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Option pools contain shares that a company plans to distribute to employees, shareholders, or other parties. They can complicate IPO pricing by diluting shareholder capital, but are useful for small businesses and can deter hostile takeovers. Option contracts may lose value over time, so some prefer cash or bond payments.
An option pool contains corporate shares that the directors of a company intend to distribute to employees, shareholders, or other parties at a future date. Many companies use option pools as a tool to keep startup costs down, while investors often use pools to lower the price of corporate shares during the initial public offering (IPO). In many cases, shares within an option pool are vested in long-term employees or given to retired workers as an alternative to cash pensions.
Before a company can go public, investment bankers must establish the entity’s market value. This process involves calculating the total value of the company’s tangible and intangible assets and subtracting the company’s liabilities. Thereafter, these bankers try to persuade investors to buy shares in the company and the capital infusions from these people increase the value of the company. Including an option pool in the equation complicates IPO pricing because creating the pool dilutes shareholder capital.
If 20 percent of a company’s shares are held in an option pool, then shareholders only own 80 percent of the company’s shares. Options are usually included in the equation before capital infusions. This means that while the company is technically valued at a price, investors only have to invest an amount of capital in the company equal to the difference between the declared value of the company and the market value of the shares being sold. They keep on the pool option. If the shares were put into the option pool after the investors’ cash infusion, then the investors would have to invest more money in the company because they would have to invest a sum of money that equals the real value of the company.
Options are a useful tool for small but growing businesses because such businesses have unlimited growth potential. These companies may offer stock options to new employees as an alternative to cash sign-on bonuses, and employees are often willing to accept such offers because the shares are potentially more valuable than a lump sum of cash. In addition, options make it more difficult for a rival company to complete a hostile takeover of a company, since fewer shares are available on the open market.
Stocks are only valuable while a company remains solvent and these securities drop in value when a company performs poorly. Securities in option pools may lose value over time, as the market value of these securities is tied to the current value of publicly available shares. Consequently, conservative people are often more inclined to accept cash and bond payments rather than option contracts.
Smart Asset.
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