Options

What the greatest technology investors say about Options

OPTIONS – OPTION POOL POSTS (15 posts)

The following is a list of the post titles by author under this topic.  Scroll further down this page to find the actual blog post by your selected author.   Author’s posts appear in reverse alphabetical order.  For example, following this list, Fred Wilson’s posts appear towards the beginning of the blog page, and Jeffrey Bussgang’s post appears towards the end of the blog page.   

JEFFREY BUSSGANG (1 post)

Jeffrey Bussgang:   Relationship between Option Pool Size & Price

BRAD FELD  (1 post)

Brad Feld:   Investors Require Employee Stock Options

JASON MENDELSON  (1 post)

Jason Mendelson:   Investors Only Care About Returns & Control

BABAK NIVI   (2 posts)

Babak Nivi:   The Option Pool Lowers your Effective Valuation

Babak Nivi:   Tips When Raising a Seed Round

MARK SUSTER  (5 posts)

Mark Suster:    Be Leary of Too High a Price

Mark Suster:   Dilution Benchmarks & Fundraising

Mark Suster:    The VC Assumes there’s an Option Pool

Mark Suster:    The VC “Squeeze” and Dilution

Mark Suster:    Options are Always Common

FRED WILSON  (5 posts)

Fred Wilson:    An Option Pool is about Price

Fred Wilson:    Options have Board Oversight

Fred Wilson:    Determine Option Pool Needs ‘Round to Round’

Fred Wilson:    Option Pool Gets Increased for Subsequent Rounds

Fred Wilson:  Options Don't Vote

Option Pool Gets Increased for Subsequent Rounds

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

When entrepreneurs go to market for subsequent investment rounds, Wilson says that “as part of the transaction the [option] pool will get increased again.   [Wilson likes] to do these refreshes as part of the financing negotiation since it is all about price.”  Fred Wilson, Valuation and Option Pool, Nov. 6, 2009 comments section http://www.avc.com/a_vc/2009/11/valuation-and-option-pool.html#comment-22043449

Determine Option Pool Needs ‘Round to Round’

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

Even if one expects multiple investment rounds, Wilson says it’s better to determine option pool needs “round to round [vs. earmarking all expected future option pool needs upfront] because you can never know where this thing is headed and when you'll sell.”  Fred Wilson, Valuation and Option Pool, Nov. 6, 2009 comments section, http://www.avc.com/a_vc/2009/11/valuation-and-option-pool.html#comment-22043449

An Option Pool is about Price

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

“One [] contentious [] negotiation [point] between an entrepreneur and a VC [], particularly [in] an early stage financing, is the inclusion of an option pool in the pre-money valuation. [] [The] fact [is an option pool] is simply about price.  [Example]:  [] $3.25mm pre-money with no option pool [can be equivalent to] $4mm pre-money with one. [] What an entrepreneur needs to do is find out what the market price for [his] company is with and without an option pool in the number. [Then], the negotiation over this point is [] less contentious.”

“[] [Wilson acknowledges that if] options are counted in the pre-money, entrepreneurs will want commensurately higher valuations to compensate for the additional dilution.”

“[][The] option pool request needs to be reasonable and based on [a] budget.  [Wilson looks for] enough options [in] the "pre-money pool" to fund the hiring and retention needs [] until the next financing.”  Wilson wants an option pool in the pre-money when he invests.  Fred Wilson, Valuation and Option Pool and comments, Nov. 6, 2009;  http://www.avc.com/a_vc/2009/11/valuation-and-option-pool.html#comment-22043449

The VC “Squeeze” and Dilution

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] most VCs have a 20% minimum [equity threshold] so bringing in multiple VCs can be very expensive in terms of dilution. [] The biggest problem [with 2 VC’s in a deal] is the “squeeze.” All VCs want to own between 25-33% [equity]”, above their internal 20% minimum.  A founder with co-founders can quickly get very diluted once an option pool is included.  “[]There are [] VCs [] who don’t cling to the old “20% or the highway” mentality [] and [Suster] suggest[s] [founders] seek them out.” Mark Suster, How Many Investors are Too Many? February 22, 2011http://www.bothsidesofthetable.com/2011/02/22/how-many-investors-are-too-many/

The VC Assumes there’s an Option Pool

Mark Suster Partner Upfront Ventures and former entrepreneur

“The VC assumes [there will be] an option pool [] to hire and retain talent to grow [the] company. [] The more senior members [the company has], then the [fewer] options [needed] and vice versa.  Industry standard post [the] first round of funding will be 15-20% [for the option pool].  [Suster] say[s] “post” funding because [one will] need more than this amount pre-funding to get to this number after funding. [] 

[It’s standard] that the VC wants the options includ[ed] before [he] funds [].”  The option pool dilutes the founder’s percent ownership, not the investor’s.  The option pool suffers the same percent dilution the founder suffers when a VC invests his money. 

“Note that the term sheet [says “Pre-Money” valuation and nowhere does] the term sheet [say] “true Pre-Money” or “effective Pre-Money”– that’s for [the founder] to calculate.”   True or effective pre-money is based on a lower price/share due to options increasing the number of shares incorporated in the calculation. The result is a lower true pre-money than pre-money, the latter which is also called “nominal” pre-money valuation.  Mark Suster Want to Know How VC’s Calculate Valuation Differently from Founders, July 22, 2010;    http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-differently-from-founders/

Dilution Benchmarks & Fundraising

Mark Suster Partner Upfront Ventures and former entrepreneur

Negotiations between entrepreneurs and investors include dilution and other fundraising terms.  “[] the “fairway” of [investor’s equity] is 25-33% per round [i.e., entrepreneurs’ dilution]. [] If [the entrepreneur is] “super hot” or “super experienced”, [he] can end up with much less dilution –in some cases 12-15%.  But this is the exception, not the rule.”

“[] [These] dilution numbers don't take an option pool into account [].  Options are additional dilution.”

“[] [Valuation can be driven up] ONLY if there’s [] competition [for] a deal.  [Investors stay honest when entrepreneurs] talk with multiple parties.”

Fundraising also requires considering how many future rounds are needed and expected total future dilution.  It’s not an arbitrary spreadsheet-driven exercise reflecting attaining profitability.  It requires “understanding [industry norms necessary] to build a successful Internet business and where [the company falls] on that spectrum given [its business type].”  Mark Suster,  8 Questions to Help Decide if You Should be Raising Money Now, February 17, 2011 and comments;  http://www.bothsidesofthetable.com/2011/02/17/8-questions-to-help-decide-if-you-should-be-raising-money-now/

Be Leary of Too High a Price

Mark Suster Partner Upfront Ventures and former entrepreneur

 “[] [Suster has] seen a destructive cycle where otherwise interesting companies have been screwed by raising too much money at too high of prices and gotten [] [trapped] when [] markets correct and they got ahead of themselves [on inherent market valuation]. []

[It’s] OK to [] shoot for the “top end of normal” for the market conditions. [] [He] caution[s] entrepreneurs from [] raising money at significantly ABOVE market valuations. []

If [entrepreneurs] haven’t figured out product / market fit and therefore still have a highly risky business [they] run great risks for getting too far ahead [] on valuation. [] [Most] investors won’t want to [][do] a “down round,” which creates tension between them and early investors.

[] [Sophisticated] investors know [a major down round] is fool’s gold.  They get a cheaper price, [] wipe out much founder stock value and [] reissue [founders] new options. [Founders] take the money []” except their incentives get eliminated.

[] He advises “[] us[ing] competition to [][ensure] a fair price [and] rais[ing] a slightly higher round than [] [otherwise for some strategic reserve]. [] [One wants] to show an uptick in valuation [] for new investor confidence and to maintain [early investor relations].”  Mark Suster  Why Startups Should Raise Money at the Top End of Normal,  June 5, 2011;  http://www.bothsidesofthetable.com/2011/06/05/why-startups-should-raise-money-at-the-top-end-of-normal/

Tips When Raising a Seed Round

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

When raising money in a seed round: “[] Take as much money as you can while keeping dilution between 15-30% (10%-20% of the dilution goes to investors and 5%-10% goes to the option pool).

Compare this to a Series A which might have 30%-55% dilution. (20%-40% of the dilution goes to investors and 10%-15% goes to the option pool.)

A seed round can pay for itself  if the quality of your investors and progress brings your eventual Series A dilution down from 55% to 30% (for the same amount of Series A cash).

Don’t over-optimize your dilution.  Raising money is often harder than you expect, especially for first-time entrepreneurs.”  Babak Nivi, Venture Hacks  How do we set the valuation for a seed round?  April 17, 2008;  http://venturehacks.com/topics/dilution

The Option Pool Lowers your Effective Valuation

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

“The option pool lowers your effective valuation.  Your investors offered you a[n] $8M pre-money valuation. What they really meant was, “We think your company is worth $6M. But let’s create $2M worth of new options, add that to the value of your company, and call their sum your $8M ‘pre-money valuation’”. [] Slipping the option pool in the pre-money lowers your effective valuation to $6M. The actual value of the company [] is $6M, not $8M. [] The [option ‘shuffle’] puts pre-money [valuation] into your investor’s pocket. [] the option pool only dilutes the common stockholders.  [] [The] investor’s norm is that the option pool goes in the pre-money.”   Nivi recommends using a specific hiring plan to more accurately determine option pool size vs. allocating some arbitrary percentage.  Babak Nivi  The Option Pool Shuffle  April 10, 2007;  http://venturehacks.com/articles/option-pool-shuffle

Investors Only Care About Returns & Control

Jason Mendelson venture capitalist and Managing Director Foundry Group

Generally investors only care about returns and control when making investments.

“[Entrepreneurs] should focus on terms like pre-money valuation, liquidation preferences, board of director elections, drag-along rights and protective provisions.   Most [other standard term sheet terms] aren’t really all that important.  [] Many of these terms have interdependencies and it’s important [to] understand how terms such as option pools, warrant grants and  the election of independent board members will affect returns and control.” Jason Mendelson, Do More Faster  by David Cohen & Brad Feld  copyrt 2011, Get Help with your Term Sheet  pg 238

Investors Require Employee Stock Options

Brad Feld venture capitalist and Managing Director Foundry Group

“Investors will almost always require that the company set aside additional shares for a stock option plan for employees. Investors will assume and require that these shares are set aside prior to the investment, thus diluting the founders.   If there are multiple investors, they must be treated as one in the calculations [].”  Brad Feld, Venture Capital Deal Algebra , July 7, 2004;   

http://www.feld.com/wp/archives/2004/07/venture-capital-deal-algebra.html

Relationship between Option Pool Size & Price

Jeffrey Bussgang  venture capitalist and General Partner Flybridge Capital Partners and former entrepreneur 

 “This relationship between option pool size and price isn’t always understood by entrepreneurs, but is well understood by VCs.”  Bussgang lost a deal because the founder believed he got a better price (higher pre-money valuation) from a competing venture capitalist.  However because Bussgang’s competitor required a larger option pool, the founder received less stock than under Bussgang’s offer.  The founder took the competitor’s deal because he didn’t understand how the option pool calculation affected his ownership.

“[In response, Bussgang’s firm instituted a policy] to talk about the “promote” for the founding team rather than just the “pre”[-money valuation].  The “promote” [] is the founding team’s ownership percentage multiplied by the post-money valuation.”  The “promote” offers an “apples-to-apples” comparison of competing offers even if one offer has a lower pre-money valuation and  smaller option pool.  Jeffrey Bussgang, Mastering the VC Game –A VC Insider Reveals How to get from Start-up to IPO on your terms book, pg 131-133, copyright 2010