Option Pool - Explained
What is an Option Pool?
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What is an Option Pool?
Startups use an Option Pool to set aside stock (or other equity-related securities, such as options) to compensate and incentivize key employees of the company. In reality, it is just a percentage of company ownership that is allocated for this purpose. When these shares are later issued to employees, it does not affect the ownership percentages of existing owners (i.e., nobody is being diluted when these shares are issued or committed to employees).
How an Option Pool is Used
Generally, a startup will create an option pool when it is going through a round of inventor financing. The investors will demand a specific percentage of company ownership in exchange for their investment. They will also demand that the company set aside shares in an option pool. The typical size is between 15-25% of total authorized shares. Whenever the startup hires a key employee who demands an ownership percentage in the company as compensation, this ownership percentage is drawn from the option pool. Investors realize that any time that a company issues additional shares, it will reduce that investors percentage of ownership in the company. This is known as dilution. To combat this, the investors demand the creation of the option pool. Setting up the option pool will affect the total outstanding shares of the company. As such, it will affect the price per share, as the price per share is based upon the total value of the company divided by the number of outstanding shares. The option pool will be accounted for in the capitalization table or Cap Table.
It is worth noting that ownership of the shares in the option pool are rarely directly issued to employees. Generally, these shares are subject to vesting over time. This means that the employee does not become the full owner of these shares until a specific amount of time or specific company milestones are accomplished. Once this time has passed or milestones are accomplished, the shareholder becomes owners of the shares.
Academic Research on Option Pool
- Forward, option and spot markets in the UK Power Pool, Hunt, S., & Shuttleworth, G. (1993). Utilities Policy, 3(1), 2-8. This academic paper reviews the set of Parallel markets, spot, option and forward in England and Wale and it is titled New Pool In England and Wales. It figures out area where pool may be further harness via creation of a conceptual framework of the pool.
- Option prices as predictors of equilibrium stock prices, Manaster, S., & Rendleman Jr, R. J. (1982). The Journal of Finance, 37(4), 1043-1057. This academic paper set to review the Black-Scholes pricing model options integrated with modified dividend payments to derive jointly implies stock prices and implied standard deviations. Information regarding equilibrium stocks prices were reveal when a comparative study were done on implied stock prices and observed stocks prices, this studies open up the pose that stock prices were not fully reflected in observed stock prices. The consequence of these observation was discussed in details.
- Financialisation and the coupon pool, Froud, J., Johal, S., & Williams, K. (2002). Capital & Class, 26(3), 119-151. This studies elucidate readers horizon on the function of capital markets further understanding was also dung out on modern practice of capitalism. The research was commenced by first examined already set terms which include corporate governance, shareholder value and fiancialization, afterward new suggestion was made for new terms which is coupon pool capitalism. Another term this research focused on is to demonstrate coupon pool ideology ideally focus on generation of contradictions and instabilities which was not the focus of other terms. Evidences which are empirical were used to explore and later support this dynamic.
- Option implied risk aversion estimates, Bliss, R. R., & Panigirtzoglou, N. (2004). The journal of finance, 59(1), 407-446. This research is centered around obtaining measure of risk aversion implied in option prices using utility function to maneuver risk-neutral PDF that was integrated with cross sections options.
- The informational role of stock and option volume, Chan, K., Chung, Y. P., & Fong, W. M. (2002). The Review of Financial Studies, 15(4), 1049-1075. This research demonstrated that investors that are well informed always start the chain of trades in stock market but this will not be applicable in the option market. This research was a derived from the intraday interdependence of order flows and price movements for actively traded NYSE stocks and their Chicago Board Options Exchange (CBOE)-traded options.
- Option volume and stock prices: Evidence on where informed traders trade, Easley, D., O'hara, M., & Srinivas, P. S. (1998). The Journal of Finance, 53(2), 431-465. This paper review the role information plays in transaction volume in option markets. And it was derived that both positive and negative option holds information about future stock prices.
- Share of Local Governments in the Union Divisible Pool: An Option Before the 13th Finance Commission, Alok, V. N. (2009). Indian Journal of Public Administration, 55(1), 71-95.
- Islamic Finance: an efficient and equitable option, Al-Jarhi, M. A. (2002). Islamic research and training institute, Islamic development Bank. This paper divulges its search light to answer the following questions; Why all the fuss about the rate of interest? Is Islamic finance, as an alternative to interest based debt finance viable and efficient? What Islamic finance implies for the whole economy? Given that Islamic finance is really viable, why it has not been adopted at a larger scale? Detailed information was provided on each of the research topic.
- Mortgage terminations and pool characteristics: some additional evidence, Heuson, A. J. (1988). Journal of Financial Research, 11(2), 143-152. This research is centered to know the distinct features of default behaviors in Korean housing and Housing finances markets and of course features of mortgage prepayment.
- Unobservable heterogeneity and rational learning: Pool-specific versus generic mortgage-backed security prices, Stanton, R. H. (1996). The Journal of Real Estate Finance and Economics, 12(3), 243-263. This research look at proffering a solution to methods that will be deploy for using information gotten from pool on its prepayment behavior over time to calculate pool specific mortgage-backed security policies.