Equity Incentives and Option Pool
AI companies cannot match big-tech cash, so equity fills the gap. Design it wrong and the cost exceeds cash — dilution without a reserved pool, worthless options from a careless strike price.
Equity incentives are not a grant — they are three conditions at once
Competition among AI companies is a competition in talent density. Cash cannot match large platforms, so equity is the only tool that closes the gap. The hard part is not how much to grant, but making three things true at the same time: the company can afford it, the employee can actually realise it, and the investor accepts it.
Break any one of them and the incentive turns into a liability. With no pool reserved, the investor demands one at the next round and every founder is diluted pro rata — effectively paying salaries with founder shares. Price the option at the latest valuation and employees see a paper loss the day they exercise. Leave out repurchase terms and departed employees hold shares outside the cap table, which diligence will require you to clean up with no negotiating leverage.
What we do
- Instrument selection: options, restricted shares, phantom equity, limited partnership holding platforms — matched to stage and recipient
- Pool design: size, which entity holds the pool, who bears dilution, how it is topped up at each round
- Documentation set: incentive plan, grant agreement, exercise notice, repurchase agreement, partnership deed
- Exercise and repurchase rules: strike price, vesting schedule (4 years / 1-year cliff), leaver triggers and pricing formula
- Tax structuring: individual income tax at exercise, deferred tax filing, tax burden modelling for the holding platform
Typical situations
Situation 1: No pool reserved, dilution forced at financing
Equity is fully allocated at incorporation. The Series A investor requires a 15% option pool. The only way to create it is pro rata dilution of all existing shareholders — the founder drops from 45% to 38%, a dilution that was avoidable at setup.
Our approach: reserve 15%-20% at incorporation and reflect it in the articles and investment agreements, so later rounds adjust the pool rather than founder holdings.
Situation 2: A key employee leaves and the shares cannot be recovered
A core technical lead holds 8% and resigns after 14 months. The agreement says shares “shall be transferred” on departure but is silent on price, transferee and consequences. The individual demands the latest valuation; the company cannot pay; the equity sits in limbo.
Our approach: lock three mechanics into the grant agreement — unvested shares lapse automatically, vested shares are repurchased at a defined formula, and failure to cooperate triggers a penalty plus an irrevocable transfer authorisation.
Situation 3: Strike price set too high, the incentive becomes a liability
Options granted after Series B are priced close to fair value. Two years later valuations correct and the strike exceeds company value — the options are worthless and team trust is damaged.
Our approach: price at fair value at grant, and keep restricted shares or phantom equity available as alternative instruments for later senior hires so a single tool does not fail with the cycle.
Process and deliverables
| Stage | Work | Deliverables |
|---|---|---|
| 1 | Recipient mapping, instrument selection, pool modelling | Incentive framework + pool model |
| 2 | Holding platform setup, partnership deed, registration | Platform documents + filing materials |
| 3 | Grant agreements, exercise and repurchase terms | Grant agreement + exercise notice + repurchase agreement |
| 4 | Tax structuring and deferred tax filing | Tax model + filing package |
| Ongoing | Pool adjustment each round, leaver settlements | Pool adjustment plan + exit settlement documents |
Frequently asked
Where should the pool sit? Domestic structures usually hold it through a limited partnership with the founder as GP to retain voting control. With an offshore structure the pool typically sits at the Cayman or BVI level and must be designed in step with the financing timetable.
Options or restricted shares? Restricted shares for the early core team (stronger lock-in, clearer tax timing); options for later hires (optional exercise, controlled cost). The two can coexist by cohort.
How should the strike price be set? At fair value on the grant date — early stage typically at nominal registered capital, later at a discount to the last round. Too low invites diligence challenges; too high kills the incentive.
Must vested shares be repurchased when someone leaves? Not necessarily. A “company may but is not obliged to repurchase” clause with a clear pricing formula and exercise window is common. What matters is deciding before departure, not at the exit conversation.
Legal basis
- Company Law (2024 revision): share transfers, shareholder rights, charter autonomy
- Partnership Enterprise Law: governance and withdrawal in limited partnerships
- Labour Contract Law: boundary between incentive arrangements and employment
- Caishui [2016] No. 101: conditions for deferred tax treatment of equity incentives
- Individual Income Tax Law: distinction between property transfer income and salary income