pre-money value of the founders’ existing equity?
- USD 4 million
- USD 16 million
- USD 20 million
- USD 24 million
Answer: USD 16 million
A 20% pre-money pool leaves existing holders with approximately 80% of the stated pre-money value: 80% × USD 20 million = about USD 16 million. The USD 4 million difference is an implicit discount.
Keep going
This is lesson 1 of 15 in Advanced Venture Term Sheet Strategy. Next up:
- Dilution Ratchets
- Recapitalization Cuts
- Liquidation Multiples
- Conversion Thresholds
- Carveout Structures
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