Building an option pool is one of the smartest steps a startup can take to attract and retain high-impact talent. In today’s competitive market, cash compensation alone rarely keeps top specialists engaged – but equity does. When contributors share in your company’s upside, they’re not just employees or advisors; they’re stakeholders invested in your success. However, equity also introduces legal, governance, and dilution risks that can threaten your company’s control if not properly structured. This is where a well-designed option pool and strong legal documentation become essential. With the right approach, you can align incentives, safeguard control, and signal professionalism to investors – setting your startup on a sustainable path to growth.

What Is an Option Pool?

Put simply, an option pool is a slice of your company’s equity set aside for future grants. It’s how you reward people who help your business grow — employees, advisors, consultants, and other key contributors. While it’s often called an Employee Stock Option Pool (ESOP), it’s actually broader than that. You can use it to motivate anyone who plays a vital role in your project’s success.

The size of your option pool depends on your stage and hiring plans. Early-stage startups usually set aside 7–15% of total equity to stay flexible when bringing in top talent. Later-stage companies, with a more established team, often reduce that to around 5–10%.

Because your option pool directly affects the company’s ownership, investors, especially lead investors, often have clear expectations about its size. These terms should be carefully negotiated to keep everyone aligned. In most cases, a 10–15% pool hits the sweet spot: big enough to attract and reward top contributors, yet small enough to preserve meaningful ownership for founders and early backers.

Understanding the Purpose of an Option Pool

An Option Pool is more than just an HR tool — it’s a strategic edge for startups. Here’s how it helps you to move your business forward:

Talent Acquisition and Retention

Competing with big-company salaries is tough, but equity changes the game. An option pool lets you attract top talent by offering something money alone can’t — a real stake in your company’s future. When contributors share in your success — whether through an acquisition, IPO, or steady growth — they’re more likely to join early, stay longer, and stay motivated.

Securing Funding

A well-structured option pool sends the right message to investors. It shows that you’re serious about building a strong, committed team — one of the biggest drivers of long-term growth. It also signals foresight and smart planning, giving investors confidence that your company can scale sustainably.

Performance-Driven Culture

You can link option exercises to clear milestones or KPIs, ensuring contributors earn equity based on real impact. Combine that with well-designed vesting and lock-up terms, as discussed below, and you’ve got a structure that keeps people focused, committed, and aligned with your project’s long-term goals.

Compensating Smartly with Limited Cash

Option pools let you reward great performance without draining your cash reserves. For early-stage startups, this flexibility is huge — you can stay lean, conserve capital, and still offer competitive, meaningful incentives to your team.

So, by establishing an option pool, you gain a strategic advantage that, when structured and implemented correctly, can significantly contribute to your business long-term success.

Option Agreements: Must-Have Terms You Can’t Skip

A well-drafted and robust equity option agreement, which governs the terms of the option grant, its exercise, and issuance of shares is not the place to cut costs. Instead, it is a strategic investment in safeguarding your company from serious legal and corporate risks, preserving control in the hands of founders, as well as ensuring long-term commitment from contributors. Below are the essential terms that should be included in your equity option agreement:

Exercise Conditions and Performance Triggers

In addition to continued service and performance, the right to exercise options can be made conditional upon meeting specific milestones or KPIs. These should be clearly defined to ensure transparency and prevent disputes over whether they’ve been achieved. If no KPIs are set, options can instead be tied to trigger events such as an exit, financing round, or other corporate milestone. Otherwise, they usually become exercisable once the lock-up period ends and the relevant shares have vested.

Vesting Schedule: Time-Based, Milestone-Based, and Hybrid Vesting

Vesting encourages long-term commitment by allowing contributors to earn ownership gradually over time. There are three main vesting types:

• Time-Based Vesting: Most startups use a 1-year lock-up (cliff) before vesting begins to ensure contributors remain with the company for a minimum of 1 year before any shares accrue. After that, shares vest gradually, for example, monthly, quarterly, or other agreed schedule, over 3–4 years. Sometimes, a small portion of shares becomes exercisable after the cliff, while the rest continues vesting. This structure rewards loyalty and alignment over time.
• Milestone-Based Vesting: Shares accrue once specific goals are achieved, such as securing a partnership, reaching a revenue target, achieving a valuation milestone, etc. While less common than time-based vesting, it’s effective for tying rewards directly to measurable impact.
• Hybrid Vesting: A blended model where contributors must stay with the company for a set period and meet certain milestones before earning or exercising shares. This balances long-term engagement with performance-based results.

Shares Transfer Restrictions

Because option holders eventually become shareholders, it’s essential to prevent them from transferring shares in ways that could harm your business. For this reason, equity option agreements commonly include specific share transfer restrictions, such as a right of first refusal (ROFR), drag-along rights, and a purchase option in the event of an involuntary transfer.

These provisions help protect the company’s ownership structure, maintain control, and safeguard the interests of founders and existing shareholders:

• Right of First Refusal (ROFR). Each holder of a ROFR is entitled to purchase shares on the same terms as those offered to an external transferee or purchaser before their transfer. This prevents unwanted outsiders from acquiring an ownership stake in the company. A ROFR holder may be the company itself, founders, other shareholders, or all of them, whether in a predetermined order of priority or based on the actual shareholdings. For example, the company may exercise its ROFR first (in part or in full), followed by the founders, and then by other shareholders. After these rights have been exercised, the selling shareholder may transfer only the remaining shares, which were not purchased by the ROFR holders, on the same or less favourable terms, provided the company’s board of directors has approved such a transfer. It is, however, a common condition that all of the offered shares must be acquired pursuant to the ROFR procedures. The ROFR clause must be carefully drafted to clearly define the procedure and timing for exercising this right to ensure transparency and avoid potential disputes.
• Drag-Along Rights. They allow majority shareholders to require minority shareholders to participate in the sale of the company on the same terms and conditions. This approach ensures that a potential acquisition or merger is not blocked by small shareholders refusing to sell. It provides transaction certainty to purchasers, simplifies negotiations, and aligns all shareholders toward a successful exit. To be effective, the drag-along provision should clearly outline: (i) the percentage of shareholders required to trigger the clause (e.g., holders of a majority of shares); (ii) the obligation for minority shareholders to sell on identical financial terms; and (iii) the notice period and procedural steps for implementing the sale. Another best practice is to include a power of attorney that enables the company to proceed with the sale even if the minority shareholder is avoiding its obligations.
• Purchase Option on Involuntary Transfer. This approach protects the company from unwanted ownership changes due to involuntary events, such as bankruptcy, death, or creditor claims involving a shareholder. In such cases, the company itself, founders, other shareholders, or all of them, has the right to repurchase the affected shares, typically at fair market value or another predetermined price. This clause helps the company maintain control over its cap table, prevent shares from falling into unintended hands, and ensure that ownership remains with individuals who actively contribute to the company’s success.

It is crucial to ensure that each option holder is required to impose the above restrictions on any permitted transferee of their shares. This prevents the transfer of shares without maintaining the same protective terms. It is also important to clearly define when these restrictions terminate. Typically, such limitations cease to apply in the event of an IPO, sale of the business, or upon a waiver approved by the company’s board of directors.

Leaver Clauses: Protecting the Company and Founders

It is crucial to clearly define the terms governing share allocation and issuance in the event a contributor leaves the project, especially in “bad leaver” scenarios. This ensures that the company retains control over unexercised options and ongoing vesting. For example, the company may have the right to cancel an option if a contributor leaves before it becomes exercisable, or terminate further vesting or repurchase vested shares if the departure occurs after exercise.

Shareholders’ Agreement

When a company has several shareholders, it is advisable to execute a shareholders’ agreement to clearly define all key matters requiring shareholder decisions and to establish mechanisms for resolving potential deadlocks. This helps prevent delays or disruptions to important commercial and operational processes. The agreement may also address share transfer restrictions and other essential governance provisions.

Even if a shareholders’ agreement is not yet in place at the time of granting options, it is crucial to stipulate that the granting of options is conditional upon the contributor’s agreement to join the shareholders’ agreement, if any, upon exercising their options. This ensures consistency in shareholder rights and obligations as the company grows.

Tax Considerations

The tax treatment of the option grant, its exercise, and any subsequent sale of shares depends on several factors, including the type of option granted, the applicable laws and regulations of the relevant jurisdiction, and the individual tax status of the option holder.

Therefore, this matter should be assessed individually in each specific case. In all circumstances, an equity option agreement should clearly state that both the company (as the option issuer) and each option holder are solely responsible for their own tax obligations arising from the grant, vesting, exercise, or disposal of options or shares. It is also advisable to include an indemnity clause requiring option holders to protect and compensate the company for any damages, losses, or claims (including those from tax authorities) related to their personal tax obligations.

Furthermore, an equity option agreement should expressly provide the company with a withholding right, allowing it to deduct or withhold from the shares issuable under the option a number of shares whose fair market value is sufficient to satisfy any applicable tax withholding requirements under relevant laws.

The Option Pool Checklist: A Practical, Do-This-Next Guide

If you’ve decided to create an option pool, here’s a straightforward checklist of key steps to cover. It’s not exhaustive, but it includes the essentials every founder should think through:

• Decide on the Option Pool Size: Decide what percentage of your company’s equity will be reserved for future grants. If you have lead investors, check whether they have specific requirements or expectations for the pool size. Aligning on this early simplifies negotiations and helps secure funding faster.
• Get the Required Approvals: Typically, corporate laws and company’s constitutional documents require approval from the board of directors and, in some cases, from shareholders to make the option issuance valid. Always ensure these approvals are properly obtained and documented.
• Ensure Your Authorised Capital is Sufficient: Remember the difference between issued and authorised share capital: issued shares are already in circulation, while authorised capital is the total number of shares your company may ever issue. Increasing authorised capital usually requires shareholder approval, so make sure it’s high enough to cover both your option pool and any upcoming fundraising. It’s easier to get this approved early – before you have many shareholders to coordinate.
• Create and Maintain the Up-to-Date Cap Table: A clear, accurate cap table ensures transparency and helps track existing shareholders, shares reserved for future grants, and investor holdings. Keep it updated regularly. Major investors will likely request to review it to assess your company’s structure before investing.
• Use Tailored, Legally Sound Option Agreements: Skip the one-size-fits-all templates. A robust equity option agreement should fit your company’s structure, comply with applicable laws, and reflect your strategic goals. It’s worth the investment to get this right — a poorly drafted agreement can cause serious issues later.
• Establish a Proper Vesting and Leaver Clauses: Define clear vesting and leaver terms to motivate contributors while protecting the company in cases of early departures or “bad leaver” scenarios. This helps prevent disputes and keeps your equity distribution clean and fair.
• Communicate Clearly with Contributors: Equity can be confusing, especially for people new to startups. Walk your contributors through how their options work: when and how they become exercisable for shares, how shares vest, and what happens in different scenarios (leaving, M&A, etc.). Clarity builds trust and long-term commitment.

Final Thoughts: Structuring Equity That Builds Commitment

A properly designed option pool does far more than distribute shares — it defines your company’s culture, incentives, and long-term alignment. By structuring it early and correctly, you not only motivate your team but also strengthen investor trust and protect your equity position. At Aurum, we help founders navigate every aspect of this process — from planning pool size and securing approvals to drafting compliant agreements and managing tax implications — so you can focus on what truly matters: building your business and rewarding those who help it grow.