The price per share of the Series A preferred stock – the first significant round of venture capital financing – is equal to the pre-money valuation of the company divided by the number of fully-diluted pre-money shares.
Per share price = pre-money valuation/fully-diluted pre-money shares
Being on a fully-diluted basis means that the total numbers of shares includes all outstanding common and preferred stock, plus all outstanding options, warrants and other convertible securities, as if converted into common stock and any shares reserved for issuance under the company’s equity incentive plans (the option pool). This has the effect of making common stockholder assume the diluting effect of the unexercised and unissued options.
As evident from the formula above, there are two ways to effect a startup’s Series A per share price: change the valuation or change the number of fully-diluted pre-money shares. Arguing for a change in valuation is difficult, but one thing startups can do to increase the share price is to decrease the size of the option pool.
VCs will almost always insist that a pool of options be set aside for future hires and to retain existing employees. The option pool will often be included in the fully-diluted pre-money shares, which has the effect of reducing the Series A per price share. Companies should try to create the smallest option pool possible and sometimes can rightfully argue the pool doesn’t need to be as large as requested by the Series A investors. As a general rule of thumb, the option pool needs to be big enough to make necessary hires through the next round of financing, or, if the company doesn’t expect another round of financing, a time period such as 12 to 18 months.
