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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?

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  • I assume this is beyond the fact that 10% of $20m is $2m?
    – Joe
    Jun 28 at 16:10
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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").

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  • Thanks for the explanation. Because the new option pool is created prior to the financing round, the extra shares created for the new option pool will dilute the value of the shares owned by founders and old option pool (on a fully diluated basis) reducing it from 20 million to 18 million. VCs don't take any hit.
    – scv
    Jun 30 at 2:59
  • Yes. A slightly different interpretation would be that the old option pool is not diluted, either. This fits with the statement that the combined option pools would comprise 20% of the pre-money. In this case, the post money would be: 5m for VCs, 2m for new option pool, 2m for old option pool and 16m for founders. Jun 30 at 16:03

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