The Option Pool Shuffle: A Founder's Guide to a Key Term Sheet Negotiation
Takeaway: The "option pool shuffle" is the standard practice of including the new employee option pool in the pre-money valuation, a subtle but critical term sheet maneuver that can significantly dilute founders and must be fully understood and negotiated.
As you negotiate your Series A term sheet, you will focus intensely on the headline number: the pre-money valuation. But there is another, more subtle term that has a direct and often surprising impact on that valuation: the size and accounting of the new employee stock option pool. The standard way this is handled in a venture capital term sheet is a maneuver known as the "option pool shuffle," and it is one of the most important and least understood drivers of founder dilution.
Understanding the math behind this shuffle is critical. It is a key point of negotiation, and a failure to grasp its impact means you are not getting the valuation you think you are.
What is the Option Pool Shuffle?
The shuffle is a simple but powerful accounting move. The term sheet will state that the "pre-money valuation includes a newly created and unallocated employee stock option pool representing X% of the post-financing capitalization."
This sounds innocuous, but the key phrase is "included in the pre-money." This means that the dilution from creating the new pool of options for future employees is borne entirely by the founders and any existing seed investors. The new Series A investors are insulated from this specific dilution.
The Math: How the Shuffle Works
Let's walk through a simple example.
Your Company's Current State:
Founders own 9,000,000 shares.
There are 1,000,000 shares in the existing option pool.
Total Pre-Financing Shares: 10,000,000
The Term Sheet:
Pre-Money Valuation: $10,000,000
Investment Amount: $5,000,000
New Option Pool: To be increased to equal 20% of the post-financing capitalization.
Without the Shuffle (The Intuitive but Incorrect Math): A founder might think the price per share is $1.00 ($10M valuation / 10M shares). This is wrong.
With the Shuffle (The Real Math): The price per share is not calculated until after the new option pool is created. The math is more complex, but the result is that to make room for the new, larger option pool, the number of pre-money shares has to be increased. This lowers the price per share for the new investors and increases the dilution for the existing stockholders.
In this scenario, the effective, true pre-money valuation for the founders is not $10 million. It is closer to $7 million, because a portion of that headline valuation is being immediately allocated to the option pool that dilutes them.
How to Negotiate It
Negotiate the Pool Size: This is your primary lever. The investor will want a large pool (e.g., 20%) to ensure the company has enough equity to make all its key hires before the next financing. You should create a detailed, bottoms-up hiring plan and argue for a smaller, more realistic pool size (e.g., 10-12%) that is sufficient to meet your hiring needs for the next 12-18 months.
Understand the Trade-Off: A lower option pool means a higher effective valuation and less dilution for you.
The option pool shuffle is a standard part of the venture capital landscape. By understanding the math and coming to the negotiation with a credible, data-driven hiring plan, you can negotiate this key term from a position of strength and secure a deal that is fair to you, your team, and your new partners.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.