Start-up Valuation with employee option pool

Question

I am reading Venture Deals 4th edition and I came across the following statement in a chapter on economic terms of the deal:

Consider $5 million investment at $20 million pre-money valuation. Assume that you have an existing option pool that has options representing 10% of the outstanding stock reserved and unissued. The VCs suggest that they want to see a 20% option pool. In this case, the extra 10% will come out of the pre-money valuation, resulting in an effective pre-money valuation of $18 million.

I don't understand how expanding option pool prior to investing round will reduce the pre-money valuation from 20 to 18. Can someone help me with the math?

Orange Coast- reinstate Monica · Accepted Answer

an effective pre-money valuation of $18 million

This seems to be referring to the founders' and current employees' point of view.
Before the deal: Founders own 90% and the old option pool owns 10% of the company. These existing shareholders and option-holders would represent a pre-money value of $20 million, if they could complete the deal without a new option pool.
The VCs then convince them to include a new option pool.
After the deal, pre-money: New option pool gets 10% of the pre-money portion. That leaves 90%, or $18 million, for the founders and old option pool.
After the deal, post-money: Of the $25 million post-money company, the VCs own $5 million, new option pool owns $2 million, old option pool owns $1.8 million (10% of the "effective pre-money valuation of $18 million"), and the founders own the remainder ($16.2 million, or 90% of the "effective pre-money").

Start-up Valuation with employee option pool

One Answer

Add your own answers!

Ask a Question